Safe savings vehicles were a tough sell in 2010. Neither financial planners nor clients were eager to put money into bank CDs or money-market funds paying 2%, 1% or even less. Fixed annuities offered the same low yields, so it's not surprising sales tumbled last year-off more than 30% from 2009.
But two product lines in the fixed annuity category set sales records in 2010. Index annuities (up 6%) and immediate annuities (up 2%) both recorded modest increases over 2009, but they did reach the highest levels on record, according to Beacon Research in Evanston, Ill. As long as we're in a low interest rate environment, with baby boomers reaching retirement age and many clients leery of equities, those trends may continue.
SLUMP AFTER TEAR
Cathy Weatherford, president of the Insured Retirement Institute in Washington, is quick to point out that last year's fixed annuity downturn came after two exceptionally strong years. Fixed annuity sales fell steadily from 2004 through 2007, perhaps because a strong stock market had increased interest in equity-oriented investments, including variable annuities.
Fixed annuity sales soared from $107 billion in 2008 and $104 billion in 2009 from just $67 billion in 2007. With the markets in turmoil, Weatherford says a flight to safety by risk-averse investors helped account for the steep rise in fixed annuity investments. Indeed, the fourth quarter of 2008 and the first quarter of 2009-when stocks crashed-were by far the peak periods for fixed annuity sales. Even after a 31.2% plunge in 2010, fixed annuity sales were still higher than in 2007.
During that three-year period, though, the composition of fixed annuity sales changed dramatically. In 2008 and 2009, sales of traditional deferred fixed annuities were about $70 billion a year. In 2010, those types of fixed annuities registered barely $32 billion in sales, a decline of more than 50% from recent peak years.
With traditional deferred fixed annuities, consumers generally pay a single premium and receive a specified interest rate for a specified time period. Subsequently, an investor can renew that annuity at the issuer's new rate or exchange for a different annuity. With yields at historic lows last year, locking them in with a fixed annuity was unattractive.
Also, fixed annuity purchases were so strong in 2008 and 2009 that conservative investors may not have had much money left last year. "Interest rates increased in late 2010," says Jeremy Alexander, CEO of Evanston, Ill.-based Beacon Research, "and expectations that rates would continue to rise may have been a disincentive for investors to lock in rates."
Still, some clients continue to buy traditional fixed annuities. After all, 2% or 3%, tax-deferred may have more appeal than a similar yield from a taxable bank account. "On the fixed annuity front, our sales are about flat compared to last year," says Jacob Stern, CEO of Imeriti, an insurance wholesaling firm in Olympia, Wash. "We are seeing more sales of first-year bonus annuities."
That is, investors receive a supplemental interest rate during the first year of the contract, perhaps to offset a surrender charge incurred when moving from one annuity issuer to another. Stern also reports that many agents are selling fixed annuities with a six-year guarantee now.
Curtis Cloke, an investment advisor at Two Rivers Insurance in Burlington, Iowa, says he has been selling three- and five-year fixed annuities to some clients, with yields of a bit more than 3%. According to Gary Baker, president of Cannex USA, a Springfield, Mass.-based financial services research firm, some investors continue to put some money in fixed annuities as part of a laddering or bucketing strategy that calls for holding a series of these contracts, with guarantees expiring each year for seven to 10 years.
ON THE UPSWING
While traditional fixed annuities are down and probably will continue to lag until interest rates rise, index annuities continue to show slow but steady growth. From 2007 through 2010, sales increased by a few billion dollars each year, to $31.4 billion in 2010, a shade below the total for traditional fixed annuities.
Sheryl Moore, president of AnnuitySpecs.com, in Mount Pleasant, Iowa, projects that index annuities will soon pass sales of traditional fixed annuities and narrow the sales gap with variable annuities. "Sales of index annuities are going to increase exponentially," she argues, "because of continued, historically low interest rates and consumer buying behavior shifting due to the recent collapse of the stock market."
Even though stocks are two years past the last bottom, the memory of the crash continues to encourage purchases of fixed annuities, including index annuities. "People have been recently reminded that it feels uncomfortable to lose money," Moore says. Every time the market declines, consumers flock to fixed and indexed annuities.
She adds that the safety and guarantees of these products make them the natural beneficiaries of this change in buyer behavior. "Many people are willing to give up the chance for stock market-type returns in exchange for guarantees."
As the name suggests, index annuities have returns that derive from index results, generally stock market indexes such as the S&P 500. Index annuities might produce higher returns than traditional fixed annuities, but can also deliver zero returns or even a loss.
Aren't they more difficult than traditional deferred fixed annuities to explain to clients? "No," Moore responds. "Index annuities are just fixed annuities with a different way of crediting interest."
Typically, index annuities credit interest based on the return of the relevant market barometer. There's usually a ceiling, so index annuity buyers might not get a 20% return if the markets surge 20% one year. There's also a floor, so $50,000 invested in an index annuity probably won't become $35,000, which was the fate of some stock market investors in 2008. There are many ways to set the floor and ceiling, though.
Stern, who says index annuities sales have picked up, cites Lincoln Financial's New Directions as an example of an index annuity that's selling well. A look at the 12-page promotional brochure reveals how an index annuity can be structured and how an insurer explains this product to advisors as well as to clients.
This fixed annuity offers three options from which investors can choose; premiums can be split among two or three options or concentrated in one. Option One is a traditional fixed annuity, with either a six- or eight-year interest rate guarantee.
Option Two has an either/or payoff, credited at the end of each one-year term. In the brochure, the illustrated annual interest rate (5%) is higher than the rate (3.5%) for the traditional fixed annuity. Thus, if the S&P 500 is flat during the one-year period specified in the contract, the client would have interest credited at 5% for that year. An initial $30,000 investment would have an account value of $31,500, for example. If the S&P 500 goes down that year, the investor would not get any interest credited but the account value would remain at $30,000.
With Option Three, there is no specified interest rate, and the measurement period is two years. On each two-year anniversary, interest will be credited to match the rise of the S&P 500, up to a specified ceiling. (The brochure shows a 15% credit for the first two years.)
If the S&P 500 is down over those two years, there is neither a gain nor loss in the account. The bottom line is that investors can't lose as long as they hold on for the six- or eight-year term, but they might get higher returns than offered by the traditional fixed annuity if they choose one of the index options and the stock market does well over the next six to eight years.
The brochure also states that a nursing home and terminal illness benefit is built into this index annuity. "We're starting to see these senior living riders in fixed annuities," Weatherford says. "They allow individuals to tap into their money for needs such as long-term care." Charges will be waived for such withdrawals, perhaps with a one-year waiting period before such a benefit takes effect.
Lincoln Financial also takes three pages of its New Directions brochure to explain a living income benefit that's available for an extra charge of 0.4% a year. This feature is very similar to the guaranteed lifetime withdrawal benefits that variable annuities have offered for several years. Such living benefits are increasingly offered on fixed annuities, especially index annuities.
"More agents are speaking about income needs and changing the conversation away from interest rates," Stern says. "So index annuities with strong income riders are selling well."
LOOKING FOR CASH FLOW
Immediate annuities are now known as income annuities, at least to many research firms and planning associations. They are included among fixed annuities, where they account for a bit more than 11% of sales: $8 billion last year out of the nearly $72 billion Beacon Research reported for fixed annuities. Income annuities also had record sales last year, as retiring boomers' desire for lifelong income apparently outweighed the relatively low interest rates used for payout calculations. Income annuities, like index annuities, benefit from growing consumer interest in guaranteed lifetime retirement income and downside protection.
"Many reps are often scared to sell income annuities," Alexander reports. "They think clients will say that putting money there is a crazy idea. In reality, though, reps who suggest income annuities often find that clients love them. After they retire, clients are happy when they receive that check every month."
More advisors are looking at immediate annuities now, Baker adds, because clients are finding they need additional cash flow in retirement. "A planner might recommend that clients put enough money into fixed income annuities to guarantee coverage of essential expenses," he says. "They can get that kind of cash flow with an investment one-third to one-half less than it would take to do the same thing with a systematic withdrawal plan."
In recent years, immediate annuities have acquired some supporters, but doubters remain. One drawback-clients may be reluctant to relinquish assets accumulated over a lifetime, even in return for lifelong cash flow during retirement.
In response to such concerns, some annuity issuers have introduced liquidity features that can provide access to money invested in an immediate annuity if the need arises. "Liquidity features are nice to have," says Keith Golembiewski, director of annuity product development at The Hartford, in Simsbury, Conn. "They can help when an advisor is explaining the product to a client."
But Golembiewski says most clients do not choose the liquidity features because they reduce the annuity's payout. "In practice, most income annuity buyers choose a period-certain or cash refund annuity," he says. These choices overcome a key objection to immediate annuities-What happens if I get hit by a truck tomorrow?-by ensuring that a beneficiary will receive ongoing income in case of an annuitant's early death.
Cloke, co-founder of thriveincome.com, finds a relatively new wrinkle on the immediate annuity to be valuable-a deferred income or delayed income annuity. Like an immediate annuity, clients pay x dollars to receive y cash flow. However, buyers of these annuities agree to wait at least 13 months and usually many years before the cash flow begins.
"The internal rate of return on a deferred income annuity tends to be greater than the IRR on a deferred annuity that is eventually annuitized," Cloke says. "When included as part of an overall plan, a deferred income annuity can provide valuable longevity insurance."
A 65-year-old buyer might be able to count on an annuity at age 80 or 85, reducing the risk of running short of cash as he or she grows older. With the oldest baby boomers reaching 65 this year, starting Medicare and eyeing Social Security, planners may find an increased interest in products that can keep cash flowing during a long and hopefully prosperous retirement.
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