Providers see growth opportunity in US retirement plan changes
A recent article from Best’s Review, by Terrence Dopp, examines new pre-rollover buy-in options drawn from the $7.3 trillion 401(k) market. Reprinted with permission form AM Best. Access the full article at www.ambest.com
Retirement planning in the U.S. has focused for many on defined contribution plans and accumulation with little discussion of how to secure guaranteed income through annuities as part of workers’ 401(k) accounts. With that about to change, the annuity industry sees a big opportunity on the horizon.
Key Points:
- Liability: Traditionally, retirement plan sponsors were resistant to including annuities as an option embedded in defined contribution plans amid legal uncertainty. That issue was cleared up with changes in the 2019 SECURE Act.
- Shift: For the industry, the move will mean employees throughout America have a new market to purchase annuity contracts through their plans. It also may open up the so-called middle market, which hadn’t been tapped by financial advisers.
- Beginning: Starting this year, 401(k) providers including BlackRock and Fidelity have announced plans to offer guaranteed income products, and more could follow.
When people review their 401(k) or 403(b) retirement plans this year, they might have a new investment option: using some of their money to purchase income annuities. And that may prove to be a growth opportunity for the industry, which is already posting strong results in the past year.
While the option is still in its infancy, federal changes and growing adoption by those who run defined contribution plans may benefit the staid annuity industry as the long-term contracts—and the guaranteed income they offer—become more widely available to Americans. Where the two products had traditionally been seen as separate, the move could make them options within one overall plan.
“As these products evolve, I think there’s an opportunity to meld them both,” said Martin Powell, head of annuity distribution, CUNA Mutual Group. “Most annuities are sold through financial advisers who are rolling over 401(k) plans, or getting peoples’ buyouts. Now here’s an opportunity before they get to the stage of rolling over, they are going to have an opportunity to make buy-in decisions on ensuring longevity of their retirement plans.”
Projections of the potential size of the pool of money are premature as the total number of players in the burgeoning space and level of adoption aren’t clear by any means. Powell used a simple example: His company—a $4 billion-plus, 85-year-old provider of financial services to credit unions and their customers—was the third outfit to sell the registered index-linked annuities that are now among the fastest-growing segment of the industry. Financial institutions chase success, he said.
Large Pot
As of June 30, 2021, Americans held an estimated $7.3 trillion in assets in 401(k) accounts alone, which accounted for almost a fifth of the $37.2 trillion U.S. retirement market, according to the Investment Company Institute, which has been tracking defined contribution plan participant activity since 2008. The 401(k) figure is more than double the $3.1 trillion cited for 2011.
Defined contribution plans allow participants to accumulate wealth tax-free, generally with an employer match, and invest it with the hope of retiring on a large pile of money based on savings and good performance. There is a caveat, however: There are no guarantees and a nosedive in the market can derail retirement plans.
The plans have largely replaced the traditional private pension funds offered to workers during the latter half of the 20th century. The defining feature of those plans, known as defined benefits plans, is certainty of income in retirement.
An annuity at the most basic level is a contract between an individual or married couple and a life insurer. While there may be many flavors they take on, the essential premise of income annuities is that the purchaser surrenders control over the pot of money and in return secures a guaranteed stream of income for either a set time period or for the duration of their life—much like a pension.
For annuities providers, the change could be akin to life insurers boosting their sales to record levels in the past year largely on the backs of smaller policies sold online. Both allow the industry to grow by getting down into the so-called middle market and customers they traditionally weren’t able to tap. “They might have $10,000 or $15,000 and they might not feel like they’re not deserving of financial advice from a financial adviser, and as we know a lot of the marketplace is focused on people who have $500,000 or more from a net investable asset perspective,” Powell said of this new market. “So this gives the person below that who’s accumulating wealth the opportunity to get more access to financial planning.”
Shifting Seas
It’s not that the sale of guaranteed income contracts was ever outright prohibited within a defined contribution plan. It was more of a black hole where absent legal provisions authorizing and regulating them led to them never really being embraced as a component. But Section 204 of the SECURE Act passed in 2019 created a safe harbor provision for defined contribution plan sponsors, or fiduciaries, concerning the purchase of annuities within the retirement plans. Specifically, the law cleared up that unknown by adding a first-ever safe harbor to the Employee Retirement Income Security Act of 1974, known simply as ERISA, which governs private pensions and defined contribution plans.
The law included requirements that the sponsor must conduct an analysis when selecting insurers for lifetime income contracts that considers, among other things, the insurers’ capability to meet the contract and whether the costs and fees involved in securing the lifetime income are in line with the benefits. The fiduciary must obtain written representations from the insurer that it is licensed to sell the contracts, has operated for the preceding seven years with a certificate of authority from state regulators that hasn’t been suspended, meets reserving requirements, and isn’t operating under an order of supervision, rehabilitation or liquidation.
If a fiduciary meets the legal requirements, it is not liable for any losses if the insurer fails to satisfy the contract for any reason.
Bruno Caron, associate director with AM Best, said the need for lifetime income products and solutions is high and has the potential to become a significant component of retirement planning. No other product has the ability to redistribute principal optimally and generate income for the unknown period of time of retirement. People often consider the size of their accounts and their personal wealth absent of a true reckoning of how much that wealth translates into income for the rest of their life because it is a major unknown.
“The income side of the coin is as important as the asset part when it comes to retirement planning; lifetime income is the suite of products that help retirees achieve an appropriate equilibrium given the many unknowns they face,” he said. “Given the current economic and demographic environment, a large-scale unique opportunity is up for grabs for the life and annuity space, and many carriers have teamed up as an industry to tackle this opportunity.”
The numbers are big, if still a little imprecise.
In October, financial giant BlackRock announced that five large plan sponsors, which represent $7.5 billion in target date investments, had elected to work with the firm to bring its LifePath Paycheck product as the default investment option in their employee retirement plans. The annuities are issued through Brighthouse Financial and Equitable, the company said.
In announcing the deal, BlackRock said it expects initial plan adoption in 2022 and it will provide the option for guaranteed lifetime income to 120,000 U.S.-based 401(k) plan participants.
Fidelity Investments, which has nearly 8 million people on its workplace savings platform nearing retirement age, said in November that its Guaranteed Income Direct retirement income product will allow individuals to convert a portion of 401(k) or 403(b) savings into an annuity with the aim of providing predictable income. The program is expected to launch to select clients in the first half of this year, with broad availability late in 2022, Fidelity said.
Powell said he expects peoples’ interest in the product to blossom given a base desire for steady income, and that stands to broaden the base. “That’s why they work on a salary in this country,” he said. “They like the guarantee of knowing what level of income they have.”
