Back in November 2008, as then President-elect Barack Obama and his staff prepared to transition into the White House amid near-cataclysmic economic conditions, Obama's chief of staff Rahm Emanuel put a positive spin on the landscape facing the new president. "Rule One: Never allow a crisis to go to waste," he said during an interview on the CBS news program Face the Nation. The gist of Emanuel's statement-which is now either famous or infamous, depending on one's point of view-was that the crisis was going to embolden Obama to push through major policy initiatives at a time when the country was looking for some big ideas to solve its big problems.
In many ways, this sentiment can also be attached to the annuity business. Not long ago, the industry was being battered by unfavorable scrutiny from regulators, the media and consumers for a host of sins-some real, others perhaps unfairly attached to anyone selling an annuity. By now the criticisms are well known: The products, especially variable annuities, are thought to be too complex and expensive, and they often underperform relative to the fees they charge.
But an interesting thing has happened over the past couple of years. Media reports are increasingly highlighting the benefits of annuities, particularly their ability to help Americans convert retirement savings into guaranteed streams of income. More significant, however, has been an unexpected endorsement from the White House. A January report from the administration's Middle Class Task Force signaled that the administration would work to promote the availability of annuities and other forms of guaranteed lifetime income. In February, the Department of Labor and the Treasury Department issued a request for information about how best to encourage 401(k) plans to offer annuities to their participants. The fact that annuities are getting a second look on the heels of a deep recession and growing concerns about a retirement savings crisis is no coincidence.
"What a difference a 100-year event makes," says Bruce Ferris, executive vice president of sales and distribution for Prudential Annuities, the country's biggest seller of variable annuities, according to LIMRA. "It's not that I wish for another one but it absolutely has shone a light on where these products might be appropriate and valuable for retiring Americans. From President Obama and the Department of Labor to the media, there has been a turn to what I would call more balanced coverage."
Of course, one high-level endorsement and a smattering of positive media coverage has not yet translated into a lovefest with annuities in this country. In fact, one could argue that we're still far from that point. Many fee-based advisors continue to shun annuities, finding them too complex or too costly. Many consumers, no doubt, feel the same. The industry must still contend with what many have dubbed the "annuity puzzle," or the lack of popularity of annuities despite the economic arguments in their favor.
"As an industry, even following post-2008, I would still give us overall as an industry a 'C' on our report card," Ferris says of the variable annuity business. "The industry is showing signs of marginal growth, but we're treading water and it's frustrating. It has not grown at the same levels as it was growing at the beginning of '03."
Ferris notes that the amount of variable annuities sold by retail advisors peaked in 2007-but it did so across all distribution channels, according to data from LIMRA. In 2007, independent advisors had a quarterly average of about $13 billion in variable annuities sold. In 2008, it dropped to roughly $10.8 billion. Last year, the quarterly average was $9.8 billion. Moreover, about $33 billion in variable annuities was sold across all distribution channels in the fourth quarter of last year. In the fourth quarter of 2007, that number was $48.1 billion. "But as we all know that was the height of the arms race and the escalation of whose product's better than whose," Ferris says. (The "arms race," as industry observers frequently refer to it, was a period of intense sales competition highlighted by the increasing use of added living benefits to sell products.)
Recent annuity sales figures are a mixed bag. The Insured Retirement Institute released a report in May showing that combined sales for fixed and variable annuities dropped 27% from the first quarter of 2009. First-quarter sales also fell 6.9% from the previous quarter. Fixed annuities, according to data from Beacon Research, had $16 billion in first-quarter sales, representing a 14.7% decline from the $19 billion it sold in the previous quarter and a 51.9% drop from the $34 billion sold in the first quarter of 2009. But variable annuities fared somewhat better. First-quarter VA sales, according to sales data from Morningstar, were at $31.4 billion, down 1.5% from the $31.9 billion it sold in the previous quarter. However, sales were up 3% from $30.4 billion in the year-earlier period.
Furthermore, data from Financial Planning's 25th Annual Independent Broker-Dealer Survey, released in June, show the growing impact annuities are having on product revenues in the space. Annuities accounted for $3.7 billion in revenues for 2009, which was 26.2% of total product revenues. Variable annuities were responsible for $3.1 billion, or 85% of this total. Additionally, variable annuities accounted for 22.3% of total product revenues. Fixed annuities, by comparison, accounted for $495.3 million, or 13.5% of total annuity revenues.
Because the sales figures don't tell a consistent story-a dip for fixed annuities and some gains for variable annuities-it's difficult to say that the annuity industry is operating with any serious wind at its back. "I think there's renewed interest, but why aren't more people buying these products?" Ferris asks.
But then he answers his own question. It's fear, he says. People are afraid to put anything at risk and so trillions of dollars are still on the sidelines. The fear that many people have about putting money back to work can obviously be intensified when they aren't sure about the possible gap between what the product promises and what it will deliver. Simply put, annuities are complex. Even their proponents mostly admit to this. So the path to gaining traction with consumers, to solving that annuity puzzle, is going to have to be made through advisors.
"The financial advisor is critical to the conversation," says Steve Deschenes, senior vice president and general manager of the annuities division for Sun Life Financial. "Not just for explaining annuities. Retirement income planning itself is more complex than accumulation planning."
As someone who used to run his own RIA, Deschenes knows what it's like sitting on the other side of the table in an annuity sales pitch. He says the industry has made an overall effort to streamline annuity products and lower risk where needed. "I think the products in some cases were getting too complex with too many different kinds of death benefits," Deschenes says. "Trying to sort through all of those options can become problematic for the advisor and the customer."
The old adage attached to annuities is that they are sold, not bought. Obviously this doesn't really put them in the best light as it conjures up images of a slick salesman pushing products in order to grab commissions. So Ferris says it takes a knowledgeable advisor to explain the benefits. "It used to be if an advisor just sold managed money they wanted no part of an annuity because it was too complex, too expensive and didn't perform well," Ferris says. "There has been a sea change where it's no longer a question of whether an annuity should be a part of a retirement portfolio-it's what percentage."
In 2009, more than 23,000 new advisors sold Prudential products. That was more than double any other year in the company's history, according to Ferris.
BUILDING A MARKET
It's one thing to convince a broker-dealer rep of the benefits of an annuity; it's a whole other ball game trying to sell a fee-based advisor on the merits. These advisors have historically made no secret of their disdain for annuities. And yet, this is a market that Jefferson National in New York City has targeted with some success. The company was the fourth largest seller of variable annuities last year, according to LIMRA.
"Fee-based advisors do not like variable annuities," admits Laurence Greenberg, president and CEO of Jefferson National. "People thought we were crazy. But what we knew about fee-based advisors is they're very education-oriented, they're very analytical and when looking at what's best for their clients they are information gatherers."
A few years ago Jefferson National launched Monument Advisor, which it bills as the country's first flat-fee VA and the lowest-cost variable annuity on the market. It currently has about $600 million in assets under management, predominantly through RIAs. The company has seen the number of advisors selling the product surpass a thousand. Greenberg says the company spends a lot of time on education. Instead of making a hard sell on their products, the focus is instead on presenting information to advisors showing the potential benefits.
"We're not saying annuitize everything, but there is a role for annuitization to generate steady income," Greenberg says. "Now some advisors will feel they can do that themselves by managing the portfolio, which is fine. But it's all about having a mix and a balance."
Ferris says Prudential has always targeted fee-based advisors as a potential market "with very little success." He notes that the value proposition of a fee-based advisor is that he's an asset allocator who decides the diversification of an investor's portfolio. However, Ferris says that advisors in some cases had no choice but to learn about annuities when their clients began losing money in 2008.
"We want to be the strategic advisor to the advisors," Ferris says. "In other words, we want to be their main consultant."
Although the industry may be making inroads with fee-based advisors, it is difficult not to assess annuities without examining the roadblocks that keep many advisors and investors away, namely, the products are seen as being too complex, too expensive and underperforming. Katie Libbe, vice president of consumer marketing and solutions for Allianz Life Insurance, says the industry still has a lot of work to do in convincing people about the benefits of purchasing an annuity. She refers to a recent survey released by Allianz that found 25% of the respondents had formed their opinion about annuities 20 years ago.
"When you use the word annuity it comes with a lot of baggage and we're very aware of that," Libbe says. "We're trying to change that perception and educate the marketplace and advisors about the fact that these products have evolved and they really do have some protection from downside risk and guaranteed streams that you can't get from other products. But they do need to be explained."
Although annuities have certainly evolved over the past two decades, some would argue that the evolution has not always been for the better. Greenberg says that when annuities were first introduced they were really built as a way to save money tax-deferred. But faced with consumers' general lack of interest in annuitization, the industry responded by creating income riders, such as living and death benefits, that allowed people to maintain control over principal they would normally lose with an annuity. But along with the riders came questions about how much value one was really getting when the costs were so high.
"You saw the industry go to a position where it wanted to become all about guaranteeing income and that led to all of the riders that became very complex," Greenberg says. "It turned the annuity into anything but a mechanism for tax deferral. It became something that was sold and not bought and brought all the criticisms about annuities-including that they're very opaque and expensive."
Criticism of annuities over high costs and complex structuring are not likely to cease anytime soon, but some in the industry suggest that the issue may not be so cut and dried. Libbe argues that annuities "can be complex but in a good way," because they serve the dual purpose of producing a steady stream of income and potentially increasing income. Deschenes is even stronger in his defense of the products.
"Sometimes when people say to me that annuities are complex and expensive, my reaction to that is, compared to what? In a sense they're complex and expensive partly because they contain inside of them a longevity hedge, an interest-rate hedge and a market hedge," Deschenes says. "If a mutual fund contained all three of those hedged positions it would be equally complex and equally expensive. And so it would be an annuity. You can't really compare it to a product that doesn't contain those instruments."
DEBATING THE MERITS
Deschenes asserts that people are often better off with guarantees because by having certainty in one part of their portfolio, they can accept more equity risk and volatility in other parts of the portfolio. He says his goal is "helping people avoid one of the worst possible investment strategies" in which they are chasing CD rates and their standard of living is declining slowly over time versus inflation. This is particularly true in a low-interest rate environment, like the one we're in now.
"I think the positive way to think about complexity is that annuities manage a tremendous amount of it, allowing the customer to have a tremendous amount of simplicity," Deschenes says. "We give you guarantees and longevity protection. Even with the worst markets and if you live to a 110, you're going to be able to live on your $50,000 a year in income from your million-dollar portfolio."
But one has to wonder, with an untold number of Americans facing a savings shortage, how many people are going to have a million-dollar portfolio to work with once they retire? It raises the question of whether the general lack of interest in annuities isn't because people are turned off by their complexity, their costs or possible performance issues, but because they don't have sufficient retirement funds to put to work.
What concerns Charlie Farrell, a principal at Northstar Investment Advisors in Denver, is that the recent push for annuities, whether it's from the Obama administration or the media, could be overselling their capacity for building retirement income. Because many people don't understand exactly how an annuity works, they may not actually understand that it will only produce money that corresponds with how much you put into it.
"You might have people thinking that somehow I have a $100,000 portfolio and it will generate $25,000 a year in retirement income," Farrell says.
When people promote the use of annuities, the discussion often begins with the basic fixed immediate annuity. It is a product that mirrors the pension by producing the highly sought-after "guaranteed paycheck for life." But because the income is fixed, it is also subject to the whims of inflation, which can seriously eat into that paycheck over time. Farrell notes that the average annual inflation rate over the past 80 years has been about 3%. So if someone were to put $100,000 into an immediate annuity at age 65, the income from that product would be cut by 45% by age 85. The income stream from that $100,000 annuity could eventually be under $6,000 a year. Although one could obviously buy an inflation-adjusted annuity, Farrell points out that the initial payouts will be lowered because the insurance company will have to eventually increase payments each year to adjust for inflation.
Instead, Farrell says the odds are great that a well-diversified retirement portfolio will deliver you a 4% distribution rate. There are other options of getting guaranteed income streams, like fixed income and Treasuries. Moreover, he believes the government should be pushing people to save more (since having adequate savings is necessary for an annuity to be successful), but also "the bulk of mental effort should be spent fixing Social Security," Farrell says.
"Everyone is trying to escape the underfunding, but the annuity is a bit of a red herring," he adds. "It doesn't create a magical amount of new income. It's a guarantee from one company concentrated on one industry-finance. We already have an excellent inflation-adjusted immediate annuity called Social Security and no one wants to fund it accurately."
FRIENDS IN HIGH PLACES
One major hurdle to fixing Social Security is, of course, getting Congress to work on a bipartisan solution, which is becoming increasingly difficult in today's political climate. For now, the long-term role of Social Security in the retirement income equation looks to be diminishing. Whether one likes it or not, the Obama administration's promotion of annuities could be a boon to insurance companies. Although some critics will acknowledge that there could be a place for annuities in the retirement plans of some people, they are opposed to the government mandating an employer-sponsored 401(k) plan. One of the questions the Department of Labor and the Treasury asked in its request for information back in February was whether an annuity or other guaranteed lifetime income product should be the default distribution instrument, and whether it should apply to the employee's entire account balance.
"An annuity product could be a good choice for an individual for all or a portion of his or her income assets, but by no means could you make that statement generally for everyone," says Elena Chism, associate counsel for pension regulation at the Investment Company Institute, the national association of investment companies, including mutual funds and ETFs. "It's really going to depend on the individual's circumstances." Additionally, Chism worries that if the government is mandating or giving incentive to a certain option, it could lead people to make a decision that isn't appropriate for them and keep them from exploring other options.
Sun Life's Deschenes says he's "a fan of having maximum access to lifetime income to the customer," whether it's inside a 401(k) plan or outside. "I think there are ways of achieving it that falls short of a requirement or mandate that I think a lot of folks have raised some serious concerns about," he says. Jackson National's Greenberg suggests that the government's role could be to make the 401(k) more attractive by allowing people to convert their account balances to streams of income. But like Deschenes, he says this can be done inside or outside of the defined contribution plan-something that's not quite a mandate. "I think it would make a lot of sense to allow people to convert to streams of income," Greenberg says. "But you need competition. The more competition, the more it draws down the costs. You can take the 401(k) to the next level and really make it a retirement tool that people need."
THE FUTURE IS NOW
The elephant in the room for the insurance industry will continue to be the annuity puzzle. If the financial crisis of 2008 does not drive more Americans to annuitize their assets, will anything actually sell them on these products? Because variable annuities are complex, with numerous moving parts, the industry will first have to convince advisors that these are appropriate solutions for their clients. Ferris suggests that Americans actually do recognize the benefits of annuitizing, but whether that translates into bigger sales remains to be seen.
"I don't think the battleground is annuitization right now," Ferris says. "It used to be that people said you give money to the insurance company and you lose, they win. But living benefits and lifetime retirement income changed that conversation." As did the growth in life spans.
Deschenes says a change in attitude is already happening in this country and annuities are starting to be looked at differently in the two years since the economic crisis. "It's been nearly a complete shift. It starts with the financial academic community recognizing some values [an annuity] can offer versus other investment products," he says. "They give you guarantees on a life-contingent basis that only an insurance company can offer."
With roughly 76 million baby boomers set to retire, the insurance industry could be poised to significantly grow its annuity market. Add to that the potential opportunity to expand in the 401(k) space and its growth prospects become even brighter. But will the potential for bigger sales lead once again to another arms race and all the baggage that comes with it? "We were just talking about this," Ferris says. "I wouldn't call it an arms race, but I think you see some companies reentering the market with more conviction or more energy dedicated to everything from product design to adding resources. The volatility shines a light on the value of these products."
This story has been reprinted with permission from Financial Planning.
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