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Picking The Safest Annuity: The Advisor's New Task

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Picking The Safest Annuity: The Advisors New Task


The headline of this article sums up a growing issue for annuity salespeople: How to respond to client requests for the safest annuity or annuity option?

In recent months, reps have been calling the products desk at National Underwriter hoping to find some answers. This article provides some suggestions, based on interviews with several annuity executives.

Advisors have a full palette of safe-money annuity options at their fingertips. These include not only fixed annuities (FAs) and their indexed annuity siblings but also the fixed accounts in variable annuities (VAs) and various other conservative VA subaccounts such as market value adjusted accounts, money market accounts, bond funds, principal protection funds, and the new TIPS funds (discussed below).

At issue is not just the respective features and potential returns of each option but also the financial structure of the annuity wrapper itself. Several callers put it this way:

The Fixed Annuity choice. FAs (and fixed accounts of VAs) both offer guaranteed returns backed by the general account of the insurance company. However, this money is subject to the claims of creditors should the company default.

Variable Annuity subaccounts. Many VAs now offer several very conservative subaccount options such as bond funds, principal protection funds, TIPS funds and more. They are separate account products and so are not subject to claims of creditors. However, they are subject to market risk.

Given those facts, advisors are asking, “What do I tell my clients about the safety of the money they place in these products?”

The question is pressing because, according to many sources, more and more clients are demanding safe money options. (See sidebar.)

“Weve seen this trend for two years or more, says John Diehl, vice president, marketing at Planco, a distributor owned by Hartford Financial, Simsbury, Conn.

Consumers financial objectives have not changed since before the recession started, he points out. They still want to fund their kids college education, their own retirement and so on. But now their risk tolerance has changed, Diehl says. They want a safe place for their money, “but they dont know where the safe place is any more.

“Most investment professionals still believe the safe place, for the long term, lies in the power of equities and asset diversification,” Diehl says. “But pressure is growing from clients. They are becoming adamant that they want a safe place for their money, with some kind of guarantee.”

This preference certainly shows up in senior buyers seen by Jack Stayer. He is president of Northern States Brokerage Inc. in Menomonee Falls, Wis.

“In response, I am only selling fixed annuities,” Stayer says. “These are FAs from top-rated companies with a history of performing well on renewal interest rates. They also have short surrender periods.”

When clients ask about the safety of money in those products, he says he points to the ratings. Because the FAs he uses have short surrender periods, he also notes that, within a few years, “you can always get your money back with no surrender penalty.”

If the client will be over age 59.5 at that time, Stayer notes, they wont have to pay the governments 10% early withdrawal penalty, either.

If the client will not be age 59.5 at time of surrender, he points out that the surrendered money would be subject to the 10% penalty. But he also says that “with the fixed annuity, you still know you can get your money back. And you know, right now, how much the absolute minimum will be,” by subtracting the 10% penalty.

By contrast, Stayer says, with a bond fund thats inside a VA, clients dont know for sure what the minimum value will be in the same time period. The VA bond subaccounts are insulated from creditors, he concedes, but “their performance is subject to market risk.”

As a result, Stayer encourages clients to put the money they want to be absolutely safe into a top-rated FA. “Then they can put their at-risk money into some kind of security.”

Some clients are considering certificates of deposits for their safest money, he adds. In that case, he says, point out that FA rates still beat CD rates, and FAs offer tax deferral, too. “This makes you a hero,” Stayer says.

The tax deferral feature of annuities, fixed or variable, “absolutely” has value for consumers, maintains David Shapiro, chief executive officer of Info-One, Campbell, Calif. That, plus the fact that annuities have a death benefit and, in VAs, investment flexibility, make annuities “an absolutely valid option” for consumers to consider right now, he says.

Its true that, in a VA, the equity and debt subaccounts do not avoid the risk of volatility, Shapiro continues. For instance, when interest rates go up, bond values typically go down and vice versa. “If you dont liquidate at that time, you wont realize the losses, but if you do liquidate, you will lose money. Thats the risk.”

However, the money in VAs is long-term money, he stresses. Therefore, even though the bond or other variable subaccount value is likely to go up and down, “the clients interest will be less likely to erode over time.”

Would market value adjusted account (MVA) options, that are inside some VAs, be a better choice? Those accounts have a bond-type yield, Shapiro points out. “But if you sell in a higher interest rate climate than when you started the account, your money would be reduced by the market value adjustment. The reverse is also true, but the point is, its a conservative option with some risk.”

One annuity expert suggests that agents read the VA contract carefully, to see if the MVA account has insulation. “Not all do,” he says.

Before considering any option, first discuss risk tolerance and goals with the client, suggests Jennifer Jennings, VA product development officer at Nationwide Financial, Columbus, Ohio. To do this, agents can use various tools to assess the options. These may include asset allocation programs and fund analytics tools, such as Nationwide offers to producers.

If a client seems to be very conservative, explore whether this is a result of current market conditions or of long-standing preference, Jennings suggests. This information should help with evaluating suitable options, she says.

Someone who is really conservative might be better directed to a VA having a fixed account, guaranteed interest options (GTOs), bond funds, a principal protection fund, and the like, Jennings adds.

Regarding GTOs, she notes Nationwide will soon add a one-year GTO to its other GTOs (three-, five-, seven- and 10-year products). The reason is telling: Brokers have been asking for a one-year version, especially for VAs that have no surrender charge, Jennings says.

Many such VAs–including Nationwides–do not have traditional fixed accounts, she points out. Now, with the one-year GTO, brokers can offer clients a VA with no surrender charge and a fixed place to park their money for the short term. (Note: The GTO is subject to a market value adjustment for early withdrawal.)

Another VA option for the conservative client is a principal protection fund, says Jennings. This guarantees a return at the end of a stated period but also offers upside potential.

VA products are definitely expanding to meet the growing demand for safe money alternatives, points out Lucy Damiani, an annuity specialist with Commonwealth Financial Group. The firm is a Boston general agency of MassMutual, Springfield, Mass.

For instance, a new VA Damiani is selling has three fixed accounts, three dollar cost averaging accounts, a money market account, several conservative mutual funds, plus various guarantee options for the death benefit, income options, and so on.

Older clients and people closer to retirement are “absolutely looking for safe options” to equities, she says. VAs having several such options are therefore becoming more and more important.

The demand for safety has kicked off interest in a new type of safety-oriented mutual fund called a TIPS fund. Hartford Financial is already offering a TIPS fund as a retail security and is now considering adding one to its VAs, says Plancos Diehl. Meanwhile, MassMutual has just added a TIPS fund to its variable universal life policies and plans to add it to its VAs.

TIPS funds are gaining attention because they invest primarily in Treasury Inflation-Protected Securities. The prices are periodically adjusted by the U.S. Treasury to provide investment results that keep pace with inflation. The advantage, says MassMutual, is that TIPS funds offer consumers a chance to make money and keep pace with inflation. They do have the potential to lose money, the insurer adds, but they may be a good choice for clients who want to avoid a recurrence of the steep market losses suffered in the past two years.

Hartford points out that, when shown a description of a TIPS fund, 77% of consumers polled said they would be likely to invest in such a product in the next six months.

In evaluating a clients request for safe money products, advisors should step back and ask what will best serve the long-term purposes of the client, suggests Diehl. “Maybe, instead of choosing a fixed or money market account, the advisor should offer a VA with some type of guarantee feature,” he says.

Indeed, says Info-Ones Shapiro, this might be the very time to recommend clients to move into, not away from, a VA product, depending on their needs and goals.

If clients are uncertain about the VAs subaccounts, they can go into the fixed account for a while, he says. Later on, they can move some money over to the variable subaccounts, if they wish. (Note: Traditional VA fixed accounts do put limits on moves from the fixed account. But Shapiro says newer fixed accounts are coming out that offer greater liquidity in return for lower interest rate.)

While in the fixed account, the money has no market risk, Shapiro reiterates, but it is exposed to business risk, in the sense that the money is invested in the insurers general account and so is subject to claims of creditors. He doesnt see this as a huge level of risk. “History has shown the industry takes good care of its policyholders” in the area of business risk, he explains. In recent years, in particular, insurers have strengthened reserves and implemented measures to meet risk-based capital requirements.

If the VA owner later moves money into the subaccounts, the assets take on market risk but they are then insulated from claims of creditors, Shapiro says.

The drastic change in investment choices that some clients are contemplating today may not be necessary, concludes Plancos Diehl. “You need to weigh the cost of the benefit versus the risk management relief the safer options provide.”

Reproduced from National Underwriter Edition, February 3, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.