Only a few years ago, many within the advisor community viewed fixed indexed annuities (FIAs) as troubled products. Hybrid solutions that incorporate features of both traditional fixed and variable annuities (VAs), FIAs were shunned by financial professionals who desired the greater growth potential of VAs and other equity-based vehicles.
Many, too, were critical of the products’ seeming complexity, believing the plethora of moving parts a hard sell. Also, life insurance agents who don’t sell securities were uncertain of the products’ future because of the prospect of regulation by the Securities and Exchange Commission (SEC).
How times have changed. Today, FIAs are among the best-selling products in the annuities marketplace, as reflected in recent industry data. Market research firm LIMRA, Windsor, Conn., pegged FIA sales at $8.7 billion in the third quarter of 2012 and at $25.4 billion for the year-to-date. LIMRA expects that (once its tally is finalized) FIAs will have a “record-breaking” year, thanks in part to robust sales of the new players.
In contrast, the LIMRA survey shows, fixed annuity sales plummeted 13 percent, closing the third quarter at $17.7 billion and year-to-date sales at $54.1 billion — abysmal numbers not witnessed since early 2007, when investors were in thrall of equities.
The robust FIA sales, say experts, can be credited in part to increased industry competition and product innovations that have made FIAs more appealing to pre-retirees. Also a major factor is the FIA’s superior performance in recent years relative to alternative retirement vehicles, among them once high-flying VAs.
“The critics have been proven wrong, as the fixed index annuity has demonstrated an ability to perform better than what they thought possible,” says Tim Barton, a chartered financial consultant and principal of Future Financial Images, Pepin, Wis. “FIAs yielded an average rate of return of from three to five percent during the recent market turmoil. No other investment vehicle I know of has done this.”
The products’ signature features — principal protection, the ability to secure a guaranteed rate of return with the potential to capture a percentage of equity market gains—are proving increasingly attractive to producers who want to offer clients a safe alternative to variable annuities, mutual funds, ETFs, stocks, and other vehicles vulnerable to market fluctuations.
Tied to an index (typically the S&P 500), the FIA has credited a rate of return based on the allowed percentage of the gain in the index. This number, the participation rate, typically ranges from 50 percent to 100 percent of the index price gain, excluding dividends.
Some FIA carriers also place caps on the amount of interest that can be credited to an indexed annuity. Most FIAs additionally entail a surrender fee, assessed as a percentage of assets or as a charge to earnings. The latter, known as a market value adjustment, might kick in when the investor trades in one annuity for another paying a higher interest rate.
A burgeoning market
The surging demand for FIAs among consumers, experts say, are prompting more annuity manufacturers to jump into the market—among them providers previously dedicated to VAs. The new entrants include Genworth Financial, Oxford Life, The Phoenix Companies, Security Benefit and other carriers that are competing with the market’s traditional players: Allianz Life, American Equity, Aviva U.S.A. and Lincoln Financial Group.
The increased competition, say market-watchers, has engendered a wave of market innovations, starting with more appealing product designs. While today’s FIAs retain the signature components and indexing methods (e.g., annual reset, point-to-point, high-water mark) of earlier iterations to calculate account value gains, many of the new products offer shorter surrender charge periods, greater liquidity and less complex vesting schedules than in years past.
The new products now also boast guaranteed living benefits that FIA proponents say are superior to Guaranteed Living Benefits (GLBs) featured in more market-sensitive variable annuities. Whereas, for example, VA owners generally have to annuitize their products to secure the guaranteed minimum income benefit, many FIA products let investors stop and start income benefits to accommodate changed financial circumstances.
And, expert say, the products’ GLB riders generate more income than do their counterparts on VAs.
“The FIA’s income guarantee is significantly higher than on what you’d see on a VA,” says Dana Pedersen, vice president and product officer of The Phoenix Companies, Hartford, Conn. “Though the rate of return on a VA may be greater, the FIA’s living benefits are better able assure a lifetime income stream.”
Also favoring FIA sales is the certainty that producers can market the solutions as insurance products, free of regulation by the SEC. Credit for this goes to a July 21, 2009, decision by a three-judge federal appeals court panel that exempted fixed indexed annuities from SEC jurisdiction, as per the proposed Rule 151A, which would have classified the annuities as securities.
The favorable developments for FIAs come, observers say, at a time when interest in variable annuities is waning, both among consumers whose VAs were pummeled during the credit crisis of 2007-2009; and among VA manufacturers that have found supporting the products’ GLBs overly challenging under current market conditions.
Indexed annuities, say experts, also compare favorably with traditional fixed annuities, which are suffering from record low interest rates. Prevailing crediting rates, sources say, are little better than the payout on other fixed income vehicles like bank CDs, Treasuries, municipal bonds, money market funds and savings accounts.
Even if one assumes no equity market gains, says Barton, indexed annuities can produce a higher income or withdrawal rate than available through a straight fixed annuity, depending on how the FIA’s income or withdrawal benefit is structured. “That’s important when you consider that retirees face on average a one in five chance of portfolio failure — running out of money — if you assume a four percent annual withdrawal rate,” he says.