Harsh economic realities have led insurers to get stingy with returns and benefits on annuities, but financial advisers think that there still is a place for these products in clients' portfolios.
Ever since the 2008 crisis, slumping interest rates and rampant volatility in the equity markets have wrought havoc on life insurers, raising the cost of hedging for variable annuities with living benefits and reducing rates of return on fixed annuities.
As a result, variable annuities this year are more likely to have limited investment menus and use portfolios that “self-hedge” against market risk. Guaranteed living benefits, which provide income or withdrawals over a lifetime, have also been ratcheted down to 5%, from levels as high as 7% just before the crisis.
By comparison, fixed annuities, including fixed indexed annuities, are growing, but at a slower pace. They are casualties of the lengthy low-interest-rate environment, which has hurt life insurers' returns on fixed-income investments and lowered the amount that carriers can credit toward the annuities.
DEMAND STILL STRONG
But changes aside, consumer demand still is strong. Net VA sales, which exclude transfers into variable annuities, were $27.7 billion last year, up 28% from 2010, according to Morningstar Inc.
Meanwhile, fixed-annuity sales last year were $75.6 billion, down 1.1% from a year earlier, according to Beacon Research Publications Inc.
“Annuities create ballast in the clients' account,” said Michael R. Suttle, a financial adviser at Suttle Financial Group. “They're like the keel on a boat; they keep you from going too far over to one side.”
Advisers and clients are finding that the products may be less generous but still are valuable. In the case of variable annuities, the emphasis is falling on income protection and tax deferral.
Meanwhile, fixed annuities still are providing attractive returns, at least when compared with certificates of deposit.
Advisers who use variable annuities are finding that the conversation with clients has changed to securing an income stream that clients can count on, from generating as much alpha as possible. As a result, having unlimited access to the most aggressive subaccount options is taking a back seat.
PROTECTING INCOME
Some advisers are willing to put up with restrictions on investments, as long as the income features are attractive enough.
“The risks to retirees' capital are as great as they've ever been, so to have that protection for the income is key,” said Susan Moore, founder and president of Moore Wealth Management.
Her tool kit includes guaranteed-minimum-income benefits from MetLife Inc.'s GMIB Max III, which provides a 5% growth rate to the benefit base and 5% income withdrawals, and Axa Equitable Life Insurance Co.'s Accumulator 11, which offers a 5.5% compounded annual growth rate.
Products that foster “stacking and resetting” — the opportunity to build the income benefit base through strong market performance, lock-ins at market level highs and compounded growth — are especially valuable.
“Because of stacking and resetting, we were able to get two good years of outperformance from 2006 to ... 2008,” Ms. Moore said. “The guarantee of the income for life in a treacherous environment for the next five years and the ability to protect against inflation are huge.”
Some insurers are banking on advisers' looking at variable annuities as a tax shelter, as opposed to seeing them as an income vehicle.
For instance, Jackson National Life Insurance Co. recently released Elite Access, a variable annuity that emphasizes investments in alternative assets but doesn't provide any living benefits. The Jefferson National Life Insurance Co. also employs the same investment philosophy, targeting fee-only advisers with a flat fee for the VA.
David D'Amico, president of Braver Wealth Management, prefers to manage the holdings within a VA actively to hedge against risk tied to traditional equities and fixed income. He uses a tactical strategy to take advantage of the structure of VAs, which permits trading without adverse tax consequences.
“You pay a small fee per year, and you're just sheltering from taxes and letting your money grow, maximizing your estate over time,” Mr. D'Amico said. “We're talking these up to our ultrahigh-net worth clients.”
Meanwhile, other advisers concentrate on exposure to alternatives within the VA to act as a diversifier against other assets a client may hold. “We use it purely for alternative asset exposure,” Tyler Denholm, director of investment research at ValMark Securities Inc., said of Jackson's Elite Access VA. “The benefit for the small client with only a $100,000 account is that they can put a percentage of those assets into alternatives, and the other benefit is the tax deferral.”
On the fixed- and indexed-annuity side, advisers are aware that reduced crediting rates to annuities make them look less attractive, but they still do well against safe-money options, such as certificates of deposit.
“Rates are lower, but it's all relative,” Mr. Suttle said. “Can you find a CD with a 1% rate of return?”
When shopping for fixed in-dexed annuities, Mr. Suttle prefers using companies with consistent cap rates — which set a ceiling on the amount of gains a client can capture — as opposed to going for insurers that may start their cap rates high but cut them later, curbing returns for the client.
“We're not rate chasers; I would take a 3% or 3.5% cap now and know that that's going to be the cap going forward,” Mr. Suttle said. “We like consistency. If you see a 5% cap rate now, the insurer probably won't keep that rate, because they can't maintain the integrity of their portfolio.”
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