Annuities changed a lot in the last year. If you’re considering an annuity based on what was available a few years ago, you aren’t likely to find the features you’re looking for. Even many of those who own annuities are likely to have seen changes in their contracts. Low interest rates, volatile equity markets, and longer life spans all took a toll on insurers.
Even plain vanilla annuities saw some changes. A few insurers stopped offering new immediate annuities, the ones that begin paying a lifetime of income soon after their purchase. With investment return so unreliable and life expectancy increasing, they were concerned about profitability. Some insurers stopped offering fixed deferred annuities while others reduced or eliminated their minimum guaranteed annual return on the annuities.
The major changes were made in the more complicated products: variable annuities and indexed annuities.
Variable annuities essentially are portfolios of mutual funds wrapped in the tax deferral of an annuity.
Several features propelled Variable Annuity sales during the 2000s. Investors could choose between a wide range of mutual funds. The value of the account rose and fell with the performance of the funds selected by the owner, but many annuities guaranteed either minimum lifetime income or a minimum account value regardless of investment performance, or both. Investors paid extra fees for these guarantees. All that has changed or is changing.
The investment menus of many variable annuities are trimmed. Insurers used futures and other derivatives to hedge the guarantees in the contracts. In the financial crisis they found that hedges often aren’t available or don’t match the performances of the funds they offered. When a hedge doesn’t cover the losses, the insurer has to make up those losses.
Some insurers stopped offering the guarantees on new policies. Other insurers decided to limit variable annuity portfolios primarily to index funds that track a liquid index that has economical hedges available. Many insurers eliminated from their menus actively managed funds and funds that invest in market niches.
Insurers also are limiting the asset allocation choices in VAs. The logical strategy for an investor with a guaranteed lifetime income or account value is to select the most aggressive investment choices. You aren’t concerned about potential losses, because you have the guarantee. You want to maximize the potential upside.
Insurers take the opposite view, and many won’t let annuity holders swing for the fences any more. Some VAs now limit the percentage of the portfolio that can be invested in equities. Some go further. MetLife has a new annuity that lets the owner choose from only four diversified portfolios. Hartford has an annuity that lets the owner choose how half the account is invested among the fund menu. The other half is invested in a diversified portfolio managed by Hartford.
Keep in mind the limits apply to annuities with guarantees. You’re likely to find more investment options in a variable annuity without the guarantees.
Indexed annuities peg their interest income to a stock market index but limit the return to something much less than the index return. They also generally guarantee no losses and might have a minimum return guarantee or so.
The guarantee, however, usually applies only to a maximum 87.5% of your account value. Your account’s return above the guarantee, if any, is based on the behavior of the stock index to which your account is indexed. We discussed the mechanics of how the indexing works in past visits, and these are available in the Annuity Watch section of the Archive on the members’ web site.
One change to indexed annuities is an improvement: some flexibility in the indexes. Traditionally, the insurer chooses the index to which the account is linked and could change the index with few limits. Now, there are indexed annuities that let the account owner choose from among up to six indexes. Some even allow the owner to change the choice annually and to have different portions of the account linked to different indexes. Choosing and managing the index can increase the returns of your account. For example, small company stock indexes tend to perform better in bull markets than large company indexes. You might want to be tied to the more aggressive, volatile indexes available when you anticipate a good market and be more conservative at other times.
Indexed annuities also have been adding some optional guarantees similar to those on variable annuities. You can choose a guarantee for minimum death benefits or minimum lifetime withdrawal benefits. I suspect these are a bad choice for an indexed annuity.
The indexed annuity already has guarantees. You shouldn’t need additional riders. In addition, an indexed annuity is a low-to-moderate return investment. Though returns are tied to stock market indexes, the portion of the index return that will be credited to your account is limited. The additional guarantees mean additional expenses will be deducted from your account, further reducing the return. In fact, there might not be enough income in bad stock market years to offset the expenses. That means your account will decline in value despite the guarantees. Before choosing one of these riders, be sure you understand how they work and what will happen to your account under different scenarios.
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