Annuity & Life Insurance News

Brian Kelley, one of the partners of IPG and I were discussing a case he was reviewing with one of our agents in Arizona and I thought that it would be beneficial to share some details of the case. The client, let’s call her Irma, is 75 years old and has a $111,000 IRA account that she wanted to begin using for a reliable and steady income stream. Irma was approached about considering purchasing an Indexed Annuity that has a Guaranteed Income Rider that would guarantee her a 5% return on her deposit for life. In addition, the company would credit an additional 5% premium bonus. It is important to note that Irma desired the income to commence immediately and that she wanted to be assured that her RMD’s would be taken care of.
Using the recommended Indexed Annuity and beginning the income benefit immediately, Irma would receive a guaranteed annual income of $5828 per year, or a yield of 5.2% based upon her initial $111,000 deposit, (plus the bonus). Given the current interest rate environment, this is a very attractive proposal. No matter what happens to the value of her Indexed Annuity contract, if she does not make any changes to the benefit, she will receive the $5828 yearly for the rest of her life. Add to this, that at any time, if Irma needed or wanted to surrender or take a partial withdrawal, she had access to any remaining cash value (less any applicable surrender charges).
The agent working with Brian asked if there were any other alternatives that he may present to Irma. One option is taking the $111,000 and purchasing a Life with Installment Refund Immediate Annuity (SPIA). Based on her age, Irma would receive an annual income of $7797 per year, guaranteed for the rest of her life, and if she passes on before her initial premium is recovered, payments will continue to named beneficiaries until the original premium is recovered. That represents a 7.20% yield based upon the initial investment, a full 2.00% better than the Indexed Annuity. This payment is also guaranteed for as long as she lives.
As I mentioned in my previous post, if a client’s primary reason for considering a GIB is the need for income, then one should consider the benefits of an income rider on an Indexed or Variable Annuity contract. Because Irma wanted to take the income immediately, she does not gain any benefit from annual step-ups or roll-up provisions. It is not out of the question that given the current caps available on Indexed Annuities, the corpus of the premium will diminish as time goes on. I bring this up because I know one of the arguments for using the GIB is liquidity, that Irma can surrender the contract for its surrender value at any time. Naturally, there are will be fees and surrender charges that will reduce the cash value, but the option is always there.
Well, guess what? The particular SPIA contract used in the presentation has a commutation provision that allows the client to take partial or full cash withdrawals of any current cash values. Are they the equivalent with the Index Annuity? That cannot be determined because one cannot predict the actual earnings that will be applied to the contract. The same holds true for the SPIA in that the commuted value will be based upon current rates and the time of the request.
So, is Irma better off with the Index Annuity with the Guaranteed Income Benefit or the SPIA? If her primary concern is income, $7797 is 33% higher than $5828. If liquidity is a secondary concern, both options provide some piece of mind. And, in terms of meeting RMD’s and keeping things simple, the SPIA provides comfort. So if Irma were your Mother, which one would you recommend? Which option do you think Irma chose?

In the 23 years I have been marketing deferred annuity contracts, the primary benefit presented to clients was that historically, annuity contracts offered a higher rate of return, combined with the benefit of tax deferral. The reason I “bolded” the word deferred, relates to the latest trend in the marketing and sale of annuities. Even in today’s low interest rate environment, deferred annuities are crediting substantially more than bank and money market rates. So what has changed? THE NEED FOR INCOME!

For those who are using the interest income to provide or supplement their current income needs, their monthly income has been decimated. For those who have been saving for future income, they are rightfully concerned about the ability to meet their retirement income goals. Not that long ago, if a client was looking to create a guaranteed stream of income, immediate (income) annuities were on of the primary solutions offered. Not that many years ago, you could use the “Split Annuity” concept to meet a current income need and maintain the corpus of the principal.

The insurance industry is, if nothing else, very creative and responsive to changing economic times. Hence, the advent of Guaranteed Income/Withdrawal Riders, added initially to Variable Annuity contracts. I have read in our professional publications that somewhere between 80-90% of variable annuities sold during the past 12 months have been issued with guaranteed income benefit riders. Wow! The historical and primary benefit of “accumulation with tax deferral” has now been placed in a secondary position behind income.

The same trend has taken place in the fixed indexed annuity market. In my discussions with the carriers we represent, the same trend is occurring, those indexed annuity contracts with guaranteed income riders are out-selling contracts without the riders.

My question and the purpose of this blog relates to which of the options, variable and fixed indexed annuity offers the best value – if the primary reason for purchasing the contract is the ability to create a guaranteed income stream now or sometime in the future? If one is going to pay the cost of the rider it follows that the primary concern is the income stream versus accumulation.

At this point it is important to mention the guaranteed “enhancement or additional interest credits’ that are available on most contracts, indexed and variable. The typical rollup period is 10 years and the average guaranteed rate applied to the income base is 5%. For a $100,000 deposit, this will accrue to a guaranteed income base of $162,889. Again, using industry averages, the guaranteed rate on the income base is 5%. So, if the client waits the full ten years before turning on the income stream, the annual income will be $8144.45. It is not hard to understand how this would be attractive.

What is the price of this benefit? This is a tricky question. The reason goes back to the assumption that the primary reason for purchasing the rider is to create a guaranteed income stream. Using that assumption, we have to take into account the entire costs involved with the underlying contract. The average total fees and expenses for variable annuity contracts with the guaranteed income feature is 4.00%, according to industry sources. Most fixed indexed annuity contracts have an average annual fee of .85% for the income rider. I have purposely left out the accumulation side of the equation, and it is certainly true that any number of separate accounts in variable annuities can perform very well. That being said, assuming the average fee of 4.00% and a 5.00% guaranteed income stream, the underlying accounts would have to have an average yield of 9.00% to maintain the original premium deposit. Compare that to the 5.85% average yield on the indexed annuity to maintain the original deposit.

Does the math make one choice better than the other? Again, going back to the original intent for purchasing the income benefit, I would argue that the indexed annuity might be a better value. But there is another important question that needs to be addressed. How many of the myriad of annuity contracts issued with the income riders will be actually exercised in 10 years? It is very important that all parties understand the cost and compare that to the potential benefit.

Deferred annuities have gone through a major transformation. In the not to distant past, they were accumulation vehicles that might be converted to income sometime in the future. According to the numbers, this has been turned on it’s head. The reason is understandable. Many if not most Americans planning for retirement were counting on a yield of 3-5% on their “safe” retirement assets. In the course of my business, I have been queried on the differences and benefits or using indexed versus variable annuities and the guaranteed income riders. As always, you have to look at the client. If the primary reason that they are purchasing the rider is to provide a known, guaranteed source of income, then using an indexed annuity can be the best choice. There are fewer moving parts, much better underlying guarantees, the “cash” or accumulation bucket cannot lose money if the underlying strategy is negative, and the cost of the rider is cheaper.

I look forward to your thoughts and responses. I am certain this is a topic that will continue to be of interest and debate.

Mike Ferguson, CFP, CLU

The Dow? The S&P 500? NASDAQ? Nope, the yield on the 10-Year Treasury has dropped from 3.15% to 2.46% in the last month. As I mentioned in my August 1st Newsletter, the 10-Year Treasury is the benchmark for yields on all types of fixed income investments. I also said that August rates for annuity contracts remained basically unchanged from July because the insurance companies were waiting to see the results of the debt ceiling debate.

The debate is over, the market has spoken loudly, and the opportunity to lock in the current rates will end quickly. In normal times, most companies will provide a week to 10-days notice of upcoming rate decreases, but given the current rates and volatility of the market, we might see rates dropping in hours and rate holds being narrowed.

There are many experts and pundits who believe that this low rate environment will continue for some time, one of the primary reasons being the weakness of the Euro and the European markets. Even given the U.S. debt and economic problems, we are still the best alternative for the safe money; hence there is increased demand for U.S. Treasuries, possibly driving yields even lower.

It is not too much of a stretch to envision 1.50% yields on annuity contracts in the near future. That makes the current yields very attractive. Although I haven’t any proof or current indication, it is within the realm of possibility that if rates remain low or decrease even more, that you might see insurance companies pulling annuity lines and products.

In the last month, the Dow has lost 10.5%. Once again, when you talk with your clients about their portfolios, you can point to their fixed, guaranteed annuity contracts. A fixed annuity is the only product that allows individuals to accumulate retirement savings, protect those savings from market losses and guarantee income for life.

According to a recent GAO Report to the Senate Special Committee on Aging, Retirement Income:  Ensuring Income throughout Retirement Requires Difficult Choices, to lessen the risk of outliving their assets, retirees should delay the start of Social Security benefits; avoid spending down their nest eggs too fast and, in some situations, considering purchasing an annuity.

The report address’s the challenge of deciding when to begin Social Security Benefits and how to use existing retirement assets to structure income that will cover income needs over a persons lifetime.

An excerpt from the report:

An immediate annuity can help to protect a retiree against the risk of underperforming investments, the risk of outliving one’s assets (longevity risk) and, when an inflation adjusted annuity is purchased, the risk of inflation diminishing one’s purchasing power.  Researchers have concluded that annuities have important benefits. For example, according to one association of actuaries, it is more efficient to pool the risk of outliving one’s assets than to self-insure by accumulating enough assets to provide enough income in case one lives to a very old age.  Annuities provide income at a rate that can help retirees avoid overspending their assets and provide a floor of guaranteed income to prevent unnecessarily spending too little for fear of outliving assets, according to one association.

The GAO report can be found at this website:  www.gao.gov/new.items/d11400.pdf

We are here to help you help your clients.  Need an immediate annuity quote?  Need a systematic withdrawal illustration?  Need a policy with a guaranteed income benefit?  Give me call, 800-873-2693, or email:  mikeferg@ipg-us.com.