Why that ‘guarantee’ on your annuity might be a red flag
Everyone loves guarantees.
Joe Namath guaranteed the Jets were going to win the 1969 Super Bowl. FDIC guarantees your bank deposits to a specific dollar amount. Social Security guarantees a retirement stipend for as long as you live. Americans definitely love a sure thing.
Ever since the market correction in 2008, the vast majority of variable and indexed annuities sold were purchased with attached living benefit guarantees for income. In the industry, they are called “income riders.” Predictably, the public flocked to those income promises offered by an ever aggressive annuity sales force. It is estimated that at the end of 2014, almost a trillion dollars was allocated to these GLB (guaranteed living benefit) income riders attached to deferred annuities.
In a recent report by the Financial Stability Oversight Council (FSOC), the annuity industry’s push to sell these living benefits pose a “meaningful financial risk” to America’s overall financial system. Now that should be an annuity industry wake up call!
‘Should I stay or should I go now?’
I’m dating myself a little by quoting the rock band The Clash, but this song lyric perfectly fits this annuity income-rider guarantee conundrum. Many variable annuity carriers have exited the living benefits business because of the potential risks involved, and some are now trying to buy back current income riders from the customers that already own them.
So the question is, should a person keep the benefit because the annuity company is trying to buy it back, or should they take the money and get out because the guarantee might be in question? There is no good answer, but this is a pre-emptive “red flag” for future potential problems in my opinion.
Let them eat cake
The FSOCs annual report placed considerable concern with guaranteed living benefits, or GLBs, attached to fixed-index annuities. These products are also called indexed annuities. Agents and promoters even use the misleading term “hybrid” to inappropriately increase sales.
The report shockingly pointed out that half of the account value of ALL fixed annuities on the books are income riders (GLBs).
Putting that into perspective is even more troubling when that 50% total valuation number includes all fixed-annuity types that don’t even offer income riders. Those simplistic and efficient products include qualified longevity annuity contracts (QLACs), longevity annuities (aka deferred income annuities), fixed-rate annuities (aka multi-year guaranteed annuities) and single-premium immediate annuities (SPIAs).
It’s important to point out that indexed annuities can be purchased without income riders, and were actually designed in 1995 to compete with CDs from an accumulation value standpoint. However, in the too often have-your-cake-and-eat-it-too sales pitch, currently two thirds of indexed annuities are purchased with GLB riders. Riders can work well for future income planning, but the high percentage growth guarantees during the deferral period is commonly and incorrectly framed as “yield” with many annuity advertisements.
The dreaded “d” word that makes all of our stomachs hurt is “derivative.” The FSOC report pointed out that to mitigate the potential risks of GLBs, the insurance carriers are now increasing their use of derivatives. Recent bank crisis anyone?
As a glaring example of this possibly disturbing trend, Arthur Postal of InsuranceNewsNet pointed out in his recent column that five of the largest 10 variable annuity issuers showed the purchase of derivatives growing from $132 billion in 2003 to an astounding $1.139 trillion by the end of 2014. This should be a good test of the Dodd-Frank bill in action, right?
Too big to ignore (fail?)
The FSOC report did include some positives concerning how annuity carriers are working through the low interest rate environment, and their overall awareness that specific risks need to be addressed.
In 2014, insurance companies represented almost half of the 26 firms that have assets over $200 billion in assets, and have total holdings of over $4.6 trillion. With annuity sales on track this year to once again exceed $200 billion, the guarantees that annuities offer still remain attractive to baby boomers and retirees.
It’s imperative that the annuity industry do everything within its power to make sure the guarantees are truly “guaranteed,” and be proactive with their risk control strategies. Let’s hope this FSOC report gets their undivided attention because people that own these GLB annuity guarantees are depending on it.
People’s retirement security are depending on it.
Originally published by MarketWatch 6.2.2015 – http://www.marketwatch.com/story/why-that-guarantee-on-your-annuity-might-be-a-red-flag-2015-06-02