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Delving into the ascendance of FIAs

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Until recently, pre-retirees desiring high investment yields and the assurance of a lifetime income invariably looked to variable annuities (VA) offering guaranteed living benefits. This no longer holds true.

Today, as I note in my feature, Reversal of fortunes, a growing numbers of aging baby boomers are favoring instead fixed indexed annuities — and for good reason. Though they don’t match the VA’s potential for market gains, FIAs outclass VAs in two key respects, both of which hinge of the products’ superior GLBs: (1) product flexibility; and (2) the ability to assure an income stream that can sustain clients throughout their retirement years.

Taking a look back

How have fixed indexed annuities managed to displace VAs in the estimation of insurance and financial professionals who market FIAs and the burgeoning number of insurers that manufacture the products? Part of the answer, as I learned over the course of my research on the topic, can be found in the VA providers’ response to the heightened market volatility stemming from economic crisis of 2008-2009, the impact of which the companies had not anticipated.

The market downturn led VA providers to revise their assumptions about annuitization rates. Eric Thomes, a senior vice president of sales at Allianz Life Insurance Company of North America, Minneapolis, observes that because VA account values were so hard hit by stock market declines, more policyholders than anticipated annuitized to secure the higher guaranteed income value.

Upshot: The VA providers were forced to revise their GLBs, notably by scaling back the riders’ benefits and/or boosting the cost of securing them. The recent market volatility, observers note, also contributed to the GLB revamp by forcing VA carriers to adopt more conservative hedging strategies on their own portfolios. The less they earn on their own investments, the less they can pass on to consumers in terms of feature benefits.

The GLBs offered through fixed indexed annuities, in contrast, required no such overall —t hanks to the products’ design.

Like traditional fixed annuities, the products guarantee the investor’s principal and assure a minimum interesting crediting rate, irrespective of market returns. Crucially, because equity market gains are defined by a contract formula, the manufacturers can be more flexible in formulating FIA living benefits than they can be with VAs.

“On the VA side, you don’t have as many options with income riders, as you typically have to annuitize to get the benefit,” says Hank Parrott, a principal of Estate & Financial Strategies, Inc., Brentwood, Tenn. “But with an FIA, clients stop the rider, allowing the account to accumulate in value and providing a higher income stream when the rider is restarted.”

Tim Barton, principal of Future Financial Images, Pepin, Wis., agrees, adding that the FIA’s ability to offer clients a choice between principal and indexed earnings is especially relevant in light of a key market statistic: 98 percent of annuities are never annuitized. The alternative offered by variable annuities, forgoing access to principal to secure the income benefit is tantamount, says Barton, to a “legal divorce” from one’s money.”

Doug Wolff, president of Security Benefit Life, Topeka, Kan., observes also that VAs with GLB riders must hedge against two risks: (1) outliving one’s income and (2) equity market volatility. Fixed indexed annuities, while hedging against longevity risk, correlate less than VAs with equity market values, thus reducing the cost of hedging. The result is greater product flexibility — and more appealing riders.

“The lower cost of hedging lets FIA carriers offer more compelling guaranteed living income and withdrawal benefits to consumers,” says Wolff, adding that most FIA buyers elect a GLB. Indeed, market research firm LIMRA, Windsor, Conn., observes that 71 percent of consumers opt for a guaranteed withdrawal benefit when available, which is most of the time: Most all (88 percent) of fixed indexed annuities marketed offer a GLWB.

Market transition

Given the superior performance of fixed indexed annuities since the downturn and the challenging of supporting variable products in current market conditions, more carriers are making the leap to fixed indexed annuities from VAs.

Among them: The Phoenix Companies, which offers two fixed annuities — Reflections Gold Bonus and Indexed Select Gold Bonus — that boast, among other features, a guaranteed lifetime income benefit; and Genworth Financial, which exited the VA market in 2011 and is spearheading its marketing push in the FIA space with a new CapMax crediting strategy.

“We felt we were better able to use our capital by investing in the commercial benefits of a fixed annuity line than by trying to compete in the VA space,” says Eric Taylor, a national sales manager for annuities at Genworth Financial. “Because the interest rate environment and hedging environment were becoming so challenging, we believed we had more commercial opportunities in fixed indexed annuity products.”

For more from Warren Hersch, see:

Report: delaying annuity income payments can boost payout by average of 9 percent