Investors and advisors alike would be hard-pressed to find a silver lining to this fall’s financial meltdown, but if there is one, says John Hancock’s Tom Mullen, it might just be found in the variable annuities marketplace. One potential positive to emerge from all the bloodshed, suggests Mullen, vice president of marketing at John Hancock Annuities, is a winding down of the “arms race” that for roughly the past two years has pitted insurance companies against one another in an increasingly risky game of living benefits one-upmanship.
That’s of little consolation to variable annuity owners who, virtually without exception, saw the value of their annuity subaccounts nosedive. But if the financial crisis does precipitate an end to the constant jockeying among annuity companies to make their guarantees more appealing than the competition’s, consumers and carriers alike will benefit in the long run, Mullen contends. For carriers, offering more aggressive benefits — a more attractive step-up provision here, an extra percentage-point of guaranteed annual income there — generally means taking on more risk. Since lenders are significantly more risk-averse in the wake of this fall’s credit crisis, explains Scott DeMonte, director of variable annuity markets at Financial Research Corp., it has become more costly for insurance companies to hedge the higher risks they assume by offering increasingly aggressive withdrawal and income guarantees. As a result, those guarantee riders, known by such acronyms as GMIB, GMWB, etc., become costlier for consumers to buy. With their willingness and wherewithal to make additional incremental enhancements to those riders curbed, carriers now must find new ways to make variable annuities more appealing to consumers.
That’s a good thing, says Mullen. “For so long the industry has been focused on getting a marginal advantage in the living benefit and withdrawal benefit niches of the market. In our opinion, there has come a point where the risk-reward profile of some of these features was no longer attractive. Some of the pricing was becoming irrational. Now, I think, we are at a crossroads, where we as an industry can turn our focus to longer-range product enhancements, things that appeal to people with certain unmet needs in areas like inflation-protection, taxes, those kinds of things.”
The huge new generation of variable annuity guarantees doesn’t seem bound for wholesale overnight extinction, but according to Steve Kluever, senior vice president of product management at Jackson National Life Distributors, carriers are likely to temper their activity in that area. “I think one of the things to expect, given poor market conditions and volatility, is a bit of retrenchment by some companies with their living benefits offerings.”
The latest figures from the variable annuity market indicate that more than 80 percent of new contracts come with some form of living benefit attached, according to DeMonte, who tracks the VA market for FRC, a Boston-based financial research and consulting firm. That huge share could erode if, as he expects, carriers not only raise the cost of guarantee features, but also reduce the level of guarantees offered in those riders. Highly unlikely, he says, is a worst-case scenario in which some carriers are forced to postpone or suspend certain guarantees, especially those that promise unlimited benefits. As long as carriers don’t price their guarantees out of the market, he says, it’s more likely that these already popular riders could gain even greater appeal because they offer certainty to increasingly skittish investors. “More than ever before, I think, people will be looking for protection on their retirement investments,” says Mullen.
The end of the living benefits arms race may indeed be at hand. But insurance companies still have plenty of new features up their sleeves, including new twists on existing benefits and new protective features designed to pick up where the current generation of living benefits leaves off. Among the new wave of features, DeMonte mentions Sun Life’s Income On Demand as particularly noteworthy. Touted as the industry’s first “income storage benefit” when it was introduced in March 2007, Income On Demand is available with Sun Life Financial Masters variable annuities for an annual fee of 0.65 percent (0.85 percent to extend it to a spouse). The benefit allows contract holders to defer part or all of their allowed annual withdrawals and to “store” those withdrawals in the contract for future use. Expect other carriers to follow Sun Life’s lead in offering such a rider, says DeMonte. “It’s just like a GMWB, but the withdrawal capability is cumulative. It’s not use-it-or-lose-it like it is with a GMWB. If you don’t take out the 5 percent one year, you can roll it over and take out 10 percent the next.”
Daily step-up features such as Prudential’s highest daily value benefit also could be bound for the VA mainstream, says DeMonte. Features that provide contract holders with the ability to lock-in an account value on a daily basis “are appealing to clients concerned about volatility,” he notes. “If you could have bought this feature [in October 2007] when the stock market was at 14,000, you would be sitting pretty.”
Prudential’s highest daily value features didn’t come along until January 2008. They’re available with its Highest Daily Lifetime Seven and Spousal Highest Daily Lifetime Seven optional living benefits, which offer a protected withdrawal value based on 7 percent annual compounded growth on the highest daily account value and opportunities to capture greater lifetime income every day the market is open. The rider carries an annual cost of 0.60 percent for an individual and 0.75 percent for spousal protection. There’s also the Highest Daily Guaranteed Return Option, an accumulation benefit that offers a guaranteed minimum account value and the opportunity to automatically lock in the annuity’s highest daily value. It carries an annual cost of 0.35 percent.
Beside the tax-deferral benefit inherent in most annuity contracts, Hancock’s Mullen says he expects carriers to introduce new features that emphasize the tax-friendliness of annuities. “Taxes are going to go up, regardless of who wins the [November] election. So it’s probably a good bet that there will be more energy expended on tax-advantaged solutions. I think, for example, that we’re likely to see interesting developments in the area of annuitization” — features that incentivize contract-holders to annuitize. Also look for more carriers to unveil so-called combination products that add long term care insurance features to the VA chassis. With new federal tax breaks for those combo products scheduled to take hold in 2010, Mullen expects a deluge in that niche beginning in 2009.
Extreme market volatility also is prompting carriers to reintroduce mandatory asset allocation into VA products, says Mullen. “We’re taking risk off the table, and people seem fine with that.” For example, Jackson National Life Insurance in October began offering new institutional asset-allocation models with some of its VA contracts. The new models, according to Kluever, are unique in their heavy emphasis on alternative investment classes: global real estate, long-short funds, private equity funds, etc.
Pointing to the new enhanced death benefit option his company introduced this fall, Kluever says he expects more carriers to come out with features that adapt to client needs through the accumulation, decumulation and wealth transfer phases. Available with the LifeGuard Freedom GMWB rider on Jackson’s Perspective and Retirement Latitudes products, the new LifeGuard Freedom DB feature is designed for wealth transfer. It guarantees that the contract holder’s death benefit amount will not decrease, provided withdrawals do not exceed the guaranteed annual limit or minimum required distribution. “A person can put $100,000 in age 60, then withdraw five percent for life, with step-up opportunities, while the death benefit remains at the original $100,000,” notes Kluever. “That’s where the wealth transfer advantage comes into play.”