Annuities saw the best of times (for clients) and the worst of times (for insurers) when the safety features kicked in during 2008. Insurers convinced they sold their guarantees too cheaply have rushed to repair the damage.

They are doing this in two ways. Some are stripping back the fancy features that proliferated in the past by offering simpler, cheaper products that carry less risk for insurers. Others continue to offer fancy bells and whistles, but at a slightly higher price.

Ken Kehrer, director of research at Kehrer-LIMRA explains that there have always been two marketing approaches: Capture the business of an advisor who sells a lot of annuities or market to inconsistent sellers. "Some of the new products are aimed at the latter market, which is a tougher row to hoe," he says. Regular sellers want the best bells and whistles. It seems their customers do too. Despite steeper costs, 84% of VA buyers in the fourth quarter of 2009 chose those with guaranteed living benefit (GLB) riders, according to LIMRA.

"Advisors continue to present the same products because they haven't changed-it's easier for advisors to keep their features top of mind, but also these products have represented a strong value for their clients," Kehrer explains.

Advisors have another interest in selling more complex VAs, says Scott Hawkins, an insurance analyst at Conning Research & Consulting in Hartford, Conn. "VAs' increasing complexity plays to advisors' advantage-as they get more complicated, the need for an advisor is greater." He points out that term insurance has gotten so simple people are buying it online directly.

Insurers' have their own selfish reasons to create "simpler" annuities since the market crash. Insurers recover "deferred acquisition" costs over time from fees, mostly from commissions insurers pay to advisors. When the market crashed, calculations for how long it would take to recoup those commission costs went out the window-insurers assuming a 5% or 6% return per year suddenly faced a 50% market drop. Accounting requirements accelerated deferred acquisition costs so that insurers had to write them off up front. The Hartford, for example, had to write off $1 billion.

The fact is that VA sales have been falling for almost a decade. From the mid-1990s until the tech wreck, insurers flooded the market with then-innovative VAs, but when the bubble burst in 2001, many quit the market as annuity owners held tight to what they had, Hawkins explains. The infamous arms race between annuity providers was, in part, an effort to get holders of old annuities to move their premiums to new, more exciting products via 1035 exchanges. This strategy worked, but it also meant that recycled premiums replaced new ones as advisors scrambled to sell the attractively commissioned products.

In recent years, up to 80% of "new" premiums have come from 1035 exchanges, but that's largely dried up because the guarantees for people in old annuities are now "in the money." "It would be almost criminal for an advisor to switch one annuity to another when a client is reaping such a benefit," Kehrer says. The premium drought will continue at least through 2012, Hawkins adds, causing some insurers to quit the market and forcing stragglers to reinvent the wheel. Stronger players-Prudential, Jackson National, MetLife and Lincoln-have been able to carry on largely as they did before the crash.

STRIPPED-DOWN CHASSIS

ING's new Select Opportunities VA, launched in March, is part of the wave of new simpler VAs. It offers a death benefit, which is return of principal, and no riders, says Bill Lowe, head of distribution at ING Financial Solutions. "We used to have enhanced death benefits, income benefits, earnings multiples, roll-ups on guaranteed withdrawal benefits, but we took all that out. We had very competitive riders in every space, but when fees went up, the value proposition changed a lot."

The new product has a built-in guaranteed benefit, an annual ratchet feature and a payout based on age and length of ownership. Lowe says that a 60-year-old drawing income on the annuity at age 65 might qualify for 4% income for life; at age 70 that customer might get 5%. "We're selling this as guaranteed income," Lowe says. The VA offers 11 passive investment choices, including small-cap, mid-cap and large-cap equity, international equity and fixed income.

Stripping out the flashy features has also lowered the cost of such annuities. The Select Opportunities VA charges a flat 2.25% versus 3.5% or 4% for a VA with active management. Advisors who sell the new VA make 75 basis points up front with a 75 basis-point trail.

The Hartford has also ditched its riders in favor of a more classic chassis. The firm won't say how much it pays advisors, but the Hartford Personal Retirement Manager, which houses a single premium income annuity (SPIA) to provide retirement income, launched in October. The hybrid VA/SPIA offers 60 investment options, carries a 50 basis-point mortality and expense fee and a distribution charge of 75 basis points against the client's premium that goes away after eight years. "Charging against premium helps us recoup distribution costs," explains Phil Michalowski, director of product development at the Hartford. Because the fees are comparatively low, "over time, the client saves a ton of money and their assets grow more efficiently," he says.

While SPIAs are "the most efficient way to generate income," they tend to be inflexible-you pay your money and receive an income stream, but your assets belong to the insurer, says Michalowski. With the Personal Retirement Manager, some of the assets go into the SPIA and no longer belong to the investor. "If you have a life event where you need a lump sum, you can liquidate assets from the growth side of the contract without impacting your income from the fixed side," Michalowski says. The SPIA pays 3%, but assets on the VA side can grow with the market to feed the SPIA. The Hartford hopes this product is distinctive enough to compete for a whole new customer base.

There are several reasons why a client might buy a VA without a GLB-for the tax deferral, or because a younger investor has a long enough time horizon to not worry about guarantees. But for most investors, VAs became synonymous with GLBs for risk-averse investors when that feature was introduced during the dotcom boom. "I have yet to have someone buy a VA without a living benefit," says Mark Thompson, a Raymond James advisor in Melbourne, Fla.

However, rising costs and stingier benefits are causing Thompson to think twice about recommending VAs, with or without GLBs. "These products just aren't as attractive as they were six months ago," he says. "I think sales are down in direct correlation to that; it's hard to recommend them, considering the higher cost, and VAs have declined at my practice as a result." GLB riders, which might have cost 50 basis points in the past, now run policyholders from 85 and 100 basis points, says Jeffrey Oster, an independent advisor with Raymond James in Alameda, Calif.

Both Oster and Thompson tell clients who own older VAs with GLBs to hold on to them. "I can't tell you how many accounts I've seen with a cash value of $90,000 and an income base of $160,000," Oster says. A client using that old annuity to buy a new one would just have the cash value of $90,000 to shop with-a win for the insurer, but not the client.

Thompson says he's very careful to keep clients within the terms of their contracts to preserve the more generous benefits. A single slip-up-say withdrawing more than an agreed 5%-can void GLBs. Thompson employs an annuity expert to keep his practice fully abreast of the small print in each contract.

Generally speaking, Kathy Schuetz, an ICA rep at Frandsen Bank & Trust, formerly Valley Bank, in North Mankato, Minn., has seen benefits, such as guaranteed income, decline from 7% a few years ago to 6% today, and she tends to stay away from other riders that are now more expensive.

Still, older annuities aren't always the best choice, she says. "An old VA might have a death benefit but no income rider. I'll also look at longevity of the client and spouse-the death benefit may be huge." Schuetz advised one client to stay in a VA that was part of a diversified portfolio paying into his income stream. The VA didn't have a GLB rider, but it was clear of surrender charges, and all he needed was a cash balance of $3,000 to keep a handsome $400,000 death benefit. He wanted to get back into the market, so Schuetz took the remaining cash value out and put it into a managed account.

Another client was willing to pay an extra 100 basis points for a new VA because her old one had no income guarantee rider. The soon-to-be-retired widow did a 1035 exchange into a VA guaranteeing 6% in lifetime income for clients over 65. The client could have annuitized her old VA for the same income, and Schuetz told her about the higher cost, but the widow thought the guarantee was worth it.

Another client was willing to pay an extra 100 basis points for a new VA because her old one had no income guarantee rider. The soon-to-be-retired widow did a 1035 exchange into a VA guaranteeing 6% in lifetime income for clients over 65. The client could have annuitized her old VA for the same income, and Schuetz told her about the higher cost, but the widow thought the guarantee was worth it.

THE PLAYERS

Like others, Schuetz limits her VA choices to a few providers she's comfortable with-Jackson National (which owns ICA, her broker-dealer), Prudential and the Hartford, although since the Hartford stripped down its VAs she rarely finds it the most suitable option for clients.

Prudential, Jackson National, MetLife and Lincoln probably account for half of a market in which a 7% or 8% market share is considered a major player. This market domination is "unheard of" in a usually much more fragmented market, says Scott Stolz, president of Raymond James' insurance subsidiary. Since these companies' products were more expensive than their competitors' before the crash, none of them has had to raise its prices significantly.

Jackson National's Life Guard Freedom and Prudential's HD6+ rider have fared particularly well. Jackson National always charged more (about 97 basis points) for its riders and now claims to have priced its VAs right all along. And Prudential's HD6+ has better liability protection, locking in the highest daily value. And if the account value falls too far, Prudential moves assets from equities into bonds. Prudential maintains more control over VA assets than any other insurer. "The question is, how fast will it get back into equities," says Stolz. "But it's a strategy advisors like right now."

Companies in the Big Four each have a selling point. Jackson National has no investment restriction-other firms limit equity exposure to 70%. (Jackson has found that most people stay within that limit anyway.) MetLife's VA has virtually the only guaranteed minimum income benefit (GMIB) on the market; most others have guaranteed minimum withdrawal benefits (GMWB). While the GMWB will credit your payout at the highest account value over a 10-year period, say, a GMIB credits you with 5% a year until you annuitize and clients can hold on to it, deferring income indefinitely. The rule of thumb is, if you need income within 10 years, chose a GMWB, Stolz says. However, advisors tend to sell what's most familiar to them

Lastly, Lincoln has "i for life 4," which lets you to cash in the policy for the value of the death benefit even if you've already received the value of the premium in annuitized payments. This would be of value to a client who needed a lump sum now more than income for life and a legacy for heirs.

Which VA is appropriate depends on the client. A client with fewer assets will have to invest more aggressively, so Jackson National's product might be a good fit. However, "if the client can't sleep at night that strategy just flies out the window," in favor of Prudential's built-in safety wheels, says Schuetz.

Her VA sales are split between Jackson National and Prudential, a pattern Stolz is seeing at Raymond James. What advisors like, they sell: The cheaper products from ING and The Hartford may be comparatively easy to explain, but sales indicate that most investors are still opting for fancier options from the Big Four. "Will advisors sell lower-commission products that also have the biggest reduction in benefits?" Stolz asks. So far, apparently not.

This story was reprinted with permission from Financial Planning.

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