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Variable Annuity Changes Rattle Advisors, Clients

Wisconsin financial advisor Juli McNeely is of two minds when it comes to the current state of the variable annuity (VA) market.

Insurance carriers often drive her batty because the latest tweaks and adjustments to their VA product lines make it seem as if VAs are a “moving target,” she said.

Yet when underwriters spend time tinkering with their VA products, it’s a sign carriers are adjusting their portfolios to make sure VAs remain profitable while still meeting demand.

“I want those products to be sustainable,” said McNeely, secretary of the National Association of Insurance and Financial Advisors. “I want to make sure companies will deliver on the promises that they’ve made.”

Who wouldn’t? Investors who sank part of their life savings in an annuity want to know that the annual 7 percent guarantee they signed up for on a $500,000 VA is going to turn up in the form of periodic payments, just as the contract promised.

For years, those contracts promised generous withdrawal living benefits. But those promises ultimately proved to be more than some carriers could profitably deliver as record low interest rates dragged on and markets swooned.

As a result, some companies dropped out of the VA market, others blocked investors from making any new contributions and still others throttled back – hard.

Carriers have intentionally dampened sales or scrapped living benefits riders, or secondary guarantees, in favor of adding some higher risk and alternative risk investments in the “VA chassis,” said Brock Jolly, a financial advisor with Capitol Financial Partners in McLean, Va.

While some annuity companies are changing the guarantees on existing contracts – never a pleasant experience for customers – it’s more common to see companies introduce new VA products, he said.

Jolly said he sees a “back to basics” approach on the part of the VA industry, one that offers investors tax efficiency, the opportunity to build a diversified portfolio and access to sophisticated managers, he added.

“I recommend that you put a nice chunk [of an investment portfolio] in a variable annuity to cover the essentials,” McNeely said. “So maybe you can’t take that cruise, but at least you know you can pay your utilities.”

A Look at the Changes

Few companies have filed new contracts and only a handful have filed new benefits as of the first quarter of this year, the latest for which statistics are available, said Frank O’Connor, product manager for annuity data with Morningstar.

VA issuers filed changes to 97 annuity products in the first quarter, an increase of more than 64 percent from the changes filed in connection with 59 annuity products in the first quarter of 2012. “In general, the changes were to reduce living benefit guarantees and constrain risk,” he said.

Fees, the lifeblood of annuities and the reliable contributors to carriers’ bottom lines, have gone up. Additions to AXA’s Accumulator and Retirement Cornerstone VA hike the guaranteed minimum income benefits (GMIB). Fees for its GMIB I rose to 1.15 percent from 1.1 percent, and the fees of the new version of the GMIB II climbed to 1.3 percent from 1.25 percent, according to O’Connor.

Nationwide Financial also hiked the withdrawal percentage of its lifetime GMIB, boosting fees to 1.5 percent from 1.2 percent, and Ohio National trimmed step-ups and withdrawal percentages of the joint version of its Guaranteed Living Withdrawal Benefit (GLWB) Plus VA, O’Connor said.

Principal Financial lowered the issue ages for its lifetime guaranteed minimum withdrawal benefit to 55 years old, and created a new withdrawal age band on the GLWB for people ages 55 to 59, O’Connor also said.

“It’s an interesting dynamic,” O’Connor said. “How much can you write these before the demand slackens?”

“I don’t think we’re at a point where consumers think VAs aren’t a good fit for them, but we’ll just have to see,” Dennis R. Glass, Lincoln Financial Group chief executive officer, said in a conference call with analysts earlier this year. Glass said that despite cutting back on features and increasing fees, demand for VAs still remains strong.

Carriers are tweaking the income side of their annuities by adjusting guaranteed income riders, McNeely said, and many companies are guaranteeing new VA contracts “in the 5 percent range.”

Stabilizing Volatility

While there’s still demand for VAs, carriers are looking to grow in other areas and advisors are pitching the advantages of stability, diversification and investment hedges aimed at absorbing volatility inherent in market spikes.

“They are trying different things and trying to put more of the risk back on the balance sheet of the investor as opposed to their own,” O’Connor said. “They are throttling back on the exposure and the withdrawal benefits.”

Nationwide Financial has added four new “managed volatility” fund options for its core VA lineup, the company said.

Securian Financial Group, for example, earlier this year announced that it, too, has added a set of “managed volatility portfolios” as investment options in some of its MultiOption VA issued by its Minnesota Life subsidiary.

“Those funds are an effort to bring more stable options to their VA customer,” said McNeely. “Managed volatility is something more stable so that there’s more [options] on the stable side.”

Carriers are offering VAs greater leeway in hedging as a bulwark against volatility, and alternative investments like real estate and commodities are turning up within the VA chassis.

Midland National Life’s LiveWell VA offers 20 alternative options, and as many as 40 carriers are offering up to 1,538 alternative subaccounts in their VA products subaccounts, according to O’Connor.

Forethought Financial Group’s ForeRetirement VA, launched in March, includes a daily lock income benefit guarantee as well as a 6 percent credit deferral bonus.

For advisors, the challenge is how to sell the nonguaranteed offerings, O’Connor said. Nor can advisors sell VAs purely on tax deferral advantages because so much of the sales have taken place in qualified annuities, he said.

In the meantime, though, advisors are selling guarantees while they will have guarantees to sell and as people move from the accumulation to the de-accumulation phase of life. “Demographics are still there for them,” he said.

Insurers ratcheted up the “arms race” of secondary guarantees in the lead up to the Great Recession, promising benefits of as high as 7 percent. But those same insurers took a hit when stocks tanked, and interest rates plunged and remained low.

VA sales, which peaked in 2007 at $179.5 billion, plunged two years later to 124 billion before recovering in 2010 to $153.6 billion, according to Morningstar Inc.

This time, though, carriers are approaching the market more shrewdly as they trim back on guarantees and hike prices. They want to make sure they can pay for their VA promises out of fees and investment returns while still making a profit.

Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. He can be reached at [email protected] [email protected].

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