Washington is not the only place that has gone conservative over the past few years. Consumers across the nation are turning to annuities primarily to conserve principal and less so for income or market gain.
That was one of the key findings from LIMRA Secure Retirement Institute’s Annuity Buyer Metrics 2016 report. The study focused on data from annuity companies and surveys charting changes in buyers’ investment objectives over three years, 2014-2016.
The researchers’ focus on objectives was natural considering the ongoing pressure to advise clients holistically rather than sell products, said Joseph E. Montminy, assistant vice president, LIMRA SRI. The Department of Labor’s fiduciary rule is only the latest manifestation of the drive for a needs-first approach.
The respondents were assessed on four objectives: income now, income later, principal protection and market growth.
The results yielded not only a greater understanding of what drives annuity buyers today but also perhaps some insight as to why the annuity market has been shifting so dramatically over the past few years.
Two objectives associated with variable annuities have dropped significantly over the period, closely tracking the slide in VA sales.
The first objective is income later, which LIMRA linked to VAs with riders such as the guaranteed lifetime benefit (GLB), fixed indexed annuities with GLBs and deferred income annuities.
“VAs make up probably around 60 percent of the income later, and the indexed annuities make up almost 40 percent,” Montminy said of annuities sold to consumers principally interested in income later. “The deferred income annuity is a really small percent. So it is really the VA and the indexed that’s driving that category.”
The other objective is market growth, which is associated with VAs that don’t have withdrawal riders.
Although the drop in these objectives mirrors the decline of VA sales over the same period, the decrease in sales might not be completely attributable to the shifting objectives. Insurance companies had been easing off VAs since the 2008 economic crash, largely because of the difficulty sustaining riders.
“GLB sales are down almost half of what they were about five years ago,” Montminy said, adding that the age of the typical GLB buyer nevertheless has been consistent at around 63 for at least the past 10 years.
Another significant factor is the DOL’s fiduciary rule, which placed VAs under the more onerous best interest contract exemption standard.
The rule also was cited as the reason the FIA market cooled off toward the end of 2016. FIAs were not placed under the BICE standard until the rule’s final version was released last April. The rule’s applicability date had been postponed to this June 9. As this edition went to press, no further delays were apparent.
The principal preservation objective steadily climbed during the period. LIMRA associates that objective with FIAs without GLWBs, fixed-rate deferred annuity sales and VAs with a guaranteed minimum accumulation benefit.
Although FIA sales grew substantially in those years, fixed-rate deferred annuities made up a majority of the principal preservation sales.
“They make up just under six out of every 10,” Montminy said of the deferred annuity sales. “That’s really what is driving much of the change. A lot of that was because we had a large block of business that came out of surrender charges from sales that occurred back in the market crisis in 2008-2009.”
That flight to safety amid the collapse carried those buyers to the relative stability of 2016. When those surrender periods ended, that money sought a new home. It found that home largely in new fixed-rate deferred annuities, which featured rates that compared well with certificates of deposit and other safe money.
“We saw a huge spike in fixed-rate deferred sales, particularly in the first half of the year,” Montminy said. “We also saw some small pockets of a flight to safety, especially in the first quarter of 2016 when there was a lot of market volatility.”
The “income now” objective was steady through the period, along with the immediate income annuities associated with that objective.
Although the burgeoning retirement-age population fuels a need for immediate income, Montminy suggested that persistently low interest rates could be dampening demand.
“Interest rates hit record lows in the middle of 2015,” Montminy said. “As interest rates continue to rise, you are going to see that market continue to grow over the next two years not only because the higher interest rates get more income, but also because of the larger demand. There are a lot more retirees who need to generate their own personal type of pension plan.”
Pensions Not Dead Yet
The concept of creating a personal pension has been growing in popularity the past few years, but that does not mean traditional pensions are extinct.
The conventional wisdom is that few Americans have pensions, and they are left to their own retirement devices, apart from Social Security. But The American College regularly studies how many Americans have traditional pensions and found the percentage surprisingly high.
David A. Littell, a professor and researcher at the college, said a recently
concluded financial literacy and asset study of people between 65 and 70 found that 75 percent had a pension. Although that percentage is high, it is down from 80 percent in 2014 — indicating a rapid drop in pension-holders. The survey respondents had at least $100,000 in assets.
“When we talk about people buying income now, the pensions even affect the marketplace,” Littell said, adding that it even affects deferred income annuities. “I was at a meeting with a bunch of different companies where they were talking about adding DIAs as an option in defined contribution plans. They said the take-up rate was really low. Part of that was just, still we are in this environment where we haven’t switched over. The people retiring today are still not those people who have only Social Security and no other income.”
The situation might change quickly for deferred income annuities because the buyers’ average age is 59. But immediate annuities might be suppressed for a while because the average age of a single premium immediate annuity buyer is 72, Littell said.
Still, the lack of interest in simpler annuities is a reflection of unwise planning, said Littell, who is also co-director of the college’s New York Life Center for Retirement Income.
“The deferred income annuity product is a good way to reduce your risk as you are approaching retirement, versus just moving it to bonds to buy income at that point,” Littell said, adding that more consumers are buying annuities with qualified money.
In Littell’s own case, he wanted the deferred income aspect of an annuity but not the date certain. The 63-year-old expects to retire in a few years and will likely work part time, but he’s not sure for how long.
So, he joined the growing ranks of FIA owners — not only because of the flexibility of a withdrawal benefit rider. He is an educated consumer who looked at the contract details and liked what he saw.
“The chances of the income beating a deferred income annuity were pretty good,” he said. “So, even if the market didn’t do well, I was going to end up at about the same place.”
At the Center for Retirement Income, he makes certain financial and insurance advisors realize the value DIAs and FIAs with riders provide. But part of the challenge is drawing advisors out of their comfort zones.
“My experience with advisors is that many of them have a product line that they’re comfortable with, and they are not equally comfortable with all the different options,” Littell said.
A particular area of discomfort for some advisors is the perception of inflexibility, the opposite of what attracted Littell to his annuity.
“The deferred annuity offers the promise to annuitize as specified with the mortality table, with some kind of guaranteed interest,” he said. “Plus, if you don’t like the price when you’re going to annuitize, you just do a 1035 exchange. So it does lock you in to an opportunity, but it doesn’t lock you in if you can get a better rate somewhere else.”
He also preaches the value of variable annuities, having bought a low-cost one himself as a tax strategy when he received a small inheritance. He’s pretty happy with the terms of the contract, so he expects to do with his annuity what a lot of consumers usually do not — actually annuitize.
“Now when it comes time to annuitize from that product, the payout rate is substantially higher than the current market rate because of the promises in that contract,” he said. “I can actually add money to that contract and still get the same promise.”
And that ought to make the insurance company a little nervous, because Littell’s father lived to 104. Longevity is a key reason why Littell and many other experts argue that failing to advise clients on the value of annuities is not protecting consumers’ best interests.
In fact, ever-expanding longevity might even undermine the argument against locking in an annuity in a low-interest- rate environment. Although Littell does admit that the low-interest-rate argument sounds compelling.
“That’s certainly the challenge,” he said. “But I think that sometimes it’s overblown. Mortality tables will probably continue to extend. Annuity costs may not ever be cheaper. It’s quite a promise for an insurance company to guarantee income for life. They might get more gun-shy over time.”
Littell said the greater insurer exposure with longevity reminds him of the long-term care insurance market, which is still grappling with policy pricing and sustaining contracts.
Littell’s father got considerable value out of an annuity he bought in his 80s, an age that raises a few eyebrows among advisors and regulators considering suitability and fiduciary duty. But few could argue that it was a bad deal if a client lives to be 104.
“He was worried he was spending down his money in his 80s,” Littell said. “He had plenty of money, but the whole idea of spending down freaked him out. He was in a retirement home and he wanted to make sure they didn’t kick him out. So, he bought an annuity to pay his retirement home bill, which let him sleep at night. Every year or so he announced that he had to live a little longer to get his money’s worth. So he did — he got his money’s worth.”
Safety and Security First
Now that Littell is in the retirement-planning frame of mind himself, he finds himself tracing his father’s careful footsteps.
“I’ve been buying income,” Littell said. “Certainly not anywhere near all of my assets, but I want the security that there is income for life. That, and it allows me to take more risks with my other portfolio.”
And there is plenty to be said for the peace of mind his father sought, according to data.
“There is a fair amount of research showing that people are happier when they have more income in their retirement,” he said. “People enjoy spending their income, but they don’t enjoy spending their assets. Like with my father — he still had a lot of money, but the idea that it was going down was disconcerting.”
That all figures into a concept that Littell teaches in the Retirement Income Certified Professional program. Basically, it’s a flooring strategy.
It’s a safety-first approach that considers the most important expenses first. That’s where low-risk products, such as income annuities, would be called for. Some advisors who don’t like annuities prefer a bond ladder, but Littell said that does not address the longevity risk.
“The flooring approach is clearly a common strategy,” Littell said. “Especially with people who come from an insurance background, who are more focused on and aware of risk assessment and risk management. There is a lot of academic support for the role of some annuitization both for the psychological and portfolio value as well.”
Littell suspects qualifying lifetime annuity contracts (QLACs) could be a bigger player in coming years. They allow consumers to buy an annuity with qualified money but postpone the required minimum distribution from age 70½ until age 85.
“A QLAC can end up providing wealth protection,” he said. “If you take a small sliver of your assets and buy an annuity, distribution will start at a much later age. That protects your wealth and protects your legacy. We think of annuities as a trade-off between income and wealth. But you really could argue that if you died young, you’d give up a little bit of wealth with a QLAC; but, because it’s a sliver of your assets, you’re not giving up a lot. If you live a long time, you’re probably going to leave a lot more to your heirs.”
Annuities represent a clear value to consumers, but that is not clear to consumers. In fact, according to The American College’s financial literacy surveys, nothing about annuities is terribly clear to consumers.
“When we test people’s knowledge on a wide range of retirement income planning issues, they perform the worst on annuity knowledge,” Littell said. “We asked the simplest possible question you could ask about annuities. It was something like, ‘If you took 20 percent of your portfolio and bought an annuity, would that give you a better chance of being able to meet your basic expenses for retirement?’ Only about a third of them got that right.”
Even consumers who had annuities weren’t sure of what they had.
“I did also ask a hard question, which was a little unfair,” Littell said. “But so many people have purchased variable annuities with GLWBs, so I asked, ‘If you had one of those and the account balance went to zero, would you still get any income?’ I wasn’t expecting good performance on that one, but a lot of people have them and they don’t know what they have.”
Littell said he makes the case to advisors that they have an obligation to explain the products and their role in planning. They should be explaining not just how annuities work, but how much they cost.
“And people should know that if you’re 65 years old, the payout rate on an immediate income annuity is about 6 to 6½ percent,” Littell said. “So basic things like that, we should be communicating to people.”
Still Leery After All These Years
Part of the annuity illiteracy even among more sophisticated consumers might have something to do with the significant resistance to the products within the financial advisor community.
“If you have been primarily handling someone’s investments and now you are doing the accumulation planning for that person,” Littell said, “you probably have a lot to learn because you’re not practiced in risk assessment and risk issues.”
Retirement carries varied risks with it, and a guaranteed income protects against many of them, he said.
» Market risk. The financial crash of 2008 was a reminder of that risk.
» Excess withdrawal risk. “Which just means that you didn't do any planning done, you didn’t have planning, or you didn’t follow the plan. You spent more than you could afford. Guaranteed income gets rid of that problem.”
» Uncertainties risk. “You want a diversified portfolio to address inflation, to address the uncertainties. You need some liquidity. Tax laws and public policy change. You need the flexibility to change course.”
» Long-term care risk. Americans are living longer. They also are more likely to live in expensive assisted living facilities or require other care.
» Financial abuse risk. “It helps you with all of these issues around frailty and aging where you have less capacity to make complex decisions. It even protects you against your kid stealing your money if you’re only getting a monthly check.”
Littell said education such as the RICP program helps break down barriers between financial disciplines.
“When we started the program in 2012, we talked a lot about seeing too many different retirement income planning approaches based on people’s financial model,” Littell said. “Some people refer to that as kind of the siloed approach, depending on how you get paid.”
Littell was alluding to the commission- based vs. fee-based compensation battle. But the silos are breaking down.
And it is not just education programs smashing silos. It is also becoming a good business model.
Chris Harclerode has a niche within a niche in Jacksonville, Fla., as the senior vice president of annuity sales at a life insurance marketing organization catering to financial advisors. He is the go-to guy for thousands of advisors looking to understand the annuities that their clients are asking about.
It just so happens that the advisors and their clients are right in line with a principal reason consumers like annuities.
“They’re just looking for a conservative vehicle with principal protection,” said Harclerode, a partner at Pinnacle Insurance & Financial Services. “These financial advisors have been reading stuff in the press about how popular fixed indexed annuities are, and they really never ever sold them. And their customers are saying, ‘Hey, I’ve been reading that a fixed annuity with principal protection has the potential to have a better interest rate than CDs. Tell me more about it.’”
Harclerode and his independent marketing organization occupy that demilitarized zone between insurance and finance, where advisors want to
incorporate life insurance and annuities but don’t know how to tread in this formerly hostile landscape. Call it a truce or a new alliance, but the IMO is finding it is very good to be Switzerland.
The IMO partners realized several years ago that with tightening regulations and market pressure, getting individual agents was becoming more difficult and time-intensive. So, they started focusing on independent broker/dealers. As they scoped out that space, they happened to find an even bigger opportunity than they expected.
“About eight years ago, this one guy says, ‘Man, our insurance platform at our broker/dealer is a disaster,’” Harclerode said. “Then we said, ‘OK, we can be your insurance platform. Our whole operation can be the back office for your financial services platform — for life insurance, annuities, disability and long-term care.’ And it took off from there.”
Now about 90 percent of the advisors that Pinnacle deals with have securities licenses. On the life insurance side, the IMO partners with wire houses and B/Ds. On Harclerode’s side, wire houses have direct contracts with insurers for those products, so the IMO focuses on independent B/Ds for annuities.
“There are thousands of these out there in the marketplace,” Harclerode said. “It’s really still untapped.”
Pinnacle offers the guidance of how to fit annuities into a FINRA-regulated world. That means making sure the advisor doesn’t put too much of a client’s assets into annuities. Prudent placement would be 5 to 20 percent. That is going by their experience with FINRA guidelines and insurance suitability requirements. But Harclerode said he has seen some excessive sales.
“I’ve been in this business for 25 years and have been running this annuity platform for the last 10, and I’ve seen so many times where advisors are putting too much of somebody’s portfolio into annuities,” Harclerode said.
So, it’s a learning curve for everybody. The IMO learned to reverse its perspective. Instead of a typical insurance shop working with a selection of products, the IMO works with advisors to assess need and then scout the larger market for products, usually from one of 25 carriers.
“We don’t know what product we’re going to go with when a rep calls us until we dig,” Harclerode said. “That’s where the case design comes in. With the independent broker/dealers that we do business with, we develop their approval sheet on products. So, that’s the 10/10 rule — no more than 10 years in surrender or 10 percent surrender charge in the first year. Just simple, clean, easy-to-explain products.”
That also means steering away from bonus annuities that are popular in the insurance distribution channel. They get a little too close to the suitability and fiduciary trip wires for B/Ds.
“If you’re going to give a client money upfront, what happens on the back end?” Harclerode asked and then answered. “They’re going to limit their upside potential.”
But it was clear to Harclerode that some carriers are still doing well with bonus products that feature long surrender periods and steep charges. Harclerode asked a company representative who was visiting his office a few weeks ago what his No. 1 product was.
“It’s a 16-year product with a 20 percent surrender charge in the first year,” he said the rep told him. “So, it doesn’t fit the criteria. We would never, ever promote something like that.”
But that particular company and others are offering simpler annuities that appeal to B/Ds and registered independent advisors. And there are promises for more of those to be rolled out this year.
Pinnacle has had to adjust its expectations with advisors. Unlike insurance agents who focus on annuities, financial advisors are turning to annuities as part of a larger picture. Instead of a single agent selling 50 cases in a year, Pinnacle will engage with more advisors who sell two or three cases a year.
The DOL Rule, Maybe
The IMO’s spot in the market puts it in a unique position for the DOL’s fiduciary rule, if it goes into effect as written. The DOL opened the door for jumbo-sized IMOs to become the financial institutions required to sign contracts for FIA sales with qualified money. But Pinnacle was not large enough and also had a different route. The B/Ds it was dealing with already were considered financial institutions.
Carriers indicated they were willing to sell through the IMO if the contract were signed by the B/Ds as the financial institution, according to Harclerode.
“It’s going to be more paperwork and compliance and more disclosure to the client,” he said. “Will it make financial advisors gun-shy and affect prospecting for new sales? Probably some. But if we can help them with that process, we will.”
Insurance companies have been relatively quiet about the DOL rule and the approach they expect to take in the event of the rule’s survival. At least, they haven’t revealed a lot to Pinnacle.
“Right now they keep on saying, ‘Business as usual, business as usual,’” he said. “We’ve got a next hurdle coming up here in June that’s going to be — well, everybody’s anxious to see what’s going to happen.”
Even with that, Harclerode said his IMO partners are sure they are steering in the right direction. The way of the future is clearer with each new advisor they deal with.
“More and more young guys coming up the ranks are securities licensed and are aligning with a broker/dealer,” he said, adding with some reluctance: “You just don’t see the insurance-only people anymore. It’s really a dying breed — just the insurance-rep guy. It’s why years ago, we had to change our model.”