By Warren S. Hersch
The multi-year guarantee or CD-type annuity may not get much attention in headier times but they’ve been enjoying a boom in sales since the onset of the economic downturn.
“There has been a fair amount of interest in CD annuities of late,” says Keith Meyers, a certified financial planner and principal of Keith Meyers Inc., Cannon Falls, Minn. “The products are increasingly seen as an alternative to bank CDs.”
Adds Henry Wetherby, a chartered financial consultant and principal of Wetherby and Associates, Bloomfield, Conn.: “A lot of people are now very attracted to the CD annuity. The product offers a level of protection to conservative investors who are looking to safely park their money for the short-term.”
The CD annuity, a type of fixed annuity, offers a multi-year guaranteed rate of interest that typically lasts for the duration of the surrender charge period. Standard fixed annuities, by contrast, generally limit the guarantee for an initial period, the interest rate fluctuating thereafter with market rates.
Why is the product so appealing now? Sources say that risk-averse investors can now secure better rates in multi-year guarantee annuities than they can with traditional fixed income investments–notably bank certificates of deposit, money market funds and treasury notes–for which yields are at historic lows.
And the longer the guarantee period, the better is the multi-year rate. Timothy Gahler, a senior annuity product specialist at Thrivent Financial for Lutherans, Minneapolis, Minn., says the payout on the company’s MYG 10-year annuity is approximately 200 basis points more than is offered on the 3-year version, which is the minimum duration generally offered on multi-year guarantee annuities.
Given the prospect of market rates falling still further, adds Gahler, now be the best time for advisors to market these annuities to clients. While the interest rate for bank CDs is generally tied to the going rate offered on Treasuries, he explains, many multi-year guarantee annuities (including Thrivent’s) invest in higher-yielding corporate bonds, thereby permitting a higher payout on the annuity.
Should market rates fall further, the spread between Treasuries and corporate bonds will increase, as the price of bonds is inversely related to the interest rate. Such a drop would make multi-year guarantee annuities not only more attractive relative to other CDs and treasuries, but also to standard fixed annuities offering fluctuating rates.
“If the Fed cuts Treasury rates, it’s our belief that in 1 or 2 years, we’ll see interest rates fall,” says Gahler. “If a client buys a standard fixed annuity and gets a high interest rate this year, conceivably that rate will be cut next year because of the market. So this is the prime time to lock into an interest rate for multi-year period.”
That message is evidently getting through to customers. Gahler says that Thrivent sales of multi-year guarantee annuities totaled $136 million during the last 15 months, a nearly 275% gain over the 2003-2007 period, when revenue totaled just $50 million for the 4-year period.
Many of the buyers are older boomers who are growing increasingly concerned about their nest eggs. According to a study released this month by AXA Equitable, New York, 51% of older affluent individuals polled (those aged 45-plus with household incomes of $100,000 or greater) rank securing a guaranteed fixed rate of return as a “financial concern.” This compares with 43% for the young affluent, or those between the ages of 25 and 45.
While demand is rising for CD annuities, the products are, paradoxically, getting harder to buy–at least through certain carriers. Thomas Kestler, a certified financial planner and chairman of Kestler Financial Group Leesberg, Va., says the cost of the product to the insurer typically ranges between 6% and 8% of the invested principal. Thus, on a $100,000 annuity, the “hit” to the insurer’s surplus (or reserves) would total between $6,000 and $8,000.
To make it worth their while to offer multi-year guarantees, says Kestler, some carriers are substantially raising minimum investment requirements. Still others are restricting sales by terminating non-profitable relationships with partnering insurance marketing organizations; or by capping the amount of business they will accept from IMOs.
“Whereas CD annuities are getting a lot of consumer interest, the carriers we interface with are slowing the volume of sales,” says Kestler. “This is the first time since I’ve been in the business that we as an industry can generate more sales than the carriers will actually accept.”
But even when available to purchase, a CD annuity should play but a limited role in a client’s portfolio, say experts. Kestler says the product is well-suited to short-term investing–5 years or less–but should be avoided for the long-term.
The reason: interest-rate risk. Should interest rates rise in the near future, as Kestler expects they will due to the growing national debt (which, in theory, can raise rates by displacing or “crowding out” funds for private capital), then investors who are stuck with, say, a fixed rate in a 10-year CD annuity will be denied the additional interest they would otherwise have earned on a vehicle offering a fluctuating rate.
Pulling out of a fixed annuity prematurely could also be costly because doing so would incur an early surrender charge. Also, should rates on Treasury notes rise between the annuity’s purchase and surrender dates, the customer would incur a negative market value adjustment as well. Thus, Gahler warns, clients need to think carefully about their financial objectives and time horizon before investing in the product.
Sources say a CD annuity often does make sense when integrated into annuity laddering strategy. Assuming 3 annuities or “income buckets,” the first and last of the buckets might comprise, respectively, a single premium immediate annuity and (for long-term investing) a deferred variable annuity. The second bucket might consist of 3- to 5-year CD annuity.
“We use this strategy quite a lot, especially for clients who come to us with income needs,” says Kestler. “But we don’t necessarily counsel buying a living benefit rider for the last of the buckets–the variable annuity.
“The two things clients can control with investments are time and allocation,” he adds. “Historically, time is what gives you performance. So the longer is the time frame, the less valuable that rider becomes.”