Variable annuities have had mixed reviews over the past couple of years. Their sales were highest in 2007 when they reached $184 billion, but are significantly less than that now. After offering guarantees that turned out to be too generous, some insurance companies stopped offering variable annuities at all while others greatly scaled down their product lines. But variable annuities still have a place in this industry and according to Wharton’s Pension Research Council, they are the product of the future. In Think Advisor’s “Revenge of the Variable Annuity,” Michael Finke discussed the findings from an annual pension review by this group of some of America’s brightest people.
The group found that both traditional pensions and defined contribution plans should really look more like variable annuities, which offer two things that retirees can’t get with other investments. Baby Boomers have $6.5 billion in IRA assets and in theory should be running full force towards variable annuities. But the products need to be easier to understand, more transparent and provide income for retirees to spend on their living expenses. Retirees benefit from having a good amount of risk in their investment products. According to the article, a “perfect annuity” gives retirees some investment risk so that their income may go up or down during their retirement. The savings before you have annuitized should not go up and down, however, only the income that you receive after retiring.
Many insurance companies have tried to take the variable aspect out of their variable annuities by guaranteeing a certain level of income, while promising the potential of higher income in the future. But when markets perform poorly, this puts a big strain on the issuer of the variable annuity product. One pension expert pointed out that it’s better for everyone in a company to continue to receive their income, even if the amount of income varies, than it is for the company paying the income to go out of business because they couldn’t keep up with the promises made when markets were down. If insurance companies don’t bear all of the investment risk that comes with income guarantees, this could help ensure that the industry and everyone involved stay in tact. Risk sharing is often the best way to protect against the uncertainty of future market returns.
Variable annuities offer two things that you cannot get with traditional fund investments. They are the optimal retirement tool because you can spend more money annually since you have pooled your longevity risk. You are also protected from running out of money during your retirement. Adding a variable annuity to defined contribution plans can offer employees longevity risk protection and the opportunity to improve upon an average investment portfolio return. More competition in offering these products will only help consumers. Unfortunately, current variable annuity products don’t perform as the so-called “perfect annuity” that they have the potential to be. Many economic experts can point to the downsides of many current variable annuity products.
Some variable annuities are too complicated, have too many features and have pricing that is hard to understand or find. The article suggests that the variable annuity industry join together and create a small number of products that would work well for an average retiree. Make the costs standardized and the disclosures simple. That way companies can compete on a basic cost structure and offer products that are very similar. Most companies aren’t jumping at this idea because they can make more money sticking with the products they currently offer. But the time is right to create a variable annuity that can change the retirement industry. Variable annuities can solve the problem of creating retirement income for future generations, but the products have to adapt to current industry and public needs.