But rightly so, insurance companies offering annuities are scaling back and emphasizing stability first. This Wall Street journal article gives more details:
When variable annuities with income guarantees were selling strongly several years ago, insurance companies competed in offering long lists of investment choices within these retirement-savings vehicles. Emerging markets, commodities, small stocks, funds run by star stock pickers—you name it.
Now, those multipage menus are out, sometimes replaced by fewer than a handful of investment choices.
Why the abbreviated selection? When markets tanked world-wide in 2007-09, minimum-income guarantees suddenly were a lot more valuable to investors—and costly to the issuers. Some insurers quit selling the guarantees, and others boosted prices and offered less generous terms. Insurers are also limiting the likelihood of taking big hits from these guarantees by requiring annuity investors to hold a fairly conservative mix of stocks and other assets—as opposed to, for example, letting someone put 100% of the account balance in technology stocks or emerging-markets shares.
The insurers have a new buzz phrase: reduced volatility. How this will all play out is yet to be determined, but sales have been strong for several of the new-style offerings, and industry consultants see it as the wave of the future.
Insurers are taking several different approaches. Giant MetLife Inc. has a new offering with just four multiasset fund choices. Called Protected Growth Strategies, these funds are aimed at guarding against “extreme market swings” and providing “more consistent returns over time,” the marketing material says, adding: “Although you may have less risk from market downturns, you may also have less opportunity to benefit from market gains.”
Hartford Financial Services Group Inc. is selling a guarantee under which half of the customer’s money goes into funds from a menu and the rest goes into a fund that Hartford uses to mitigate the risk of the overall account. That fund holds stocks, bonds, futures, options and cash, in levels depending on the managers’ view of market conditions.
AXA SA’s AXA Equitable Life Insurance Co., meanwhile, requires consumers to either put at least 40% of their money into bond funds and the remainder into a small lineup of funds, or invest in Strategic Allocation portfolios. Among other features, in periods of high stock-market volatility these portfolios use index futures to mitigate their exposure to stocks.
The general concept behind all these offerings is that if buyers’ accounts lose less, there’s a shallower hole to climb out of when markets rally. Many insurers contend there is no alternative to this new approach, because the 2007-09 financial crisis revealed how risky the guarantees are for their own financial health when tethered to funds that can rise and fall spectacularly.
“Can you have your cake and eat it, too?” Suneet Kamath, a stock analyst at Sanford C. Bernstein, asks about consumers’ expectations for annuities with income guarantees. In a growing number of products, the answer is, “if you want the guarantee with its sleep-at-night protection, you have to give something up,” he says, and that something is complete control over how the money will be invested.
Still, brokerage-firm executives say this new and largely untested approach to variable annuities runs the risk of turning off some advisers who previously were big advocates of the pricey products. And they are expensive: The annual fees on variable annuities, including the guarantee, typically total about 3.5% of the invested amount—a serious drag on performance.
In simple terms, variable annuities are a tax-advantaged form of investing in funds. The minimum-income guarantee is available for an added annual fee, typically at least 1% of the account balance. Rules vary, but in general the guarantees promise lifetime income of a specified minimum amount per year.
To determine the amount of guaranteed income, customers must keep track of two account balances. One is the actual balance. The other is a “benefit base.” The two balances start out the same. The actual balance rises and falls with the fortunes of the annuity’s investments. The benefit base, meanwhile, typically rises by a specified minimum amount—5% a year after fees is common now, down from 7% before the crisis.
In many instances, the base also “steps up,” or resets, to incorporate investment gains in the underlying funds, if the account balance enjoys strong gains and is higher than the benefit base. The benefit base never declines.
Owners can withdraw money based on either the actual balance or the benefit base.
If they withdraw based on the actual balance, they can take whatever amount they want, whenever they want. But guaranteed income must be pegged to the benefit base and must be withdrawn in annual amounts that depend on when the owner starts taking payments. Typically, people who are in their mid 60s when beginning withdrawals and who choose guaranteed income receive 5% of the benefit base per year for life.
What’s the Attraction?
So why would consumers want an annuity that sacrifices potential big gains to limit potential losses when they are paying for a guarantee to protect against market declines?
One answer is that many consumers want their benefit base to step up to the actual account value as often as possible, and this becomes less likely once the underlying funds suffer big losses and the account balance lags behind the benefit base.
In addition, while the presence of a guarantee may help people sleep at night, the fact that lump-sum withdrawals can’t be made from the benefit base means that a healthy actual balance at retirement gives investors more options.
And for people who value predictability, “these options are still more attractive than short-term fixed-income investments in this low-interest-rate environment,” says Mark Cortazzo, a senior partner with financial-advisory firm Macro Consulting Group in Parsipanny, N.J. He advises such investors to focus on annuities that allow them to shut down the account without penalty in four years or less, so that if interest rates rise they can move their money to higher-yielding bonds at that point.
Prudential Financial Inc. has been one of the boldest pioneers in this area. Before the latest financial crisis, it launched what was then considered an oddity: a variable annuity that uses a proprietary computer algorithm to move customers’ money between stock funds and fixed-income investments, based on market events. As much as 90% of customers’ money can end up in fixed-income holdings in stressful times.
The product became a top seller after the 2007-09 market slide, which Prudential executives say is in large part because the design—by protecting the insurer—allows it to offer one of the most generous guarantees on the market. It steps up the benefit base every day that investment gains in the account push it above the base; many other products step up just once a year if the account balance on that date exceeds the benefit base, meaning that gains during the year that are lost in a market downturn before the contract’s anniversary date won’t be incorporated.
Allianz SE’s Allianz Life Insurance Co. of North America, meanwhile, is among several insurers not just winnowing down the fund menu for new customers, but also exercising what they say are contractual rights to restrict access to risky stock funds in offerings sold years ago. Earlier this year, Allianz closed more than half of the funds in two older offerings to new investment and transfers from other funds in the product.
The restrictions infuriated some financial advisers who put clients into the contracts in part because they could move clients in and out of various high-flying options. Jasmine Jirele, an Allianz Life vice president, says many insurers are “making changes they didn’t anticipate because of the highly volatile market we are experiencing.” The company says complaint volume has been low.