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Guarantees gone wild

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Who’s busiest among the 10 employees at Partners Wealth Management, a financial advisory firm based in Naperville, Ill.? It very well could be the person charged with tracking all the new annuity features flooding the market.

In fact, says Partners Wealth founder and principal John Freiburger, CLU, ChFC, CFP, the pace at which annuity companies are rolling out customization features is so fast that that the job of tracking them and keeping colleagues informed about them has turned into a full-time position at the company. “There’s maybe 30 carriers in this marketplace and each of them has one to four or five different [annuity] products, and each product has maybe two to six different riders. Sometimes those riders have several customization options. So there are literally a couple hundred variables to consider every time you put an annuity on the table for discussion.”

From the latest twist on a guaranteed minimum income benefit (GMIB) rider to new withdrawal, bonusing and step-up features, it’s no easy task for advisors to keep abreast of the guarantees, participation opportunities and protections carriers are offering with annuity products. Most of those features are available (at a cost) as add-ons to variable annuity contracts. And many of them are designed with senior and baby boomer investors in mind.

Without the luxury of a dedicated annuity tracker on staff, many advisors who sell or recommend annuities must take on that responsibility themselves. According to Freiburger, it’s a worthwhile, though time-consuming, endeavor. “What these features do, if you take the time to analyze them, is help you control the costs and benefits the contract-holder receives.”

If the sheer volume of annuity features is enough to make an advisor’s head spin, imagine what it can do the typical client, he says. With greater customization comes greater complexity. “Explaining all the options to clients is one of the challenges. It’s hard enough for us, and we do this every day. One of the things I tell people is not to try to get on the Web, do a Google search and try to figure this out themselves. In most cases, clients want [their advisors] to do the work and then get back to them once they’ve figured it out.”

Living benefit features are leading the deluge of new annuity features. And many of those are riders that assure the contract holder (and in some cases, that person’s spouse) some level of minimum annual income for a lifetime, even if funds within the contract are exhausted. These GMIB riders continue to multiply in the variable annuity space as carriers seek to address a major concern shared by today’s seniors and boomers: longevity risk.

Prudential Financial’s Lifetime Five GMIB rider offers a prime example of how quickly features can evolve in today’s fast-paced, fiercely competitive variable annuity space. Unveiled in March 2005, Lifetime Five guarantees 5 percent annual compounded investment growth for up to 10 years and a 5 percent annual withdrawal stream for life. A year after introducing Lifetime Five, Prudential enhanced it in March 2006 with a spousal lifetime income guarantee and an automatic step-up provision. Another enhancement came last November with introduction of Highest Daily Lifetime Five, which gives investors the opportunity to increase the basis amount for guaranteed lifetime income every day the market is open and trading — providing daily step-ups. But Prudential wasn’t done yet. Just this March it further enhanced Lifetime Five with a guaranteed minimum account balance feature and an enhanced protected withdrawal value feature.

At about the same time Prudential was unfurling its latest annuity feature, MetLife was announcing enhancements to the GMIB Plus and Predictor Plus riders it introduced in 2005. In late February the company increased the compounding income base component of those riders from 5 percent to 6 percent.

Something for everyone

Such is life in what Tom Mullen, vice president of marketing in John Hancock’s annuities division, calls “a very fluid and dynamic product environment and a cycle of innovation.” Freiburger is all for competition among carriers because ultimately, he says, it yields better products for clients. “The insurance companies are trying to bring something to the marketplace. They’re looking for ways to differentiate themselves.” “We’re constantly looking at our [annuity] portfolio and scanning the competition,” acknowledges Lisa Kuklinski, a vice president and actuary in MetLife’s annuity division.

Growing demand for features that guarantee people won’t outlive their retirement savings is giving carriers a chance to separate themselves from the crowd. Through extensive market research, insurance companies also have found that today’s younger seniors in particular want customized features that give them a sense of ongoing control over their retirement nest eggs. They’re no longer content with one-size-fits-all annuity contracts that come with few if any riders.

Annuities of old were packaged such that the contract holder essentially surrendered control of that segment of their retirement savings to the insurance company. Today more people are unwilling to relinquish that control, says Jac Herschler, senior vice president and head of marketing for Prudential Annuities in Newark, N.J. “What we have learned is that people feel differently about the retirement savings they have managed themselves than they do about employer pension plans and those kinds of things. This proliferation of exciting new features reflects a realization among [annuity] product designers that what people want is more control and flexibility over the retirement savings that are produced by money they managed themselves.”

The annuity-buying public also is telling carriers they want features that provide the best of both worlds: the protection of guarantees on principal, income and death benefits, but also the ability to participate in the potential upside of equity markets. “They want the safety,” explains Freiburger, “but at the same time they kind of smile at you and say, ‘How can I still grow these dollars?’ Now there are features where, when you put in a lump sum, it’s going to guarantee you a certain amount of income down the road, but still give you upside potential. It addresses longevity risk and satisfies the greedy side of people, if you will, by giving them the market participation they want.”

Explaining Prudential’s motivation for adding a daily step-up provision to its Lifetime Five rider, Bob O’Donnell, the company’s senior vice president of annuity product management, says, “We kept seeing this incredible demand for greater participation in the performance of their contract. There’s comfort in opportunity, comfort for people in knowing they’re never going to miss out on the best day their annuity investment ever had.”

Another driving force in the annuity customization frenzy, says Herschler, is a desire among carriers to position their variable annuities as viable alternatives to immensely popular lifecycle (target) funds.

“There are risks and dangers in the systematic approach to investing that these target funds take. Really, what you want as an investor is to be able to maintain a level of risk that you’re comfortable with in your retirement portfolio, whether you’re 65, 70, 75 or 80 years old. Annuities with these new income and participation features provide flexibility that target funds don’t.”

The boom in annuity features isn’t limited to living benefits, however. For people seeking to maximize wealth transfer and minimize the tax burden on their heirs, carriers are rolling out enhanced guaranteed minimum death benefit riders that give beneficiaries a larger death benefit when the contract holder dies before annuitizing the contract. It’s well suited to people who have a health issue that makes obtaining permanent life insurance prohibitively expensive. Designed to help cover income taxes or estate taxes stemming from the annuity, these riders typically come with several options for growing the death benefit beyond the contract’s base guaranteed minimum.

Coming attractions

According to Mullen, the spurt of innovation in withdrawal benefit features may be close to running its course. “We’re almost at the point of commoditization of these types of benefits.”

Thus, carriers like John Hancock already are putting their product designers to work on new features built to capitalize on other emerging growth opportunities in the annuity segment. The next wave of innovation, says Mullen, could come with features designed to address risks posed by inflation and healthcare costs. “Those two areas probably represent the biggest challenge and opportunity for annuity product developers.”

Riders that carriers have offered to address inflation risk “haven’t been as successful as they could have been,” he notes, “so there’s some work to be done to develop inflation based-payouts.”

Recently enacted federal incentives that, beginning in 2010, will provide tax-advantaged treatment of annuity income used to pay for certain kinds of healthcare also will be keeping product designers busy, Mullen says. “Between now and 2010 I think you’re going to see features that combine annuities with various long-term care solutions.”

With so many new features having arrived and many more on the way, how are advisors and their clients to keep pace? Carriers say they recognize the problem and know how to address it. “The key is to design solutions that meet peoples’ needs without getting too esoteric,” explains Kuklinski. “Our consumer research tells us folks want it simpler, and they want it easier to understand.”