As advisors grapple with ways to make sure their clients have income in retirement, one financial advisor is calling living benefits in variable annuities a “false solution.”
Sales of living benefits are gaining momentum. In its 2007 Fact Book, NAVA, Reston, Va., estimates that 68% of variable annuities sold are purchased with living benefits. Sources in the industry speculate that the number is even higher, coming in at over 70%.
Chris Cordaro, a wealth manager with RegentAtlantic Capital, Chatham, N.J., a fee-only wealth management firm, called living benefits a “step backward.” Cordaro made the remarks during a panel discussion on retirement sponsored by Jefferson National Life Insurance Company, Louisville, Ky.
The reason, he explained, is that the guarantees are so costly that “it really is guaranteeing that insurance companies will keep your money for a very long time.
“It actually put us a step backward in the retirement income challenge instead of moving us ahead,” Cordaro said.
Costs for variable annuities run in the 3% range and even if you earn an 8% rate of return on equities over the long term, the result is a “very low rate of return,” he said. “I just think that they are horrible.”
Payout funds that the mutual fund industry is now offering are “equally offensive to me,” he continued.
The Investment Company Institute, the mutual fund trade group based in Washington, currently does not track sales of payout funds, according to an ICI spokesperson.
“Why are they becoming popular?” Cordaro asked. “Because living benefits are so popular. If you read the marketing material, they really sound like living benefits.”
The reason, he explained, is that these products “create the perception that they are solving the problem. But we are not solving the problem.”
What can help solve the “fundamental issue” of having income in retirement, Cordaro said, are products that pool longevity risks. For instance, he cited annuities with a long deferred starting date that would commence at around age 85. Premiums for such products are much lower and you are actually insuring for the problem of living too long, he added.
Another product that Cordaro said could provide income in retirement years is the tontine because of the way that it pools risks. It shifts the investment and longevity risk to the insurance company and has the advantage that it will bear the investment risk as well as the longevity risk along with the rest of the pool.
“There is no real secret sauce here,” said Cordaro. “As planners, we need to manage risks as well as assets.”
“All things being equal, lower costs win,” said Jeff Daniher, co-owner and lead financial advisor with Ritter Daniher Financial Advisory, LLC, a fee-only firm based in Cincinnati. “Why pay for something that you don’t need, and equally important why pay for something that you don’t knew that you are paying for or may not even want. So we look for transparency in pricing. I don’t have any concern over however someone gets paid as long as the client understands where the money is going.”
However, he cited products such as single premium immediate annuities as reason to be optimistic. But he also noted that under the current interest rate environment, “the hard part is annuitizing at 3%. At 8%, we’d be all over it [recommending it to clients.]“
He added that longevity insurance can be a tough sell to clients, and consequently, clients have to understand that insurance is a cost but that there is a benefit. If the client is focused on the maximum amount of money to leave to heirs, he continued, then that choice could have its own set of consequences–the risk of not having enough money on which to live.
Norse Blazzard, of the law firm of Blazzard and Hasenauer, Pompano Beach, Fla., and a NAVA founder, said that different living benefit guarantees have different benefits and when properly used or when used in tandem with several living benefits, they can offer the consumer income protection.
For example, he said that guaranteed minimum income benefits are appropriate for those who can wait 7-10 years before starting to annuitize.
Annuities are designed to achieve 4 goals, he said: longevity protection, inflation, deflation and liquidity.
Blazzard said that 3% is the total cost usually associated with a variable annuity and that is on the high side of the spectrum. On average, living benefits cost approximately 30 basis points or .003%, he added.
But, he continued, it can be money well spent given that there is a .005% chance that your house will burn down and a 65% chance that a person will outlive income. It is considered wise to insure one’s home so why wouldn’t it be as wise to insure against outliving income, he noted.
Kathy Cody, senior vice president–alternate retirement solutions with Phoenix Companies, Hartford, Conn., said that the cost of a living benefit guarantee in a variable annuity reflects current market conditions.
These costs are tied to the cost of hedging the equity risks in these products which depend on the volatility of the equities market and current interest rates, according to Cody. For instance, she explained, if there is high volatility, it would cost more to buy a 10-year put which allows the put holder to sell a particular equity.
The cost associated with VAs, and associated living benefits have to factor in hedging costs, insurance company expenses and a margin for the company, she noted.
The cost of Phoenix living benefit guarantees have ranged from 85 basis points to 125 basis points, or .0085%-1.25% depending on market volatility and interest rates, she said.
Insurers can try to keep costs lower by being very focused about the guarantee being offered or trying to find more reasonable ways to hedge, she said.