Annuities - The New Wave in Retirement Planning

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1 INSURED RETIREMENT INSTITUTE A1 TRENDS IN PRODUCT DEVELOPMENT A Short List of Recent Winners A6 EASING THE REGULATORY BURDEN Progress on the Legislative Front A7 SOCIAL SECURITY BASICS Helping Your Clients Understand How It Works ISSUE 4 VOL 4 Trends In Product Development The hot products and topics in the world of variable annuities are almost too extensive to list, but a short list of recent winners is apparent. The key trends in VA product development, based on ongoing Morningstar Research, can be classified into a few categories. The first is the continued growth of alternative investments offered inside VAs that play to VAs strength as a tax-efficient structure, coupled with advisors demand for uncorrelated products. The second is an increase in the variability in the guaranteed side of variable annuities, in the sense that everything is up for grabs: step-up rate, payout rate, and fees. As a result, VAs now offer more flexibility than ever before, allowing advisors to choose the precise design mix that is right for their clients. Finally, the growth of deferred income annuities is an ongoing trend and a product that continues to do well. These advances in product development are mirrored by a parallel trend: improvements in client education. Advisors and plan sponsors now have access to new tools to share the good news about VAs and can transmit information about VAs advantages more effectively. What do these changes mean for investors? The answer is simple: VAs continue to provide unique value to investors, particularly in the context of today s interest rate levels and overall economic environment, said Rob Pettman, Senior Vice President, Investment & Planning Solutions at LPL Financial. Alternatives VAs value proposition has many components, with the guaranteed features getting the lion s share of attention in recent years. But VAs are experiencing a back-to-the-future moment. Their tax advantages, once their main selling point, are once again in vogue. These advantages become critically important when it comes to housing alternatives, which tend to be tax inefficient. A number of firms are going old school, offering VAs with no living benefit riders but lots of investment options, said John McCarthy, Product Manager, Annuity Solutions, Morningstar. Many of these investments could be classified as alternatives, such as long-short funds, or managed futures. The ability to get these offerings inside VAs is very appealing to investors, McCarthy added. Carriers have stepped up to the plate in terms of their range of alternative offerings inside VAs. For instance, AXA Equitable s Retirement Cornerstone VA is a platform that offers access to more than 100 investment managers as well as choices about retirement income protection in a tax-efficient structure. Other AXA products provide access to indexes, coupled with downside protection. We see a lot of excitement around these new investment stories, said Todd Solash, Senior Vice President, continued on page A2 Advertorial Prepared by SourceMedia s Marketing Services Group

2 Trends continued from cover A number of fi rms are going old school, offering VAs with no living benefi t riders but lots of investment options. John McCarthy Product Manager, Annuity Solutions, Morningstar Retirement Services Product Life Cycle Management at AXA Equitable. Nationwide s marketflex product also provides a large number of investment options, both alternatives as well as strategic, traditional options. There is no living benefit, however. Instead the focus is firmly on tax deferral. marketflex has resonated strongly with investors: It s on track to double sales from last year. Eric Henderson, Senior Vice President of Life Insurance and Annuities for Nationwide Financial, explained why alternative investments inside a VA have proven to be such an attractive offering to investors. We like to use the METALS concept, he said. METALS is an acronym for: Minimums. Alts inside a VA tend to have much lower investment minimums than stand-alone alternative investment funds, making them more accessible for investors. Expenses: lower than for a hedge fund or other alt manager. Tax-efficient. Accreditation. You don t need to be an accredited investor to invest in these products unlike many alt offerings. Liquid. VA alt offerings are liquid, unlike the long lockup periods of private equity or hedge funds. Spousal protection. Nationwide products provide a death benefit on whichever spouse dies first. Henderson pointed out that Nationwide has been in this space for more than 10 years and, in this sense, is more experienced than many alt managers themselves. If investors are already sold on alts in a VA, or interested in exploring this type of investment further, perhaps METAL (or METALS if spousal benefits are included, which isn t always the case) is why. Variability in variable annuities; growth in deferred The other major trend of the moment is new variability on the guaranteed side, VA PRODUCT CHANGES Correction: In the June issue of Insight, Morningstar should have been referenced as the source for the graph (Benefits of Tax Deferral) on page A2. We apologize for this oversight Significant new product innovations as tracked by Morningstar. Source: Morningstar A2

3 providing new flexibility as well as choices for advisors. Previously riders would say you can take a certain percentage of account value for life, and that guarantee was based on certain step-ups, McCarthy said. Today, all these parameters can be changed. Shaping these changes are the economic environment of ultralow interest rates. Someday interest rates will rise. The parameters of lifetime income products are changing to reflect these economic realities. Being able to tie product design to market conditions can give consumers better outcomes while allowing carriers to better manage risk. To take a concrete example, AXA Equitable s Retirement Cornerstone product, described above, is tied to the 10-year Treasury. When interest rates rise, investors will be able to capture some of this upside. We think this trend toward variability makes a lot of sense, Solash explained. It helps consumers get a better value proposition while reducing carrier risk. It can truly be a win-win. Another hot trend is the continuing increase in sales of deferred income annuities. (Call it trend 2.5, only because this overall market remains small compared to that of VAs.) Deferred annuities are like an immediate income annuity only the payment is locked until a future starting date. By deferring income into the future, the guaranteed payout is that much larger. Deferred annuities continue to hold enormous promise for Americans planning for their retirement income. Given today s low interest rates as well as continuing economic uncertainty investors have reason to be concerned about how they will fund their life in retirement. Deferred income annuities offer an option and the looming retirement of 79 million Baby Boomers is one driver of sales. The sales of deferred income annuities keep growing, McCarthy noted. The product is doing really well. Consumer outreach These advances and improvements in VAs aren t only happening in terms of product design, they are occurring on the communications and educational front as well. Carriers are finding new ways to transmit information to investors about the velocity of VA product development and the unique advantages VA s provide. We have new tools that improve the educational experience of the end investor, Pettman said. For instance, LPL has launched an annuity visualizer that is optimized for the ipad. Investors can personalize scenarios, and see in graphic form how annuities can solve for their needs. Last year, AXA Equitable introduced an ipad app for its Structured Capital Strategies VA to help advisors bring the product to life. Using the app, advisors can run through different scenarios in seconds instead of calling the sales desk or going online to do it. Carriers are providing many other information access points for advisors interested in annuities. These include customized s and even dedicated product consultants who can answer all questions in a single phone call. One larger information challenge that is now closer to finally being solved is the ability to integrate lifetime income into conventional portfolio tools focused on accumulation planning. Tools for accumulation tend to emphasize risk and return rather than income planning. These aren t easy things to square, Solash said. Conventional tools might look at the volatility of a portfolio, rather than how much income do I have and how long will it last me? New tools that better integrate income into retirement planning provide valuable insights to planners and clients. At the very least they might raise questions about the viability of self-insuring for retirement income. For instance, is the safe withdrawal rule of four percent still valid, given where interest rates are today? What is a more realistic safe withdrawal rate, can the client live on this, and how We think this trend towards variability makes a lot of sense. It helps consumers get a better value proposition while reducing carrier risk. Todd Solash, Senior Vice President, Retirement Services Product Life Cycle Management, AXA Equitable long will the portfolio last in retirement? Using these new tools to do side-byside comparisons of retirement income provided by different products can only highlight the true value of variable annuities. Solash noted, Tools that highlight income measures mean more astute buyers of income, which is good for consumers and insurers. The result of these advances in income planning tools which are in varying stages of development coupled with advances in product design in VAs can only lead to one result: a big win for consumers. A3

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5 The ABCs of Variable Annuity Riders In recent years, living benefit guaranty riders have become a more common offering in variable annuities. The Great Recession and slow recovery left many Americans questioning their level of exposure to market risk. The search for safer investment and retirement income sources offers one explanation for the rise of riders. Formerly, principal protection against investment risks under variable annuity contracts was offered only in the case of death. Now some type of living benefit rider is offered with 69 percent of variable annuity contracts. These riders are optional and can offer protected lifetime income for an additional fee. Besides offering these in new contracts, some companies allow them to be added to existing contracts. There are several different types of riders available that can offer income, the return of principal or both. Some specialize in providing immediate income, while others are designed to provide distributions at a later date. These are four principal types of living benefits. A Guaranteed Minimum Income (GMIB) rider is designed to provide the investor with a base amount of lifetime income when they retire regardless of how the investments have performed. It aims to guarantee that if the owner decides to annuitize the contract payments are based on the amount invested, credited with an interest rate of typically four-to-five percent. An investor must annuitize to receive this benefit and there is typically a seven-to-ten year holding period before it can be exercised. Age limits may also apply. A Guaranteed Minimum Accumulation (GMAB) rider is intended to guarantee that an owner s contract value will be at least equal to a certain minimum percentage usually 100 percent of the amount invested after a specified number of years typically seven to ten years regardless of actual investment performance. Many GMABs require some form of asset allocation. A Guaranteed Minimum Withdrawal (GMWB) rider allows for a certain percentage usually five to seven percent of the amount invested be withdrawn annually until the entire amount is completely recovered, regardless of market performance. Reducing withdrawals in one year does not allow for increased withdrawals in subsequent years. However, if a contract owner defers withdrawals and the account value grows, the amount of subsequent withdrawals allowed may be larger. If the underlying investments perform well, there will be an excess amount in the policy at the end of the withdrawal period. If they perform poorly and the account value is depleted before the end of the withdrawal period, the investor can still continue to make withdrawals until the full amount of the original investment is recovered. If the investor decides to terminate the contract before the end of the withdrawal period, they will receive the cash surrender value of the contract. Recently a step-up feature has been introduced that periodically (e.g. annually or every five years) locks in higher guaranteed withdrawals if investments do well. Another type of GMWB rider that is designed to guarantee withdrawals for life was introduced in The Guaranteed Lifetime Withdrawal (GLWB) guarantees that a certain percentage often based on age of the amount invested can be withdrawn each year for as long as the contract holder lives. This percentage may vary depending on the person s age when withdrawals begin. New benefits, such as spousal continuation, have recently been introduced. Living benefit guaranty riders expand and diversify the capabilities of variable annuities. Financial advisors must remain on top of innovations in this product segment to ensure they offer clients the most appropriate insured retirement income solutions available. Make sure you understand how a guarantee is calculated as well as any additional costs. Consult the Insured Retirement Institute s 2013 Fact Book, a complimentary member benefit, for more information on the mechanics of riders, associated fees and more. A5

6 Easing regulatory burden could mean more retirement income advice for clients W hen it comes to regulation, advisors expect they will need to satisfy certain requirements. However, insurance licensing across multiple states is viewed as redundant and burdensome. Regulatory obstacles created by stateby-state licensing requirements affect the willingness of some advisors to sell STATE REGULATIONS AND LICENSING Eight in 10 broker-dealers believe that state insurance regulations are duplicative In firms with 500 or more financial advisors, 47% This study shows that 83% of advisors are licensed in two to 10 states. have licenses in 21 or more states. income-guaranteed products at a time when Americans retirement security is especially vulnerable, the Insured Retirement Institute (IRI) found in its research. Unlike securities licenses, which are regulated federally through the Financial Industry Regulatory Authority Inc. (FINRA) for broker-dealers and require In firms with 10 to 499 advisors, 30% of advisors have licenses in 21 or more states. Seven in 10 broker-dealers believe that state insurance licensing can be ambiguous or poorly defined. In addition, 75% of broker-dealers stated that it is difficult to stay current with state mandated annuity training requirements. Source: IRI 2013 Study: Broker/Dealers, Financial Advisors & Clients: Annuities and the Regulatory Environment one form for licensing in multiple states, insurance licenses are regulated on a state-by-state basis. Each state sets it own criteria on granting licenses, continuing education, renewals, and fees. Some are straightforward, others not so much. Many require the same information, but in different formats, adding to advisors workloads. On the securities side, the licensing is a click of a button, said Kathy Van Noy-Pineda, Chief Compliance Officer with LPL Financial Services. You need to register in Ohio, for example, and you pay the fee. But on the insurance side, it is working with every single state, every single set of forms, making appointments with the insurance carriers, and so on. IRI supports the formation of the National Association of Registered Agents and Brokers (NARAB), a national licensing clearinghouse for brokers operating in multiple states. We re very encouraged that if this could go through, it would be a terrific next step in streamlining the insurance licensing process, VanNoy-Pineda said. Biggest issue for advisors Advisors, particularly those working as sole operators or in small firms, often find the licensing process cumbersome. This is probably the biggest issue we hear from our financial advisors: the difficulty of the licensing process, said William Nelson, President of Southwest Insurance Agency in Dallas. The majority of our advisors have multiple licenses. For an advisor, there is no consistency from state to state. IRI s research points to the fact that 83 percent of advisors are licensed in two to 10 states. What s more, in firms with more than 500 advisors, 47 percent are licensed in 21 or more states. It s not uncommon for clients to move out of state in the course of a relationship with an advisor. An advisor would need to obtain a license in the new state in order to continue providing that client with insurance products. A6

7 According to IRI, advisors spend an average of 55.5 hours a year on licensing requirements in order to sell annuities, compared with 46.8 hours to sell other investments. Eighty percent of brokerdealer firms cited state regulations as a burden to conducting annuity sales, that s higher than the number of those citing federal regulations. Need for retirement income on the rise Yet consumer demand for lifetime income is on the rise. An IRI survey conducted by Cogent in 2012 found that 84 percent of financial advisors reported having a client discussion about retirement income planning, including annuities. Nearly half (46 percent) of broker-dealers say they would like to sell more annuities, but time constraints and regulatory hurdles prevent them from doing so. Because of the burdens, you might have some financial advisors shying away from offering these products, Nelson said. Another issue advisors confront is a lapsed insurance license. Because the states have different licensing and renewal requirements, the advisor may not be aware of this until he or she tries to sell an insurance product. If 10 to 15 percent of your business is annuities or insurance, then you ll be willing to go through the hurdles, Nelson said. But if it comprises less than that, advisors are likely to take the path of least resistance and not offer the insurance products to their clients. With Americans facing bigger retirement challenges the disappearance of traditional defined benefits programs, coupled with increasing longevity many advisors believe they need more simplified ways to offer their clients retirement income guarantees. Removing some of the state licensing obstacles could help retirees access annuities to increase their retirement security. Progress on the legislative front In early June, the National Association of Registered Agents and Brokers Reform Act (NARAB II) cleared the Senate Banking Committee and is now slated for a vote on from the full Senate. Introduced by Sen. John Tester, D-Mont., and Sen. Mike Johanns, R-Neb., the bill mandates the creation of the National Association of Registered Agents and Brokers, a membership organization that will streamline the process of obtaining licenses in multiple states. However, states will retain their jurisdiction over consumer protection, market conduct, and unfair trade practices, while also retaining oversight of licensing, supervision, disciplining, and the setting of fees. We want to make sure that brokers are still appropriately licensed and trained, Van Noy-Pineda said. That s a good thing, but there needs to be a way to ease the burden on advisors. Social Security Basics F or about 80 percent of retirees, Social Security makes up 45 percent or more of their post-work income. Even retirees of greater means rely on the federal pension program to bridge the gap between their retirement living expenses and what they can draw down from their own resources. Because of how important Social Security is for retirees financial wellbeing, it s important to help your clients understand how it works. Who is eligible? To be eligible for Social Security benefits, retirees must have earned 40 credits during their working years. That equals 10 years of work. Benefits are based on lifetime income, with an average taken of a person s 35 highest earning years. A formula is applied to those earnings to determine the benefit amount. Workers can get an estimate of what their Social Security benefit is likely to be on the Social Security Administration s website at www. ssa.gov/estimator. Full retirement age Full retirement age was 65 for many years, but has slowly risen, going up to 67 for those born in 1960 or later. However, eligibility for Social Security begins at age 62, but with a reduction in benefits for each month that it is started prior to full retirement age. On the other hand, waiting to take Social Security can mean a benefit increase for each month that it is postponed until age 70. Considering taxes Social Security might be taxed depending on a retiree s other income. For married couples filing jointly, 50 percent of the benefit is taxed for those earning between $32,000 and $44,000. If combined income is over $44,000, then 85 percent of Social Security benefits are taxed. Individuals can expect 50 percent of their Social Security to be taxed if their income is between $25,000 and $34,000 and 85 percent of the benefit for individuals earning more than $34,000. Look for more information on Social Security, including practice management and client materials, at A7

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