Rising interest rates steer some clients away from fixed annuities

Jun 5, 2006 @ 12:01 am

By Gary S. Mogel

NEW YORK - Steadily rising interest rates and a flattening yield curve are causing some types of fixed annuities to lose sales steam, according to industry observers.

Meanwhile, certificates of deposit, universal life insurance and rate-sensitive mutual funds are among the products benefiting from higher rates.

Fixed-annuity sales were $16.8 billion in the first quarter, down 7.4% from the amount during the year-earlier period, according to a study released last month by Beacon Research Publications Inc. in Evanston, Ill.

"The flattening yield curve - with one-year and 10-year Treasury rates converging - was the main reason for the drop in fixed-annuity sales," said Jeremy Alexander, chief executive of Beacon Research.

When CD and fixed-annuity rates are comparable, it often doesn't make sense to tie up money for the longer period usually required by fixed annuities to obtain the same rate, according to Michael White, president of a Radnor, Pa., consulting firm bearing his name.

Lagging CDs

Last week, three-year-CD rates were about 5% - higher than rates paid by many fixed annuities. Fixed-annuity rates tend to lag those of CDs, which are adjusted daily, Mr. Alexander noted.

"Clients that purely shop price might prefer short-term CDs, but those that focus on the fundamental benefits of fixed annuities might not," said Doug Mantelli, vice president of marketing strategies for fixed annuities at Jackson National Life Distributors Inc. in Denver. Those benefits include tax deferral, death benefits and retirement income options, he added.

Fixed annuities can become attractive as interest rates rise if a maturity laddering strategy - similar to bond laddering - is used, according to Mr. Alexander.

Also, once the taxes are taken off the CD returns, the tax-deferred fixed annuities start looking much better, said Gary Chard, senior financial representative for The Principal Financial Group Inc. of Des Moines, Iowa.

Insurance products with equity market participation, guarantees and downside protection are also gaining ground in the rising-rate environment.

For instance, universal-life policies with no-lapse features guaranteeing a certain level of death benefits - even if the subaccount investment balance goes to zero - are becoming more popular.

"I think there's still a lot of room to go up with interest rates - about three more points in the federal funds rate - before we'll see a trend away from universal life and back to guaranteed rates," said Ray Trueblood, vice president of life insurance marketing strategy for Jackson National.

Variable annuities are benefiting from higher rates because of their income guarantees; however, much of the activity involves 1035 exchanges to obtain the guarantees, rather than new sales.

Money tends to flow from fixed into variable annuities as equity markets rise, and vice versa when the markets fall, said Mr. Alexander.

Other investments

An equity index annuity - a type of fixed annuity tied to the performance of a stock index - can become more attractive as interest rates rise, if the insurer responds by raising the upside caps and crediting rates, according to Mr. Mantelli.

Advisers who don't like recommending annuities and insurance products as investments increasingly are using bank loan funds such as prime-rate funds - mutual funds that invest in interest-rate-adjustable loans. They are also gravitating to floating-income funds, which invest in short-term fixed-income securities.

The advisers say that these types of funds - currently returning about 6% to 7.5% - are superior to Treasury inflation-protected securities because the funds can react to the expectation of inflation, while TIPS react only to inflation that actually occurs.

"My clients haven't been interested in TIPS, because the yields aren't all that attractive," said Mr. Chard.


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