At the moment, the variable annuity (VA) business continues to sort itself out. While the aftershocks of the financial crisis are still palpable, the situation has bred some product innovations in the VA space that we think are pretty nifty. Life insurance actuaries and product developers have packaged risk exposure and risk protection into new kinds of VA + Rider combinations.
In this article, and with the help of experienced observers, we assess the three main types of VA innovations that have appeared: the “investment only” variable annuity (IOVA), VAs with non-living benefit income options, and the structured VA. In one way or another, variable annuities address the public’s need for growth and some of the rider innovations also address protection of principal. However, IOVA’s still allow investors to live without more firm, more expensive guarantees. Which one you might want to consider will depend on your sensitivity to risk—and desire for more serious risk transfer—which could change at the next major market shift.
Variable Annuity Innovations to Consider
Old is New Again: Investment Only Variable Annuities
Investment Only Variable Annuities (IOVAs) are generating the most buzz this year.
Investment Only Variable Annuities (IOVAs) are generating the most buzz in our offices this year. The acronym “IOVA” is used slightly ironically, because until the late 1990s all VAs were “IO.” Unlike the previous IOs, however, these products typically offer dozens of subaccount options, including some “alternative” investments (real estate, hedge funds, emerging market debt, arbitrage and commodities) that institutional investors use.
Compared to the VA with living benefits, they’re also pretty inexpensive. When sold without living or death benefits, they don’t require hedging or significant capital reserves. The mortality and expense risk fees are generally low and merely fund the acquisition costs. (Annuitization options are, by definition, available on all annuity contracts whether variable or fixed.)
Jefferson National is sometimes credited by registered investment advisers (RIAs) with discovering a market for the low-cost, accumulation-oriented alternative-heavy VA. But its IOVA sales of its Monument Advisor contract appear to be relatively small. We would point to Jackson National, with their Elite Access product, as the company that turned the IOVA into a “category.”
Elite Access and Monument Advisor no longer have this market to themselves. There’s the Nationwide MarketFlex II VA, introduced in 2012, the AXA Investment Edge, the Protective VA Investors Series and the Prudential Premier Investment VA.
The ability to own high-turnover actively managed funds in a tax-deferred cocoon is the main selling point of these products.
The ability to own high-turnover, actively managed funds in a tax-deferred cocoon is the main selling point of these products.
The ability to own high-turnover actively managed funds in a tax-deferred cocoon is the main selling point of these products. But to the extent that they offer alternative investments, managed volatility funds and guided portfolios, they also provide an implicit form of downside protection.
The protection comes from the hedging strategies in the managed volatility funds and the diversification provided by the alternatives, whose performance generally isn’t directly correlated with the performance of U.S. stocks or bonds. This type of protection arguably addresses the investors’ expectations of an insurance product while costing much less than similar products with guarantees would cost.
“You’re going to see a further proliferation of managed-risk funds in VAs,” said Colin Devine, an independent insurance company analyst. “In addition to being a requirement for living benefit options, they will begin showing up in the IO products. There are two reasons for that. One, people don’t like losing money. Two, and this is the most important reason, managed risk strategies can be very helpful to people who are using systematic withdrawal strategies to fund their retirements. It will help protect them in down markets. People might say, “I know that managed risk funds won’t guarantee me income for life, but there’s a better chance that my portfolio will last my whole life.”
“We’ll see more entrants into that product space,” agreed Steve Saltzman, of the Charlotte-based consulting firm Kehrer Saltzman. “We’ll also see more death benefits as alternative options on those products in an attempt to provide an insurance feature.”
Without a death benefit, he said, these products are considered unsuitable for funding with qualified money(money in a retirement account), because those accounts are already tax deferred. “Different firms have different standards. Some will allow funding IOVAs with qualified dollars if the product offers unique access to investment options,” he added. And IOVAs may not be right for older investors — some companies will not sell IOVAs to clients over a certain age, because the client’s investment horizon is too short to make tax deferral valuable enough to justify such a purchase.
“There will be a continuation of interest in IOVAs—investment-oriented products with large numbers of fund options, including exotic or sophisticated ‘alternative’ investment options, and with streamlined death benefits,” said Timothy Pfeifer, a consulting actuary at Pfeifer Advisory in Libertyville, Illinois.
Income Without a Living Benefit
There’s a reason why variable annuities were given the privilege of tax deferral. It’s because they’re expected to deliver retirement income when the taxpayer may be in a lower tax bracket. But is there a way to do that without living benefit features in the contract and without the loss of liquidity, which is typically associated with taking a guaranteed income stream (annuitization)?
Some products suggest that it can be done, using either non-guaranteed (but tax-efficient) payouts or deferred income annuities with variable accumulation periods. For instance, two accumulation-driven VAs, the AXA Investment Edge and the Lincoln Investor Advantage, have variable payout options (Income Edge and i4Life, respectively) that allow contract owners who purchased the VA with after-tax (non-qualified) dollars to convert their assets to what resembles a “period–certain” annuity, but with some liquidity. (A period-certain annuity will typically provide a set amount of income for a set number of years, but not for the life of the owner.) The Guardian Investor ProFreedom is a bit different. It offers the option to gradually move all or part of your account balances to a deferred income annuity.
For non-qualified contract owners who are concerned about tax efficiency during the payout phase or in the case of withdrawals, all three of these contracts offer something that living benefits and systematic withdrawals typically don’t—the ability to adjust your income flow to spread the deferred taxes on the interest and earnings across a period certain or over a lifetime of income payments.
The Indexed Variable Annuity
There are now at least four companies—Allianz, AXA, MetLife and CUNA Mutual—that have introduced so-called “structured” VAs. These accumulation-oriented products work a lot like fixed indexed annuities, with one important difference. You don’t get 100% protection from downside loss and, as compensation for assuming more risk, the cap on your potential earnings is higher. Generally, the more downside protection in a product, the less upside potential you get.
CUNA Mutual’s Member Zone VA works a little differently from the other three entries in this category. The Allianz, AXA and MetLife products absorb the first 10%, 20% or 30% of losses over an interest crediting term (depending on the option chosen); the investors absorb losses beyond those thresholds. The Member Zone product, which is more straightforward (perhaps because CUNA distributes through credit unions), leaves the investor exposed to up to a 10% loss in any given year. The issuer absorbs any loss that exceeds 10%. These protections come with certain investment allocation requirements. Be sure to read the contract terms and conditions, along with the prospectuses, before you purchase.
The arrival of these new products doesn’t mean that variable annuities with living income benefits are going away. Supply has dropped, because of the declining risk appetite of insurance companies, but Baby Boomer aging and retirement continues to drive demand for flexible guaranteed income. Please note that any guarantees of annuity contracts and riders rely on the financial strength and claims-paying ability of the issuing insurance company.
For more information on variable annuities and for an investor kit on each of the below VAs, contact Annuity FYI at 866-223-2121.
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