Single premium immediate annuity (SPIA) sales are increasing faster than other fixed annuity markets. Why?
There is now general agreement among academics, economists and most others who have studied the retirement income market that retirees need a secure base of stable income for the rest of their lives. Moreover, there is general agreement that a retiree could safely receive more monthly income from a SPIA than from any other fixed investment with a similar default risk profile.
That is important, because Americans face a looming retirement income crisis. Without proper planning, many once proud, financially successful baby boomers could suffer through the last two decades of their lives penniless. Fortunately, longevity (living too long) is an insurable risk. By pooling retirement assets, insurance companies guarantee that annuitants never run out of money.
Today’s financial markets require simple, positive answers to simple questions even when the underlying issues are complex. In the past, SPIAs have provided poor answers to questions about liquidity, inflation, principal guarantees in the event of an early death, and methods to decrease the costs of longevity protection. This is largely because the traditional SPIA is designed to trade liquidity and principal guarantees for higher income while the annuitant is alive.
The result of poor answers to simple questions has been poor SPIA sales and suboptimal use of client assets with respect to maximizing retirement income, providing longevity protection and tax efficiency.
Recently, however, recognizing the clear and growing client need, a number of creative minds in the insurance industry took up the challenge to find a way to do much better. The fruits of their efforts are now arriving on the market, according to the October 2007 CANNEX SPIA Features Survey of 50 SPIA carriers.
The survey shows there are at least 18 carriers with SPIAs that now address liquidity concerns. Most allow the annuitant to receive a commuted value of the remaining guarantee payments on request. Ten provide this flexibility without an initial charge–fees are built into the commutation calculation and only charged if the client chooses to cash out of the policy. In addition, 8 will continue to pay 100% of the modal life contingent income when the payments resume after the guaranteed payment period.
For annuitants who need cash after exhausting their guaranteed payments, 3 carriers provide the ability to cash out of the policy, 3 others allow taking extra cash in exchange for reduced future payments, while one allows clients to receive 6 months of income payments at once.
Several carriers have addressed liquidity with unique designs. One carrier provides a cash value equal to the premium, minus benefits received. Another adjusts both the cash value and income payments by changes in the Consumer Price Index. A third allows clients to lengthen or shorten their guarantee period. A fourth allows clients to receive 30% of the present value of the remaining payments based on life expectancy on the 5th, 10th, 15th policy anniversary or on proof of a significant non-medical financial loss. And a fifth allows terminally ill clients to receive 100% of the commuted value of their guaranteed payments plus up to one year of their life contingent payments.
Guaranteed inflation protection is a challenge for any financial product. While variable investments have historically provided better long-term inflation protection than fixed products, the tradeoff is increased short-term risk.
Any kind of guaranteed inflation protection in fixed products comes at a cost. The tradeoff for much higher future income is reduced initial income. Fixed annual cost of living increases have been commonly available from 23 carriers for a long time.
Recently, however, 5 carriers introduced designs that provide increases linked to the CPI (all use CPI-U published by the Bureau of Labor Statistics). One of these carriers links all key values–income payments, cash available for withdrawal and a final death benefit–to this index. Another promotes a holistic retirement management account that combines mutual funds with a daily valued SPIA that is able to receive multiple contributions purchased over time in order to dollar cost average the transition from accumulation to income.
A lot of research points to annuitant reluctance to purchase insurance products that do not have principal guarantees. Insurance carriers that added living benefit guarantees to variable annuities now dominate that market.
Four-fifths of carriers in the SPIA market now address this need with installment refund guarantees (available from 30 carriers) or cash refund guarantees (available from 28 carriers). In addition, 17 carriers offer some form of return of premium death benefit in the event that the annuitant(s) dies after paying the premium but before receiving any income benefits.
Extra guarantees and inflation protection come at a cost. Savvy annuitants and their advisors might want to find ways to reduce the cost of longevity protection by reducing the guarantees and possibly replacing these guarantees with products with which they are more comfortable.
Five carriers provide advanced life deferred annuities (ALDA) to address this need. Typically, these products are purchased at or just prior to retirement (e.g. age 65) and only begin to pay income at an old age (e.g. 85). An ALDA can be thought of as the tail of a SPIA–aSPIA minus the income benefits the client would receive until he or she reaches a specified age (e.g. 85). Eliminating the first few years of income payments greatly reduces the cost. Only 9% to 12% of a SPIA’s initial premium is needed to provide a 65-year-old annuitant longevity protection when income is deferred until age 85.
If the client prefers another investment vehicle over a SPIA but needs the protection in old age in the event she lives beyond age 85, she could use a small portion (say 10%) of her retirement assets to purchase an ALDA while using a systematic withdrawal until the fixed date she turns 85. If she reaches age 85, the ALDA would pay her a guaranteed monthly income for the remainder of her life.
Finally, while annuitants in poor health can be expected to live a shorter life, they still need a guaranteed base income for the rest of their life–a need best addressed with a SPIA. Nine carriers now provide an increased income to clients with medical records showing they are in poor health.
Clearly, the insurance industry is rallying to leverage its unique ability to provide longevity protection by addressing the perceived shortcomings of SPIAs. Clients who require liquidity, principal guarantees, inflation protection or low cost longevity protection can now use a SPIA for the portion of their retirement income plan that addresses a base level of guaranteed income that cannot be outlived.
With retirement fast approaching, baby boomers will need to find ways to maximize income while ensuring they will never be penniless. A SPIA is integral to an optimal retirement income strategy for clients who feel more income is more important than more flexibility or for clients who are concerned about outliving assets. In other words, a SPIA is a required part of an optimal retirement income plan for most Americans.
Lowell Aronoff is CEO of CANNEX Financial Exchanges Limited, Toronto, Can. You can email him for names of carriers offering some of the specific features. His email address is Lowell.Aronoff@cannex.com. This article first appeared in the December 2007 issue of Income Planning, an online publication of National Underwriter Life & Health. You can subscribe to this monthly e-newsletter for free by going to .