A year ago it was hard for me to keep variable annuity (VA) wholesalers out of my office. The features offered by various insurance companies would change so rapidly that I’d have to take meetings to stay up-to-date.* There was essentially a competition between insurers to load more and greater guarantees onto their products to attract the most new money. But when the stock market started collapsing, the reaction by insurers was very interesting. You see, a large number of annuity contract holders never use the guarantees they pay for. The rider expenses and other fees paid by contract holders which provide them the peace-of-mind they are looking for also keep the insurance companies running profitable businesses. When many contracts became worth dramatically less than the initial premiums, insurers had to hope that there wasn’t a rush to exercise those income benefits, which could have potentially put some insurer’s VA divisions out of business. Not only was each insurer’s ability to ‘hedge’ well enough to pay their riders in question, but their overall balance sheets, in many cases full of bonds and other investments were also cracking at the same time. The snowball effect can lead to ratings cuts which ultimately leads to broken trust and confidence by investors.
A few months ago the government opened up TARP to several insurance companies, giving contract holders a breath of fresh air. At the end of the day, insurance is a game of trust, and if your insurer goes bust you may not get what you paid for.
So how have the surviving VA providers reduced their risk? Primarily by cutting living benefits and/or altering withdrawal rates. According to data from Advanced Sales Corp., in Oakbrook Terrace, Ill, 158 product changes were filed with the SEC since November, 2008. One strategy used by insurance companies is to force investors into certain fixed portfolios controlled by the insurance companies, rather than allowing investor’s to self-direct the investments in their annuity sub-accounts. Raising fees has been a popular method of protection as well. An income rider which cost .95% last year may cost 1.2% this year. While that may not sound like such a big deal, it is. Annuity expenses are usually annual, and .25% shaved off your return over 20 years can cost a bundle.
Finally, withdrawal rates are getting cut. For example, last year many insurance companies were offering 7% annual withdrawals from contracts without penalty. This would allow the owner of a $300,000 contract to pull out $21,000 annually, a nice supplement to income. Those withdrawal rates are starting to drop closer to 5%, or $15,000 on a $300,000 contract. They’re also raising the age in some cases at which clients can withdraw a larger percentage of income, sometimes from 70 75 or 75 80. The bottom line here is more restricted access to contract holders.
So where do we stand on this today? Variable annuities can still be an important part of a retiree’s investment portfolio. The difference today would be that a greater level of due diligence is necessary when determining what percentage of a client’s total assets to put inside insurance contracts. Monitoring costs and showing clients the differences between putting money in a variable annuity vs. a mutual fund portfolio vs. a brokerage account is essential.
*Guarantees are based on claims-paying ability of the issuer. Surrender charges may apply. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. The investment returns are principal value of the available sub-account portfolios will fluctuate so that the value of an investor’s unit, when redeemed, may be worth more or less than their original value. Optional features may involve additional fees. Living benefit riders are available at an additional cost and have restrictions. Limitations may be subject to age, state and a restricted list of fund and asset allocation models.
Investing in mutual funds involves risk, including possible loss of principal.
Securities and certain investment advisory services offered through: First Allied Securities, Inc., a registered Broker/Dealer. Member: FINRA/SIPC. Premier Financial Advisors, Inc. is a Registered Investment Advisor. First Allied Securities & Premier Financial Advisors are not affiliated entities.