Planning with Annuities

Striking A Balance Between Value & Price

Slumping annuity sales should lead to better deals for consumers

by Andrew Murdoch, CFP

Mr. Murdoch is President of Somerset Wealth Strategies, a retirement and investment planning firm in Portland, Or. Visit somersetwealthstrategies.com

Annuity sales have been in a slump for at least a year, and insurance companies aren’t happy about it. For consumers, however, it is probably good news.

They are likely to get a better deal if interest rates increase, as widely expected. This is because insurance companies will be able to earn higher interest rates on bonds, their primary investment, enabling them to introduce more attractive annuities.

They will pursue this course to stimulate sagging sales. In fact, they have already begun doing just that. One insurance company recently increased rates on a deferred income annuity; another materially improved the index participation rate on a fixed indexed annuity.

The rollout of more attractive annuities, coupled with other factors, produces nearly a picture-perfect backdrop for an annuity sales rebound.

The stock market, a common investment alternative, has been stumbling in the wake of a six-year-plus bull market, the longest ever. Moreover, many experts believe future long-term stock market returns will be a more modest 6-8 percent annually, down from about 10 percent, giving stocks a less compelling edge over alternative investments.
If you think about it, annuity sales in any case should be strong, not weak, because the huge and affluent baby boomers are in or on the cusp of retirement. Like previous generations, they like the guaranteed lifetime income that annuities offer.
The sales rebound, though, has yet to arrive. Data from the Insured Retirement Institute (IRI), Morningstar Inc. and Beacon Research highlight the decline in annuity sales.

A True Picture

The IRI recently reported that second quarter 2015 annuity sales reached $58.4 billion, up 11 percent from the first quarter. This number, however, was impacted by seasonality, partly because many people do their taxes in the second quarter, take a fresh look at their tax burden, and, if the shoe fits, get more motivated to invest in tax-deferred annuities. The comparison that counts is 2Q 2015 over 2Q 2014, and that was down 2.5 percent – the fourth year of decline in second quarter over previous second quarter sales.

Another way to get the true picture is to compare first half 2015 sales to first half 2014 sales – those figures were $111.1 billion and $116 billion respectively, a decline of more than 4 percent.

Over time, annuity sales have largely followed a see-saw pattern, impacted by shifting interest rates and a fluctuating stock market, IRI data show. But that pattern has been deteriorating in recent years. As an example, 2012 was a particularly bad year, with sales declining 8.4 percent to $211.9 billion, according to IRI data.

Over time, annuity sales have largely followed a see-saw pattern, impacted by shifting interest rates and a fluctuating stock market... but that pattern has been deteriorating in recent years.

Sales have subsequently improved but remain disappointing in part because interest rates, which strongly influence annuity sales, have been mired at record-low levels for years. There is light at the end of the tunnel, however. The Federal Reserve is widely expected to begin increasing rates this year. Those rate increases almost certainly will be modest, but I believe that an increase of 1 percentage point is all that is needed to prod insurance companies to offer better annuities.
Annuity sales have declined, in part, because they obviously pay lower interest rates when overall rates are low. There are also down, however, because of the way the insurance industry has reacted to low rates.

Consider, for example, variable annuities. Six-and-a-half years ago, they typically paid about 6 percent annually. A year later, that fell to 5 percent. Now rates are about 4 percent, or a tad higher. VAs today also charge higher fees – typically a total of 3.5 percent annually, as much as 0.75 percentage point higher than before. And joint policies for married couples, which once paid the same as single policies, now pay about half a percentage point less.

Attractive Once Again

The $64,000 question is whether insurance companies are willing to make VAs and other annuities more attractive again. The answer, I believe, is yes. If interest rates, now 2.2 percent, rise about a percentage point – a highly likely scenario over the next 12-18 months – insurance companies will introduce more attractive annuities.

Insurance companies will react because they have the wherewithal. They have strong balance sheets, having trimmed their exposure to higher-cost annuities. They also have a track record of improving, as well as degrading, annuity features. When the stock market collapsed in 2008 and 2009, insurance companies dramatically improved terms on some annuities so they could attract fresh capital and maintain strong industry ratings.

Among those who agree that annuities will again become more attractive is Kevin Loffredi, senior product manager of annuity sales at Morningstar Inc. “The balance in annuities between value and price has teetered too far to the wrong side and will be corrected,” Loffredi recently told me.

Insurance companies, of course, are aware that consumers have choices. People like guaranteed income for life, but they don’t have to own annuities. Most of the time, they can fare well by simply maintaining, say, a stock and bond fund portfolio weighted 60/40 stocks and bonds. According to Monte Carlo simulation research by T. Rowe Price, those who do so and annually withdraw a maximum of 4 percent of their portfolio have only a 6 percent chance of running out of money over 25 years.

Companies in all businesses have to offer good value to thrive, and insurance companies are no exception. So if you are among the ranks of baby boomers potentially interested in buying an annuity, sit back and relax as interest rates slowly rise. When they climb enough to prod insurance companies to spruce up their annuities, that will be the best time to go shopping for one.