Annuity News

Fall 2009

Buying Value in Today’s Annuity Marketplace

by Jim Teague

Warren Buffet is quoted as saying, “Price is what you pay. Value is what you get.” That phrase, whether it came from Buffet or someone else, is a perfect reminder for brokers who are helping their customers shop for fixed annuities.

Over the last several months, market-weary consumers have flocked to fixed annuities looking for safety and a dependable return on the retirement nest egg they have spent a career accumulating. As a result, the sale of new fixed annuities was up 60 percent in 2008 over 2007 and 39% for the first half of 2009 over 2008.

That number is very impressive when you consider that fixed annuity sales have been trending down slowly over the last five years. As savers and investors lick their market wounds and seek safe havens for dollars they can’t afford to lose, fixed annuities have become the big winners. With short-term treasuries and CD rates hovering only slightly above sea level, the 3.0-4.5 percent guaranteed returns offered by fixed annuity carriers have been very attractive. And with no tax on the interest until the proceeds are distributed from the annuity, the tax-adjusted return is more like 4.0-5.5 percent. Not bad in today’s scary investment environment.

Historically, comparison shopping for fixed annuities has been limited to new money rates and broker compensation. Annuity contract provisions are fairly uniform across the industry with 10 percent free withdrawals, waiver of surrender charges for nursing home confinement and terminal illness being standard menu items.

Fixed indexed annuities offer more variety in contract features with different indexes, participation schedules and multiple fund accounts, but when it comes to distinguishing one five- year, guaranteed-rate fixed annuity from another, rate is usually the first thing that leaps off the page. Oftentimes, the prospect does little more than ascertain that the crediting rate exceeds whatever rate he is currently earning on his safe money. If the answer is yes, out come the new annuity application and the 1035 exchange forms.

Because annuity crediting rates are a function of the performance of the general account assets of fixed annuity carriers, looking at the rate without looking behind the curtain to see what supports the rate could prove to be a costly mistake.

General account investment portfolios generally consist of corporate bonds, government securities, commercial mortgages and a handful of other very conservative investments. In recent months, much has been written about the beating that insurers have taken on their bond portfolios. Billions of previously highly rated bonds have been written off the books of some major insurers, while all insurers maintain internal watch lists of bonds that may join the ranks of fallen angels before the sagging economy flushes out all the losers.

Many analysts believe the next shoe to drop in the sub-prime stumble may be commercial mortgages. A number of big insurers have sizeable commercial mortgage portfolios that could suffer significant increases in defaults as tenants are unable to pay their rent and property values continue to tumble. What looked like a good loan two years ago at 65 percent loan-to-value doesn’t look nearly as solid when the LTV increases to more than 100 percent with falling property values.

So what is the message for annuity brokers? Dorothy had to look behind the curtain to figure out that the Wizard wasn’t exactly as advertised. Brokers need to do the same thing to help customers determine which annuity provider offers the best value, not just the best price. Some of the determining factors should be:

Length of time the carrier has been in the annuity business. Some carriers have entered the annuity marketplace fairly recently and may be less willing to support the annuity business line as spreads have narrowed and profitability has been squeezed.

Number of years the carrier has received a top rating from A.M. Best (the original and most comprehensive insurance rating service). Best publishes a list of carriers that have received their top rating for the past 50 and 75 years.

Renewal rate history for fixed annuities. Consumer-friendly carriers publish the renewal rate histories for most of their fixed annuity products, information that will provide you an idea of the renewal treatment your customer can expect as the policy ages.

Make-up of current general account investment portfolio. Know what the carrier is buying to support your customer’s annuity rate. If the carrier is buying primarily corporate bonds, find out the average overall rating for the portfolio. If it is less than an A-rated portfolio, ask more questions.

Information on the expected performance of portfolio assets. Try to get a copy of the carrier’s bond watch list, recent 10-Q or financial statements. If they issue or purchase commercial mortgages, ask to see a report on the mortgage portfolio performance and look for a low historical default rate.

Non-annuity lines of business that may be having problems. Most carriers have multiple lines of business. Even when the annuity line might be performing adequately, make sure there are not significant financial problems elsewhere in the system.

Overall financial condition for the carrier and holding company if one exists. Look for recent downgrades by any of the rating agencies.

Buffet has the equation right when he talks about value versus price. Will Rogers said it another way: “I’m more concerned with the return of my money than the return on my money.”

In today’s economy, I suspect most annuity buyers share Rogers’ sentiments. One way you can provide value as their advisor is to complete your own due diligence on the carriers you represent before you make a recommendation. Rate will always be important, but true value includes many factors beyond just the first-year rate.

 

Jim Teague is vice president for Individual Annuities at The Standard in Portland, Oregon.