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January 06, 2008 at 02:00 PM
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.
