The search for sound income-oriented products that consumers at or near retirement age find useful and affordable continues with no signs of abating, yet the search has been somewhat elusive.
What are the objectives and problems, and what worthwhile solutions either exist or are on the drawing boards? For some suggested objectives, see the box below. We will discuss some solutions in this article.
The solution everyone knows about is the single premium immediate annuity. In its simplest form, the SPIA provides a flow of payments as long as an annuitant is alive. SPIA sales, despite intensive insurer activity, have been quite modest.
Current, relatively low interest rate levels make it much harder to offer a competitive monthly return. Remember that such payments will continue at this level for life. Consumers don’t recognize its value and for good reason. While the vehicle meets the first objective, it doesn’t meet the rest particularly well!
Many insurers offer single premium immediate variable annuities. These SPIVAs, as they are often called, provide performance linked to equity and other non-guaranteed investments. With respect to the income objectives outlined here, they provide assurance that annuitants can’t outlive their assets, and they do provide upside potential; but they also can pose a serious risk of downside performance if the return is less than the rate assumed in the determination of the purchase rate.
The guaranteed minimum withdrawal benefit design is available in many deferred variable annuities. Today’s more advanced designs provide a GMWB payment promise for life. Of course, these benefits, when paid out, are paid out on the less favorable last-in, first-out (LIFO) tax basis. Companies utilizing this feature seem to have concluded that SPIA-based designs are facing too much public and producer resistance and therefore that the GMWB approach represents a promising and achievable first step to educating the consumer about longevity issues. As for payments under GMWB, actuarial observations indicate these are relatively modest.
One company has developed a very interesting and promising annuity vehicle that addresses the first objective. Its very modest initial cost also may have significant appeal. In some ways, this product could be viewed as providing insurance against the financial concerns of longevity, since it promises a monthly annuity payment beginning at an advanced age, say 85, and continuing as long as the annuitant lives.
In one form, the investment is lost if the annuitant dies before age 85, but, of course, that’s what makes this product so inexpensive. The product protects against what we actuaries call the “tail,” and because the cost is so modest, it enables the bulk of the investments to remain under the client’s control. By only providing protection against longevity, most of the other issues are satisfactorily addressed.
Another vehicle combines long term care protection with an SPIA. This offering enhances the payout amount when the annuitant needs LTC over the long term. The step-up in payout amount is intended to be permanent and parallels the annuitant’s likely increase in living costs and shortened life expectancy. Design flexibility, of course, exists. SPIA payment taxability reflects an exclusion ratio that returns a combination of principal and interest so that there is some tax efficiency there.
Another consideration that some products address is the ability to keep up with increased living costs. A new annuity vehicle linked to the stock market provides potential upside protection, with only a limited downside. There is no doubt that newer vehicles will provide only upside potential, without downside risk.
In its basic form, both the existing vehicle and the newer vehicle are SPIA structured, although in the newer one, deferred annuity attributes are present. The upside performance can be very interesting because its application can be very immediate, in which case its value would be considerable, or it can be spread over a number of years, or structured to be highly liquid. Consumers can maintain their initial income level, provide for greatly increased early returns or spread out the benefit of positive return over the product lifetime.