As Americans continue to live longer, the demand for income that will last a lifetime has grown substantially. Insurers have responded by developing new products tailored to their customers’ individual needs.
This innovation is accelerating, and the result is a broader offering of retirement income products. One such product, deferred income annuities (DIAs), is emblematic of the product expansion taking place across the insured retirement market. Since their emergence several years ago, DIAs have become the focus of insurers’ efforts at innovation, providing financial advisors and their clients with another lifetime income option.
Anyone who studies mortality tables for a living could have seen this coming. Americans were living longer and, as a result, were spending more years in retirement. At the same time, traditional defined benefit pension plans were disappearing and more workers were saving for retirement with 401(k) and other defined contribution plans. These plans have been largely successful at helping Americans accumulate financial assets for their later years.
The Investment Company Institute estimates that $5.1 trillion in assets were held in these plans at the close of 2012. That said, the defined contribution system resulted in more workers being self-responsible for saving for retirement, investing retirement assets and managing withdrawals during their retirement years – transferring new risks to plan participants in the process. One of these risks is longevity risk – the risk of outliving retirement savings.
To manage this risk, many consumers have turned to annuity products as a source of guaranteed lifetime income. Guaranteed income is the top reason consumers purchase an annuity, according to an Insured Retirement Institute (IRI) and Cogent Research study. To meet this demand, the insured retirement industry continues to develop a menu of strategies to provide retirement income, with each approach tailored to meet the needs of each customer. These strategies include, among others: variable annuities (VAs) with guaranteed living benefits, indexed annuities (IAs) with guaranteed living benefits and single-premium immediate annuities (SPIAs). Each of these product classes has its own unique features, which are developed to cater to specific markets. VAs with living benefits, for example, provide consumers with the ability to invest in equity markets in a tax-deferred savings vehicle, while offering guarantees and providing for income flexibility.
To cater to those interested only in insuring against longevity in its purest sense, insurers had developed advanced life deferred annuities (ALDAs), sometimes
simply referred to as “longevity insurance.” With the ALDAs, after a one-time premium payment, the income stream would be deferred for a long period of time – 15 to 20 years for example – until the beneficiary reached an advanced age, often age 80 or 85. Then the income stream would begin, providing fixed payments for the duration of the owner’s life. Because of the long deferral period, risk pooling and the lack of bells and whistles, ALDAs provided a low-cost and extremely efficient strategy to insure against longevity while providing the most income per premium dollar.
While a simpler product was able to provide higher payouts, the lack of features would impede ALDAs from gaining popularity. ALDAs generally did not provide death benefits, so the entire premium would be lost if the owner died before the income stream commenced. ALDAs also had no cash value, so they couldn’t be tapped in the event the owner needed the liquidity. As a result, few companies marketed ALDAs, consumers shied away from them and significant sales never materialized.
The concept of providing an income annuity later in life, when other assets may be exhausted, still had merit. With roughly 10,000 baby boomers reaching retirement age each day and the need to protect against outliving retirement assets persisting, insurers began rethinking their approach to longevity insurance. The outcome would become a new product: deferred income annuities or DIAs.
To address consumers’ concerns with ALDAs, insurers reduced the minimum deferral period, previously in the 20- to 30-year range, to two years. Most DIAs on the market today offer the ability to defer income for as long as 40 years, but the majority of the contracts sold have a deferral period of five to 15 years.
To further address the rigidity of the ALDA, insurers added more flexibility to DIA contracts. Now, most DIAs offer the option to modify the benefit commencement date – typically just once – to provide some limited flexibility. Most DIAs also allow the client to contribute additional premiums before the income start date. In addition, most DIAs now have a death benefit, which typically was not available with ALDAs. Many insurers also have added liquidity features and cost of living adjustments pegged to a preset percentage or to the Consumer Price Index.
DIA products were launched into the market several years ago. Last year, they achieved their first year of significant sales, estimated to be about $1 billion, with six companies offering DIA contracts. Now, a dozen insurers either are offering or have filed to offer a DIA product. Meanwhile, sales continue to increase. Beacon Research reported that DIA sales increased for five consecutive quarters, reaching a record high during the first quarter of 2013.
And while relatively new to the market, trends are beginning to emerge on DIA clients. In general, those who are purchasing DIA contracts are similar to those who purchase VAs or FIAs with living benefits. DIA buyers are, on average, in their late 50s. The average deferral period is about eight years.
Although DIA sales are growing, they make up only a small percentage of total annuity sales. That said, IRI expects DIAs to be the fastest growing product class on the market in 2013 on a percentage basis. This trend should continue into 2014. What remains to be seen is whether DIAs will be a long-term success or a passing fad. Their market presence, however, demonstrates the industry’s commitment to innovate and to develop new products to meet the needs of consumers. Their recent success also shows the continued consumer appetite for retirement income strategies focused on managing longevity risk through guaranteed lifetime income. As Americans continue to live longer, and as baby boomers exit the workforce en masse, there will be a continued need for guaranteed lifetime income strategies. DIAs, for the time being, will provide consumers with another option for attaining income for life.