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Mark Miller: Remaking Retirement

The Uptick in Annuities

Contributor Mark Miller looks at the factors driving the healthy growth in fixed annuity sales.

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Annuities are sold, not bought, the old saying goes. If so, someone is doing a pretty good sales job on fixed annuities.

There are two main types. Fixed-rate deferred annuities provide a CD-like guaranteed return for maturities of three to 10 years. Indexed annuities provide protection of principal and participation in some upside, usually tied to the performance of a stock market index.

Both are enjoying healthy growth. According to the LIMRA Secure Retirement Institute, fixed-rate deferred annuity sales jumped 34% in 2018; fixed indexed annuities were up 27%. Both were well ahead of a healthy 15% rise in sales of all annuity products. The trend continued in the first quarter this year: LIMRA SRI reported last week that fixed sales were up 38% compared with the same period last year. Variable annuity sales were down 7%.

In part, those strong gains reflect a bounceback following the demise of the U.S. Department of Labor fiduciary rule, which has removed the threat of litigation against insurance companies and brokers if they sell products that don't meet fiduciary best-practice standards.

But the fast growth for fixed products suggests something else may be going on, too: They are being purchased for their liquidity features. As such, these products may be starting to overcome one of the biggest annuity purchase objections: turning over a large lump sum of cash in return for an uncertain lifetime return.

Such reluctance is a case of "show me the money" human behavior: When given the choice to hold on to money--or get it sooner rather than later--we do it. It's not much different than the tendency to file early for Social Security or take a lump sum offer on a pension. There's a compelling argument that annuities can help mitigate longevity risk. But that argument hasn't made annuities more than a small niche player in the overall retirement product market, as Morningstar's John Rekenthaler noted recently.

Another barrier is fees: Annuities have a reputation for high commission costs. Indexed annuity commissions vary widely but typically range from 5% to 7%, and variable annuities carry similar fees, says Matt Carey, co-founder of Blueprint Income, an online marketplace for annuity products. Income annuities (such as Single Premium Income Annuities) typically have commissions around 3%.

Fixed-rate deferred annuities are a bit different. They are less expensive, with commissions usually ranging from 2% to 2.5%, Carey says. They are structured like high-rate certificates of deposit, with a guaranteed rate and a set term of investment (three-, five-, seven-, and 10-year terms are the most common). At the point of termination, you can either take your money and run, roll it into another fixed-term vehicle with the same insurer (or a different one via a 1035 exchange to avoid any tax consequences), or convert it into an annuity stream.

The recent stronger performance of annuities owes, in part, to the rising-rate environment throughout 2018, notes Carey. In 2019, however, the Fed has halted rate increases and bond yields have trended downward again.

"The market is very rate-sensitive," he says. "And the volatility in equity markets late last year also moved people toward safer products."

Five-year payout rates (net of fees) are at 4.10%, up from 3.50% in the summer of 2016, Carey's data shows. Compare that to a five-year CD with an APY of 1.44%, according to BankRate.com, or a mutual fund option like  Fidelity Total Bond Fund (FTBFX), which currently has a trailing 12-month yield of 3.28%.

The relatively flat yield curve also plays a role in making fixed payout rates more attractive, notes David Lau, founder of DPL Financial Partners, which has created a marketplace of commission-free annuity products for use by Registered Investment Advisors on behalf of clients.

"With the very flat yield curve, most RIAs are not investing in anything beyond very short instruments--if rates rise, holdings at the long end of the market will have turned out to be a bad idea," he says.

Current market trends aside, some retirement analysts argue annuities will be superior fixed-income holdings in retirement portfolios going forward. Retirement researcher Wade Pfau has argued that the most efficient portfolios are those that rely on income annuities, not bond funds, for their fixed-income allocation. That's because of the volatility of bond funds and sequence risk, he notes, and the mortality credits offered by annuities.

Morningstar's David Blanchett also looked at this question in a paper he co-authored comparing bond ladders and immediate income annuities. He found that increasing annuitized income opens the door for retirees to take more risk in the equity portion of their portfolios.

Regulatory Clouds Lift
Another factor driving higher annuity sales is a changed regulatory environment. The U.S. Department of Labor rule, implemented in 2017, put tight fiduciary requirements on advice given to owners of qualified accounts, which made it more difficult to sell annuities via rollovers from 401(k) or IRA accounts. The insurance and broker/dealer lobby never gave up the fight to dismantle the rule, and the ensuing fight created an uncertain marketing environment. The uncertainty lifted when the rule was vacated last year.

Sales of all annuities fell in 2017 while the rule was being implemented. Comparing annuity sales in 2018 with 2016, total sales were up 5% and the fixed market was up 24%, according to LIMRA SRI. Fixed-rate deferred showed an even more impressive gain, rising 20% from 2018 to 2016. And fixed annuities are gaining market share against variables: They accounted for 57% of sales last year, up from 53% in 2016.

"There's no question that the disappearance of the DoL rule played a role in the resurgence of annuity sales, especially fixed index annuities," says Barbara Roper, director of investor protection at the Consumer Federation of America, which has been a key proponent of tough fiduciary standards. "Insurance regulators have made clear they have no interest in adopting tougher standards."

Industry analysts agree that the demise of the DoL rule has paved the way for growth. Tellingly, they don't seem worried about the coming Securities and Exchange Commission Regulation Best Interest Rule, which is widely viewed as more friendly to nonfiduciary brokers.

All of this is bad news if you think it means insurers will take advantage of people rolling assets out of retirement plans by pushing mediocre, high-cost products like variable annuities. IRA rollover sales rose 18% compared with 2017, according to LIMRA SRI data--although the gain mirrored the 17% gain in nonqualified sales.

Todd Giesing, director of annuity research at the LIMRA SRI, argues that most of the sales spurt stems from the improved economic climate for annuities. And he notes that many of the changes insurers had to make to accommodate the DoL rule have remained in place.

"Everyone had to make changes and adjustments in their business processes to accommodate the rule, and then the business environment became uncertain, with a lot of speculation about whether the rule would be upheld," he says. "Even with the vacated rule, we've heard from many annuity providers that they made changes that remain in place today due to the rule, but now there is at least some short-term clarity." Those changes include changes to business processes and practices, and disclosure policies, he says.

Regulatory clarity also has set the stage for greater annuity product innovation, Giesing says. That includes new annuity types, but also changes in distribution.

Blueprint is an example of what the industry likes to call InsurTech: the growing trend among legacy insurance underwriters to work with more-nimble tech startups that are streamlining the buying process and making it easier to educate consumers on product choices.

Roughly $2.5 billion was poured into InsurTech ventures last year, according to a Deloitte estimate. Startups were popping up at the rate of nearly 200 per year through 2016, though that pace has leveled off.

"There is a ton of potential here," Giesing says. "Insurance is a legacy business that can be slow to adapt to change."

And RIAs now have access to online marketplaces such as DPL that make it easier to analyze and recommend annuity products to clients, rather than outsourcing that to a broker. Another example of this is Envestnet, which recently launched an insurance exchange for advisors who use its network.

Prudential Financial is one of the insurers on that network.

"We're looking at this as a pivotal time to connect with RIAs with income solutions," says Kent Sluyter, president of Prudential Annuities. "In many ways, they are more relevant and reachable for our business--there is an understanding in that community that there's an opportunity to engage with clients more holistically, including income protection and outcomes."

Mark Miller is a journalist and author who writes about trends in retirement and aging. He is a columnist for Reuters and also contributes to WealthManagement.com and the AARP magazine. He publishes a weekly newsletter on news and trends in the field at Retirement Revised. The views expressed in this column do not necessarily reflect the views of Morningstar.com.

Mark Miller does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.