The investment annuity: New wine in an old bottle?

The variable annuity’s immediate attraction—at least for me, in the 1970s—was automatic rebalancing. I thought rebalancing was ultra-cool, and it was a blessing in that it was free. You had this collection of sub-accounts from top investment companies inside an annuity wrapper, and every quarter, you could have free rebalancing, putting all the investments back in line. If it were a non-annuity investment plan, a portfolio, with 10 percent of this and 20 percent of that, and so forth, it was tedious to rebalance, and it could be expensive, too, since even minor changes required transactions costs and new commissions. But there’s no need to worry when the investments are inside a variable annuity.

The second great thing about variable annuities was that they were designed to be used in retirement as a way to keep up with inflation because of unit-value participation in the stock market. It was believed in the 1950s that participation in the stock market was the sane way to keep up with the costs associated with inflation—this is not a new concept. There were two phases inside the variable annuity—accumulation and distribution. Accumulation units were used to accumulate for retirement and annuity units were used for the payout (one could split both kinds of units between fixed and variable in the original models). Variable units (investments) would “vary” based on market performance, and, thus, the annuities were variable annuities. 

While variable annuities still have units, they are not often mentioned; the emphasis for the last 15 years has been on guaranteed lifetime income, aka “living benefits.” Living benefits are relatively new—they gained traction in the late 1990s and took off like rockets in the early 2000s. The idea of a guaranteed lifetime income probably seemed like manna from heaven after people discovered that stock prices could go down. For a time, it was as if variable annuities had bulletproofed everything: Now there were guaranteed rates of return on income bases and future never-ending streams of lifetime income for one or two. The only hiccup was relatively high expenses, but even that seemed OK, given that the separately calculated income bases and lifetime incomes didn’t seem to have expense ratios themselves, other than a requirement that there be some money in the contract; if the cash inside the product got close to zero, some contracts could be “annuitized” and so still provide lifetime benefits. 

All-in expenses for many income-for-life benefits now hover around 4 percent yearly and contracts are now written so that down-the-road cost increases are possible. (A contrary opinion holds that few life insurers have yet had to actually use their own money to honor guarantees—most all annuities are probably still in the black and company claim reserves are relatively untouched. even so, with people living longer, a lifetime guarantee of income for two people, sometimes with death benefits added, are a significant long-term obligation.)