Annuities have been on a significant growth upswing since the equities market started tanking in 2008. So if annuities were more popular when the market dropped, will they lose favor if the economy improves? Don’t tell the mutual fund^ industry, but it would appear that increased annuity allocations are here to stay. Since 2008, consumer surveys of retirees have shown over and over that sentiment has shifted… retirees are no longer focused on just maximizing returns but rather **guaranteeing that their retirement savings will last as long as they do. Dick and Eric look at some of the changes in the annuity marketplace and what those changes mean for you.
**Guarantees, including optional benefits, are backed by the claims-paying ability of the issuer, and may contain limitations, including surrender charges, which may affect policy values. During this segment, Dick and Eric are referring to Fixed Annuities unless otherwise specified.
Read the “Annuity Perspectives” Article by Jack Marrion, that inspired this weeks entry.
The End Of The Beginning
In recent months I’ve been looking at the fixed annuity space; from new products to changed older ones, at recent surveys showing how consumers feel about and are using annuities, at census data and at how economic variables are affecting everyone from the individual consumer to the carrier to the global economy. I’ve also talked with people in the annuity world that are disheartened by the events in 2012 and pessimistic about the future of the industry. And yet as I did more research I became more optimistic. In fact the phrase “the end of the beginning” kept resurfacing in my thoughts.
In the early days of World War II Britain experienced a series of defeats. However, in the fall of 1942 they defeated Erwin Rommel’s Afrika Corps at El Alamein and Egypt was saved from invasion. Shortly thereafter Winston Churchill gave a luncheon speech at the Lord Mayor’s house in London. In the speech Churchill said this victory did not mean that the war was ending or even that it was the beginning of the end, but that it was, perhaps, the end of the beginning of the bad times. Now, I am not trying to equate the struggle of wartime Britain with recent difficulties in the annuity industry. What I am saying is that I believe the annuity industry has faced and is working through its problems. While the fixed annuity sector may not quickly soar back to the previous heights we are at least almost done falling – it is the end of the beginning of the bad times. I’d like to share why I believe this to be so.
Bond Yields Have Bottomed
Bond yields reached their cycle low at on 7 December 2012 at 9:43 AM. Well, I might have gotten the time wrong, but there are indications that bond yields have fallen as far as they’re going to. Two indicators of interest rates, yields spreads and leverage, show that financial conditions are much looser than they have been. When the St. Louis Financial Stress Index and the National Financial Conditions Index are positive it indicates there is stress in the financial markets and lending is tight. The charts on the next page clearly show the tension during the 2008 financial crisis. However, for the last several months these indicators have been negative showing that money is available. Indeed, November 2012 was a record month for corporate bonds issuance showing that corporations believed that there would never be a cheaper time to borrow money than now [The Economist, 8 Dec 12. page 74].
Even though the Federal Reserve Board stated in December that they would keep short-term rates low until unemployment is substantially reduced, the reality is the Fed had already shot their bolt and this announcement will have little additional effect on rates. The driver for increasing bond yields is an improving economy. The economy will improve as 2013 progresses and bond yields will also increase. Another factor helping overall rates is that yields on U.S. Treasury bonds and notes are abnormally low relative to corporate debt yields – a hangover from concerns stemming from the 2008 crisis. Even if overall bond rates stay the same Treasury yields will move up as investors realize they priced too much risk into corporate bonds. As long as the U.S. avoids a full-scale recession bonds will pay more interest as 2013 progresses. [Read More…]
Annuity Guys® Video Transcript:
Eric: Today, we’re looking at whether or not the annuity world is improving at the same pace the economy is.
Dick: Well, that depends on what we want to judge the economy’s pace.
Eric: Is the economy improving? I guess is the first question most people would ask there.
Dick: I think generally speaking, folks are optimistic right now about the economy coming back somewhat.
Eric: Here we’re really foreshadowing into 2013. We’re looking, as we expect things to improve if our projections are right and the band aids get applied. We have that nice new skin that we’ve now in the economy.
Dick: Eric, one thing that’s prompted us this week, is this article that we have here by Jack Marrion and he’s looking at different aspects of annuities and how they’re affected by the bond market and by consumer sentiment the popularity or the supply and demand.
Eric: First of all we should talk about how insurance companies make money. It’s pretty basic. They take in and they buy an investment, they get it here, and then they have to pay you out, whatever they make between what they have got there.
Dick: Between a bond yield and their expenses.
Eric: The expense of the annuity payment is where they make their money. They make their money on the spread. What we had seen in the last couple of years is the pull back of benefits. Boy, they really tightened down the minimum **guarantees and all those pieces, almost to the point that some people are saying there is no benefit at all.
Dick: Maybe they even overreacted, that’s what Jack said.
Eric: That’s what Jack is saying here. Here’s the good news. Even if the bond market does not change much or if we do not have that much improvement in the economy, we’re likely to see an improvement in the annuity world, solely because some companies pulled back further and tighter than they needed to. That’s not saying every company did.
Dick: One thing that excites me about this is that obviously, when it comes to new annuities we like to see new benefits or new or better earning possibilities, but what really excites me is that those folks that already purchased a hybrid or a fixed index style annuity as things loosen up, their caps and ability to earn will continue to increase and improve.
Eric: And a lot of people do not grasp that concept. Those cap rates are not set for the life of the annuity.
Eric: They adjust on an annual basis, typically. Some of them are a biannual, but you’ll see adjustments in those caps. So yes, some people get mad when things go down or lower than when they started, but they also have the potential to go higher than when you started. So if you are a new entrant in the last couple of years, don’t panic. There is a good chance that those caps will increase with you.
Dick: That’s right. Really what’s more important for most folks, like our clients that we have worked with, is really the contractual **guarantees on the income, is more important than the caps or the cash accumulation.
Eric: We always say the **guarantee is what you hang your hat on, so if you can live with the **guarantee and that’s not going to change. Those **guaranteed pieces don’t change.
Dick: For those of you who already have your annuity, your contractual **guarantees are probably even better than what’s going to be there in the future.
Eric: The other change that may not be so positive in a sense, is that a lot of these rollups and ratchets we’ve seen in the last couple years 7.0-8.0%. Those are the things that make…
Dick: They’re now thinking about pulling those back.
Eric: Because those are long-term pieces.
Dick: They’re liability. Folks, a lot of times and we’ve sat and talked with different ones that have been a little skeptical. Like “Well, the insurance company’s making money. They’ve got it all figured out and they can afford to do this 7.0% or 8.0% or whatever.” Well, when they sit down and they work the numbers out, sometimes they have to pull back on those, because it is too generous.
Eric: So if you’re looking at one of those hybrid styles right now. We do not want to tell you to wait to look for something better, because the better may already be here on that side.
Dick: Right, on the contractual **guarantee side.
Eric: What we’re hearing is kind of what the expectation for the changes in the upcoming year may be more cash values, more increases in cash potential and benefits, based off of actual cash, rather than these **guaranteed withdrawal benefits.
Dick: Right, which is really the pension aspect of the annuity that so many people use effectively.
Eric: And talking about pensions. Jack talks about the changes in people’s perceptions. Ten years ago, when people were actually offered company benefits about half of them would take the pension style and the other half would take the lump sum.
Dick: Right. It’s changed a lot.
Eric: Today, almost 90% of the people or about 90% of the people are taking the pension benefit, so what’s that saying?
Dick: They’re saying “I want the annuity.”
Eric: They want the **guarantee and I think that’s the aspect that their attitudes are changing. They’re not worried about accumulation, so much as worried about having money that’s around as long as they are.
Dick: Well, even annuity owners in the studies that he mentions in here, and folks we will put this out on the blog, so that you can look at it.
Eric: It should be down below, portions of it anyway.
Dick: But one thing that Jack points to from one of his studies, is that of the people who actually own annuities, about 73-75% of those people actually, feel that that’s a very important part of their retirement plan. It’s a strategic allocation to their overall retirement strategy.
Eric: It’s not going to be part of what we are talking about here, but I just read another study that talked about the inclusion of a fixed indexed annuity in a retirement plan and the probability for success and having money at the end.
Dick: Right, I was looking at that also.
Eric: Your probability of success when it includes a fixed annuity versus, either a variable annuity# or just using stocks and bonds or mutual bonds, your probability of success is greatly enhanced, when you had a combination of those pieces. We’re starting to see more and more people consider annuities as a replacement for bonds.
Dick: For bonds right, for that portion of their portfolio.
Eric: Because it takes that degree of risk from the increase in the bond prices or the change in the bond prices.
Dick: Well, there is another layer of insulation, between the bond market and the investor and the consumer.
Eric: You put that portion of liability, really on the insurance company to manage.
Dick: It also gives another aspect which is of protection, which is the longevity aspect the insurance company takes on the longevity risk.
Eric: The last point that I want to make, as far as what Jack talked about. He talked about so few consumers truly understand how annuities work, and that’s probably why you’re sitting here listening to us at this stage, is you’re wanting to learn more about how annuities and how work and how they function. With all these innovations and these changes, the one thing we always say is work with a local financial advisor, because they’re the ones that keeping up on the innovations. It’s their job to take what you’ve learned now, and enhance your ability to pick the right product and right solution for your needs.
Dick: According to the study, less than half of the people feel like they have any knowledge about annuities that are all in this retirement group. It’s the largest group of retirees that are facing retirement that we’ve ever seen. Less than half of them have any real knowledge and only about 5.0% feel that they’re very knowledgeable, so there’s just a lot of room, folks to learn about annuities and know how they’re going to fit.
Eric: So can annuities be part of a successful retirement plan in 2013?
Dick: Absolutely and I do think that as the economy improves that these annuities will take their place and continue to innovate and improve and also very fortunate, for those who already have an annuity that it’s going to be able to keep up.
Eric: Good deal. Thank you very much, for tuning in today.
Dick: Thank you.