Sour economy drives sales boom

Sales could top $65 billion this year, up from last year’s record $53 billion, as shell-shocked investors seek conservative investments.

Unlike variable annuities – whose value changes according to the performance of the selected investment options – fixed annuities earn a stated return called a “crediting rate” that is either guaranteed for a period of time or reset periodically.

And the returns aren’t bad.

Insurance agents and brokers market fixed annuities as a higher-yielding alternative to bank certificates of deposit, which currently pay at most 4.68% for five years, versus 6% for top-yielding fixed annuities with a five-year rate guarantee.

Booming

Fixed-annuity sales reached $32.5 billion through the first half, up 22% over the period last year.

Meanwhile, variable-annuity sales fell 21% to $57.8 billion through this year’s first half, according to LIMRA International, a life insurance industry trade group in Windsor, Conn.

The resurgence in fixed annuities is welcome news for insurers such as American International Group Inc. in New York. AIG’s newly acquired American General unit is the biggest seller of fixed annuities through banks.

But while fixed-annuity sales will help offset declining fee revenues from lower variable-annuity sales and asset levels, they won’t totally replace those lost profits, says analyst Jeffrey Hopson, a vice president with A.G. Edwards Inc. in St. Louis.

While fixed-annuity sales are expected to grow by more than $10 billion this year, that doesn’t compensate for the $20 billion or so decline seen for variable annuities.

Adding to insurers’ headaches, fixed annuities generate lower returns for insurers and require them to reserve more capital to ensure repayment.

On average, insurers price fixed annuities to generate an 11% to 12% return on equity, compared with 13% for variable annuities, says John Fenton, a principal with insurance consultant and actuary Tillinghast-Towers Perrin in Atlanta.

Some financial advisers suggest that fixed annuities make sense for investors who are determined to stay out of the stock market, or those who are convinced that interest rates will continue to decline, and want to lock in current five- or 10-year rates.

However, Glenn Daily, a fee-only insurance adviser in New York, says that investors are overlooking another attractive option: Series I savings bonds, which currently pay a 6% effective annual yield.

“I bonds are tax deferred, exempt from state and local income taxes, and carry a very small, 1.5%, surrender charge that disappears after five years,” says Mr. Daily.

“They are backed by the full faith and credit of the U.S. government, and there is no hanky-panky with renewal [crediting] rates, so you know what you are getting,” he adds. (For more information on I bonds, go to savingsbonds.gov.)

However, an annuity can also make sense for investors stuck in a poor-performing cash-value life insurance policy that is worth less than its cost basis.

An investor could exchange into a fixed or variable annuity and use the excess cost basis to shelter future earnings on the annuity.

For example, if you paid $50,000 into a universal life policy that now has a cash value of $10,000, you could roll the $10,000 into an annuity through a Section 1035 exchange. That would allow you to shelter $40,000 of future investment earnings.

“It’s like a Roth IRA,” says Mr. Daily. “You’re foolish not to do it.”

Mr. Daily also cautions against buying fixed annuities with non-guaranteed rates of return.

He calculates that the odds of a non-guaranteed-rate fixed annuity remaining among the top quartile of performers after five years are less than 50%.

Related Topics: Annuities