For much of the past decade, variable annuities were “destination” products for clients’ retirement-oriented dollars, and with good reason. Variable annuities gave the vast baby boomer generation, then pre-retirees, market-linked accumulation potential, provided generous lifetime riders that limited downside risk through guaranteed benefits, and maintained liquidity.
The variable annuity benefit capability, however, is altered today as a result of volatile equity-market conditions combined with the historically low interest rate environment. In the face of skyrocketing costs for hedging, various firms have exited the variable annuity business altogether. Remaining competitors generally have scaled back (and/or increased the price of) the lifetime guarantees offered in their variable products.
For more coverage from our 2013 boomer survey, visit www.LifeHealthPro.com/BoomerSurvey.
With more modest and expensive lifetime income guarantees, many variable annuities have moved closer to their originally intended purpose of providing powerful tools for accumulating retirement assets. Importantly for advisors and clients, this repositioning of variable annuities has paved the way for a more rational, financially responsible spectrum of annuities in which the roles played by different products are more clearly delineated and more easily matched to the client’s stage of life.
The contemporary annuity continuum
Variable annuities — which pair income guarantees, liquidity and potential for asset growth with the possibility of market-induced downside risk protection — anchor the more aggressive end of the guaranteed retirement income spectrum. At the opposite end are deferred income annuities (DIAs) and single-premium immediate annuities (SPIAs), characterized by strong income guarantees and stable account values but little or no liquidity and no market-related growth potential. The former clearly have a place for clients still in the retirement-accumulation phase of life, and the latter should appeal to the more risk-averse clients and those squarely in the decumulation phase who seek income they cannot outlive.
Neither, however, may be desirable to many boomer clients, given their stage of life and the present macro environment. With portfolios battered by, and barely recovering from, two stock market crashes in less than a decade, boomers in or approaching the early years of retirement continue to need income growth potential yet cannot afford to sacrifice principal protection for growth. This need for growth, combined with the relative illiquidity of income annuities, may make DIAs and SPIAs a difficult sell to boomers. Variable annuities, however, may be too volatile for these clients and provide too little guaranteed income.
Spanning the gap between these two product groups is a new generation of fixed indexed annuities (FIAs) with riders that guarantee lifetime income. Like DIAs, FIAs guarantee specific future payout levels that (generally) are higher than those guaranteed by variable annuities. Like variable annuities, the account values in FIAs are accessible and provide the potential for increasing account values and future payouts over time — in the case of FIAs, via crediting options linked to performance of a financial market index and, in most FIAs, a fixed account option as well.
Perhaps most importantly for boomer clients, contemporary FIAs with guaranteed living benefits entail little to no market-related tail risk (as compared to variable annuities). The bulk of the premiums are invested in the insurer’s general account, which gives the insurer greater control over the assets and makes account values less volatile. Only a small portion of premiums is exposed to the equity market, so the insurer’s hedging efforts are centered more on longevity risk, which is predictable with a fair degree of accuracy, and less on market risk, which can be highly unpredictable. Easily estimated by actuaries, longevity risk is less costly to manage, and the cost savings can be passed along to consumers in the form of more attractive and/or lower-cost benefits, including lifetime guarantees.
A more complete solution set
Recent modifications are returning variable annuities to their originally intended use as liquid vehicles for accumulating retirement assets. The income annuities continue to offer a much needed choice for principal protection and a generally higher guaranteed income once clients enter the payout/asset drawdown phase of retirement. And the advent of FIAs with lower costs and stronger lifetime benefits is a timely and appropriate response for the large cohort of boomers who stand somewhere between asset building and asset spending. Given the size of the boomer market and the number of years till the last of them are firmly entrenched in the decumulation phase, FIAs deserve consideration in many advisors’ solution sets.