The annuity market is changing rapidly. Investors interested in any type of annuity or that already own annuities need to be aware of the changes. They also need to stay informed of what’s happening in the market, because more changes are likely.
One major change is insurers dropping out of annuity markets. Both fixed and variable annuity markets have seen some insurers stop offering products. Many insurers have decided they don’t want to offer a full menu of products or try to offer something for every consumer. Instead, they’re dropping products that don’t generate enough return on investment or for which they’re minor players in the market. The buzzwords among insurers are streamline and focus.
Low interest rates also are a problem. Fixed annuities are less attractive to consumers because of low yields. Some insurers are dropping the products, because there isn’t enough demand at current rates. They’re also finding it difficult to pay for promises they made in past annuity contracts because interest rates have fallen so much.
Low interest rates make it expensive for variable annuity providers to offer living benefits and other features that attract consumers. Recently withdrawing from the variable annuity market partially or completely were Genworth, ING, and Ameriprise.
The three major variable annuity providers now are Prudential, MetLife, and Jackson National. They combine for about 20% of the market and made about 40% of new sales in 2010. You should expect that in the next few years available variable annuity offerings will concentrate in these companies and a few others.
Other changes are afoot in variable annuities. Some insurers who remain in the market changed their policies in ways that are adverse to consumers.
Variable annuity owners are finding they have fewer investment options. During the boom period, insurers often tried to offer as many investment options as they could. In the last year, however, a number of insurers quietly reduced the funds offered in their variable annuities, even for existing annuity owners. Some major insurers closed dozens of funds in their variable annuities. ING closed about one third of the funds available in one of its annuities.
The funds that are closed generally are those that are actively managed or invest in assets other than straight stocks and bonds, such as traditional inflation hedges. One reason for closing funds is to reduce the costs of administering the annuity. Another reason is to efficiently provide living benefits and other guarantees. To provide the guarantees against losses, insurers have to hedge against market declines. Hedging is easier and more efficient when investors invest in funds that track a major index that has a big, liquid hedging market. In the 2008 crisis, insurers found that hadn’t hedged well against losses in actively managed funds that differed greatly from an index, especially in funds that took more risk than major indexes. Inflation hedges also can be difficult or expensive to hedge, especially when inflation expectations are rising. So, insurers are trimming variable annuity offerings to those that closely match indexes and that are easier to hedge.
Insurers also are reducing one of the features that sustained variable annuity sales the last few years: living benefits. After several years of increasing these benefits, some insurers are reducing them.
The most popular living benefit by far is guaranteed minimum income benefit (GMIB) or guaranteed minimum withdrawal benefit (GMWB). There are many variations of GMWBs, as I’ll call them, but here’s a sample. You’re guaranteed that after a minimum period of years, usually at least 10, you’ll be able to withdraw annually for seven years 5% of your contract value, and after that 4% annually for life. The initial withdrawal is higher (up to 10% on some policies) when you begin the withdrawals after a longer accumulation period. The withdrawal rate can be reduced below 4% once you withdraw more than the entire account.
The GMWB sounds similar to owning a variable annuity for years, and then using it to purchase an immediate annuity to generate income for life. The difference is the GMWB also guarantees the account value. Traditionally the guarantee was of the initial investment or the highest value on the policy’s anniversary date. More recently, insurers guaranteed a minimum growth rate of the initial investment of 5% or so annually. It’s usually a simple rather than a compounded growth rate. This guarantee costs you an annual fee, of course, and some insurers base the level of the fee on the riskiness of the investments you select. Invest in higher risk assets, and your fee will be higher.
In recent months, however, some insurers have reduced the GMWB terms. Low interest rates are part of the reason. Insurers can’t guarantee 5% or higher returns when market interest rates are so low and likely to remain so. Some also are stretching the initial period you have to let investment returns accumulate before qualifying for guaranteed withdrawals. The reductions generally apply only to new annuity purchases but are so significant that at the 2011 Insured Retirement Institute’s marketing conference in February financial advisers said they were reconsidering recommending variable annuities. According to Investment News, “The advisers on the panel said that the reduction in living benefits, along with higher fees, ultimately might force them to stop recommending variable annuities to clients.”
Another change is short-lived offerings of attractive policies. Insurers now want to limit their exposure to the risks of guaranteed benefits, so they make some policies available only for a short time. Often no closing date is announced. To combat this approach, it’s best to decide what you want in an annuity and be prepared to commit to a policy when you learn one with those features is available.
One bit of good news in annuities is the introduction of variable annuities using only ETFs as the investment offerings. Since ETFs have lower fees than traditional mutual funds, the lower fees pass through to the buyer. While still not cheap, an ETF variable annuity decreases total average costs from around 3.5% for an average annuity to closer to 2.5% of assets each year.
For complicated tax reasons, an all-ETF variable annuity can be purchased only through retirement accounts such as IRAs. The first such annuity is offered by Western & Southern Financial Group and is called Varoom (Variable Annuity for Roll Over Only Money). It includes 18 ETFs from Vanguard and iShares.
The annuity also includes a living benefit. The benefit varies by age. A buyer who is 55 may withdraw 5.5% of the benefit base annually for life beginning at 65 or 6.5% at 70. The benefit base is the original investment increased by annual gains that increase the account value. The base once established isn’t reduced by losses.
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