Variable annuity providers have been introducing products with a little more variability built in as a move to mitigate risk.
Some insurers have built products allowing them to change certain aspects of in-force contracts, by altering payout rates, rider fees and roll-up rates, for example.
“Increasingly you're seeing a trend toward those becoming more variable,” according to John McCarthy, senior product manager of wealth management products at Morningstar Inc.
The variability in question occurs on specific VA riders that offer a lifetime income benefit to investors, which guarantee an income stream over an investor's lifetime. Examples of certain in-force changes insurers can assess include the ability to reduce income payouts if the account value is depleted, alter rider fees and change roll-up rates based on volatility, according to an
Insured Retirement Institute report issued last week.
MetLife Inc. is one of the latest insurers to offer such a product, on its FlexChoice Expedite VA rider that
debuted in February.
The rider guarantees a payout rate of 6% to an investor taking his first withdrawal at age 65. However, if the investor's account value were to be depleted by age 79, the guaranteed rate reduces to 4%. Factors that could affect account value include withdrawals, market performance and fees.
As another example, AIG — through its Polaris Income Plus and Polaris Income Builder rider benefits — has the option to change rider fees based on market volatility as measured by the VIX volatility index. An individual investor is guaranteed a rate of 110 basis points for the first year of the contract, and the fee then can fluctuate quarterly based on movement of the VIX index, up to a maximum 220 bps and down to a minimum 60 bps. Moves can't be more than 6.25 bps per quarter.
Prior to such types of product design, things such as contract payout rate, rider fees and roll-up rates tended to be fixed, Mr. McCarthy said. Debuting more variables shifts some risk to investors and makes
products more complex for them, Mr. McCarthy added.
This type of product design isn't necessarily anything new, though — insurers have been using this product design for the past few years.
“I think unfortunately for [insurers] it's been an unnecessary evil as interest rates have been so low that their profit margins are squeezed,” according to Judson Forner, director of investment marketing at ValMark Securities Inc., an independent broker-dealer. “So in order to offer an appealing product or build in some sort of marketing appeal, they're building in some of this variability to position themselves differently or stand out.”
Pegging fees to market volatility is also a reflection that hedging costs increase in step with higher volatility, Mr. Forner added.
While such changes have occurred gradually in the past few years, more insurers could follow suit or refine strategies if interest rates remain persistently low, industry watchers say.
NO SURPRISE
Variability being built into some newer VA products shouldn't necessarily be a surprise to advisers or their clients because it's often displayed prominently in marketing materials, and is not contained solely within pages of lengthy prospectuses, advisers said. In that sense, insurers have been largely transparent about such changes that could be made over the life of a VA contract.
However, some advisers stay away from contracts with these types of variables because they feel it diminishes the value these products are supposed to offer investors.
“When the client needs the contract [guarantee] the most, I don't want to disappoint them,” according to Gregory Olsen, partner at Lenox Advisors Inc. “So we're not utilizing contracts that can have that type of hit [to payout or roll-up rates].”
Entering a VA with a guarantee to avoid market fluctuation, only to have market fluctuation then undermine a guarantee because it deteriorates account value within the annuity, is counterintuitive, Mr. Olsen said.
“The back-end variability makes them theoretically more difficult to use in a financial plan when you're counting on that income,” Mr. Forner said.
However, it could allow for some flexibility as well. MetLife's FlexChoice Expedite product, for example, allows investors to take higher withdrawals early in retirement through higher payout rates. That depletes the account more quickly, and could trigger a lower payout rate more quickly through the contract, but could be a useful strategy to protect against sequence of return risk in other parts of a client's portfolio, Mr. Forner said.
Sequence of return risk is more dangerous early on in retirement, because there's less time for an investor's portfolio to recover from a hit to the market; taking a higher payout from an annuity early on, thereby giving IRA and 401(k) assets more time to recover in that eventuality, could be used tactically to offset that risk, Mr. Forner explained.
“It kind of depends on the type of planning you're doing,” he added.
