The annuity market continues to roll along. According to the LIMRA Secure Retirement Institute, total U.S. annuity sales were $177.7 billion for the first nine months of 2014, a 6 percent increase from the same period in 2013. Indexed annuity sales were particularly strong and were up 36 percent to $36 billion.
Investments only, please
Advisors with a few gray hairs will remember when variable annuities (VAs) were positioned as tax-deferred investment vehicles for clients who had maxed out their other retirement savings vehicles. The products had basic supplemental living and death benefits, but the emphasis was tax-deferred investment growth. The subsequent competition among insurers to offer more generous living benefits changed the market’s focus. Some observers, however, believe the products’ original intent is regaining momentum with the growth of investment-only VAs.
Earlier VAs’ investment options consisted primarily of sub-accounts managed by mutual fund companies with an emphasis on the major asset classes. In contrast, today’s investment-only products offer a broader range of traditional and alternative investments, giving advisors and investors more sophisticated portfolio construction options. Frank O’Connor, vice president of research and outreach with the Insured Retirement Institute in Washington, D.C., notes that investment-only VAs also generally have lower costs than products that offer living and death benefits.
These VAs’ strategies are generally outcome-oriented and can include an alternatives-based strategy, an inflation-defending strategy, and a rising interest rate-defending strategy, among others. “Those strategies often will include tax-inefficient asset classes such as alternatives and income, and those are well-positioned in the tax-deferred variable annuity,” he says.
Greg Cicotte, president of Jackson National Life Distributors in Denver, Colorado, points out that alternative investments often require accredited investor status, creating barriers to entry for less affluent investors. Investment-only VAs avoid the high-net-worth requirement, which gives more investors access to the strategies. The general idea, says Cicotte, is that the alternative investments have low correlations with the stock and bond markets and enhance overall diversification. “So, when the market goes the wrong way, a portion of your portfolio, hopefully, if they do what they’re supposed to do, goes the other way and balances out that rough ride,” he says.
The QLACs are coming
Guaranteed lifetime income for retired clients is the Holy Grail for many retirement advisors. In particular, advisors who advocate the income floor approach seek guaranteed incomes, including longevity annuities, to cover clients’ essential living expenses.
Immediate income annuities and deferred income (longevity) annuities are ideally suited for that role, but the required minimum distribution (RMD) rules hindered longevity annuities’ adoption in retirement plans. The Treasury Department’s July 2014 ruling on qualified longevity annuity contracts (QLACs) clarified how these products can be used in retirement plans to avoid RMDs. Purchases are limited: Investors can’t put more than the lesser of 25 percent of their non-Roth IRA funds or $125,000 in a QLAC. Also, the QLAC’s lifetime income distributions must begin by age 85.
Joseph Montminy, assistant vice president, LIMRA Secure Retirement Institute Annuity Research in Windsor, Connecticut, believes that the Treasury Department’s ruling could spur retirees’ interest in guaranteed lifetime income products. The QLAC market is likely to evolve slowly, he says, and probably won’t have a “huge impact on sales.” Nonetheless, QLACs will allow advisors to offer a “more complete retirement planning process,” he says.
O’Connor cites several factors that could contribute to QLACs’ adoption. First, baby boomers hold large amounts of assets in qualified plans and IRAs. As that cohort’s participation in traditional defined benefit plans declines, they are seeking lifetime income solutions, so the demographics favor QLACs. The product can also benefit insurance companies, he says. Longevity annuities have a different risk profile than, say, a VA with a living benefit. Selling QLACS can help the issuer diversify its product portfolio and risks.
Pay me later
Even before QLACs start selling in any appreciable quantity, the general category of deferred income annuities (DIAs) will continue to gain momentum, although sales are starting from a low baseline. LIMRA Secure Retirement Institute reports that DIA sales totaled $607 million in the third quarter, an increase of 21 percent from 2013. For the first nine months of the year, sales were up 35 percent to $2 billion, with the top three issuers accounting for 75 percent of sales.
Admittedly, $2 billion out of total year-to-date annuity sales of almost $178 billion isn’t going to set the world on fire, but DIAs’ emergence marks an important shift in retirement advisors’ thinking, says Montminy. Until recently, advisors focused largely on wealth accumulation. That’s still important, but the boomers’ transition to retirement has made retirement income planning more important for advisors’ businesses. DIAs and single premium immediate annuities (SPIAs) are the most efficient way to maximize income, he notes, so they continue to gain importance. SPIA sales support his contention: Year-to-date sales increased 30 percent from 2013 to $7.4 billion and could surpass annual sales records.
DIAs’ design is likely to evolve, as well, says Dan Herr, vice president of annuity product management for Lincoln Financial Group in Hartford, Connecticut. The products could be packaged with VAs, for example, which he sees as “a natural package of combining a variable annuity with the back-end certainty of a DIA product.” Such a combination would allow retirees to distribute their investment allocation over a certain period and manage their other assets over a defined period, such as to age 75, 85, and so on.
A smoother ride
The usual investment advice for retirees is to view their investments holistically by following a unified investment approach that considers all their holdings so they maintain the desired asset allocation and risk level.
VAs’ guarantees allowed investors to skew their VA portfolios toward higher risk investments, however. When the markets tanked in 2008, those portfolios dropped significantly, and insurers found themselves facing benefit promises that were much larger than the accounts’ values.
Managed volatility VA portfolios address that problem. With these investment strategies, investors’ accounts don’t go up as much as unconstrained accounts, but they don’t drop by as much, either. Approaches for implementing managed volatility portfolios vary. With a tail-risk strategy, for instance, the goal is to eliminate investment results that are far above or below the statistically likely outcome.
Less volatile results can help improve investors’ behavior by generating reduced volatility, says Herr. “So, [you] take out the highs and the lows and try to get a smoother ride for the investor so they are more likely to stay invested into the equities rather than getting out at the wrong time and in at the wrong time.”
The strategy hopes to accomplish this by managing to a volatility target. Volatility typically is a predictor of downswings in the market, he explains. The investment manager can use that information to reduce equity exposure in periods of high volatility or increase it when volatility is low. Managed-volatility VAs are gaining popularity. According to research firm Strategic Insight, assets in these strategies grew from $30.9 billion at year-end 2006 to $360.9 billion in June 2014. That translates to an annualized growth rate of 36 percent, and VAs account for 72 percent of managed volatility funds. That growth is likely to continue in the fixed index annuity market, as well, says Dana Pedersen, head of annuity product and development and pricing at the Phoenix Companies in Hartford, Connecticut. She estimates that roughly 30 percent of indexed annuity deposits are going into volatility-controlled accounts and believes that number will increase.
In a low interest rate environment, one way to provide consumer value, especially when it comes to living benefits, is to offer indexed accounts linked to volatility-controlled funds, she says. The dampened volatility gives the carrier more flexibility, she says. “That allows the insurance company to offer more attractive guarantees when it comes to guaranteed benefits or more attractive potential credited rates, caps and participation rates when you’re talking about an indexed annuity,” she says. “So I definitely think we’ll see further development in that space.
Tell me more
The annuity business has been criticized, unfairly in some instances, for being a bit behind the times when it comes to business analytics and customer service. For example, consider the use of big data in the wealth management industry. Investment firms and banks are spending large sums to implement big data-based changes in their businesses. It goes beyond number crunching; these efforts are aimed squarely at improving customer service and capturing a greater share of clients’ wealth.
The annuity industry is beginning to use more sophisticated technology to improve its service, as well, says Elizabeth Forget, executive vice president, MetLife retail retirement and wealth solutions in Charlotte, North Carolina. She cites MetLife’s recent hiring of a new analytical team to help analyze the client base, improve cross-selling and ensure that clients have the right types of coverage. “We, as an industry, have a ways to go, but I think there’s a lot of opportunity there,” she says. “Now that we’ve kind of shaken out from the financial crisis and the product pricing changes, I think people can turn their focus to that customer experience aspect and efficiency, and I think that will serve everybody well.”