When financial markets behave unpredictably, investors tend to flock to products that offer predictability. So it’s no surprise that amid all the recent financial upheaval, interest in traditional fixed annuities appears to be surging.
Fixed annuities are largely overlooked–and in many cases, consciously avoided–in bull markets, especially when interest rates are low and the yield curve unfavorable. But with their ability to protect principal while providing guaranteed income and modest but positive returns, they suddenly look pretty appealing to the investing public when equity market performance heads south. While the returns they provide are hardly spectacular in today’s low-interest-rate environment, fixed annuities are making believers of investors who, prior to the recent financial crisis, scoffed at anything offering guaranteed returns as “low” as 4 or 5 percent. Funny how quickly a person’s perspective can change after watching the value of his or her investments shrink significantly in a matter of a few days.
“Just last week I had a conversation with one of my clients, the CFO of a Fortune 500 company,” recounts John Freiburger, CLU, ChFC, CFP, principal and founder of Partners Wealth Management, a financial advisory firm based in Naperville, Ill. “This is a guy who’s worth over $10 million, someone who never wanted to talk about insurance products–who said he despises insurance companies. Well, he walked into my office and guess what he wants to talk about? A fixed annuity. It’s amazing how quickly sentiments can change.”
The latest flight to fixed annuities actually began well before the financial crisis came to a head this fall. Sales of traditional fixed interest annuities (including book value and market value adjustment contracts) hit $15.6 billion in the second quarter of 2008, nearly doubling the $7.9 billion sales figure from the same period in 2007, according to figures published by Evanston, Ill.-based Beacon Research in its Fixed Annuity Premium Study for the second quarter of 2008 (third quarter figures were still being compiled at press time). Buoyed by general market turmoil and an increasingly favorable yield spread relative to CDs, overall sales of fixed annuities (including fixed-index and immediate contracts as well as book value and MVA products) rose to $24.6 billion in 2Q08, an increase of 54 percent from the second quarter of 2007 and 30 percent from the previous quarter of 2008–and the highest level reported by Beacon Research since it began tracking the fixed annuity market in 2003. On a year-to-date basis, total fixed annuity sales for the first half of 2008 were up 47 percent from the same period in 2007. Beacon’s estimates are based on data provided by 50 insurance companies representing 87 percent of the U.S. fixed annuity market.
The lesson for advisors to take from the recent market meltdown, at least as far as fixed annuities are concerned, is not to wait for a crisis to talk with clients about conservative, relatively simple fixed-return products, because these instruments are suitable for a wide range of investors, regardless of prevailing market conditions. Advisors such as Freiburger and Samuel Gott, CFP, ChFC, CLU, a registered investment advisor based in San Antonio, Texas, say they were just as inclined to suggest fixed annuities to clients before the financial crisis as they are to suggest them now. “I haven’t changed my tactics,” says Freiburger.
“We’re having the exact same conversations with clients as we had a year ago about the role fixed annuities can play in portfolio diversification.”
The justifications for investing in fixed annuities rather than other fixed income alternatives such as CDs and bonds are the same now as they were prior to the crisis, advisors say. Sometimes, though, investors have to feel the financial floor drop out from under them to be reminded of the advantages that have made fixed annuities a vital, if unsung, product for so long. Those advantages include:
- Tax-deferred growth of income, something a CD can’t offer.
- Protection of principal.
- A guaranteed rate of return, which other types of annuities can’t offer.
- The opportunity to annuitize.
- Probate and creditor protection (in certain states). “Depending on the state you’re in,” explains Gott, “the assets in a fixed annuity are protected against lawsuits, and if you put a beneficiary on there, the annuity contract can pass to the beneficiary free of probate.”
- The fact that annuity income doesn’t count toward calculations for Social Security benefits.
All those features add up to a package that skittish investors may find particularly attractive. “The simplicity, the clarity, the transparency of a fixed annuity is something people certainly are finding appealing,” says Freiburger. “With a fixed annuity, they can get guarantees on the fixed-income segment of their portfolio that they can’t get in the bond or equities markets.”
“It’s a good product for the guarantees it provides,” adds Gott. “And it’s just easier for older clients to understand a fixed annuity.”
As straightforward as fixed annuities are, there are key distinctions to keep in mind in shopping for a contract. One is the carrier offering the product. Some insurance companies have seen their ratings downgraded of late. Gott recommends buying fixed annuities only from companies with a rating of A or higher.
Timeframe is another key consideration. Freiburger says he favors putting clients in shorter-term contracts of three to five years in length to preserve flexibility in the portfolio. “The world keeps changing. We want to be able to take advantage of opportunities as they arise. As great as fixed annuities look right now, we want the opportunity to readdress how they fit in client portfolios when, somewhere down the line, the situation with the client or in the market, changes.”
Also keep a close eye on rates of return. As of mid-November, it was reasonable to expect returns of at least 4 percent on three-year contracts, at least 4.75 percent on five-year contracts, and at least 5.8 percent on seven-year contracts, according to Freiburger. “The numbers change almost daily.”
In the current environment, however, returns may be secondary to the rating of the insurance company. Ultimately, he notes, a few basis points won’t make nearly as much of a difference to a fixed annuity contract holder as an insurance carrier’s sudden inability to meet its obligations to contract holders.
Gott also favors buying fixed annuities from insurance companies with a strong customer service record. “I look for companies that service my needs as well as those of my clients,” he explains. “Are my questions answered promptly? Are statements user-friendly? Some companies are good at service, some aren’t. It’s important to know which are the good ones.”
Once you’ve done your due diligence in those areas, the fixed annuity sales equation suddenly boils down to getting client buy-in. And nowadays, that’s a virtual no-brainer.