The bond market's struggles have ignited investor interest in fixed annuities, though the products come with warnings, as insurers deal with the same rate pressure as bond owners.
Don't call it a comeback, but fixed annuities are starting to pick up some buzz amid investors' anxiety about the bond market.
Investors have scurried away from bonds, yanking some $60 million from bond funds in June, according to the Investment Company Institute. Worries that the Federal Reserve would back off its bond-purchasing program and its low-interest-rate policy were the main drivers of the sell-off in bonds, which drove rates up.
That left investors, particularly those approaching retirement, caught between a rock and a hard place. Equities certainly aren't the safest place to invest, but bonds aren't looking so great either.
Enter the lowly fixed annuity, which has benefited from a short-term boost in interest rates. The rate on 10-year Treasury notes, the key measure for insurers and their products, was sitting at 2.61% yesterday. Back in early May, it was as low as 1.66%.
Since insurers are large bond investors, the low interest rates have hurt them. They've been forced to clamp down on the interest they credit to fixed annuities and to trim back commissions. Skyrocketing rates aren't necessarily a good thing, either, as they hurt bond prices — and discourage customers from turning to fixed annuities because they may want to look at certificates of deposit and other alternatives.
Gradual increases in interest rates, however, mean insurers that want the business can afford to be a little more generous on credited interest. It also means clients who hesitate to get into bonds or stocks might have a safe alternative.
The first quarter wasn't a good one for fixed annuities: Sales were down nearly 12% compared with the year-earlier period, falling to $14.9 billion, from $16.9 billion in the first quarter of 2012, according to data from Beacon Research Publications Inc. Sales of fixed-rate annuities with market value adjustments fell to $972 million from $1.36 billion, a decline of nearly 29%. Meanwhile, those that don't have market value adjustments declined by 24%, falling to $4 billion in sales, from $5.2 billion.
The panic in bonds is fairly new, but it was enough to boost sales of different flavors of fixed annuities over the short term at Raymond James Financial Inc.
Last month, the firm sold $24.4 million in indexed annuities, which credit rates of interest tied to the movement of an index. For July, so far, that number is now at $38.6 million. Traditional fixed annuities, which include offerings that credit one set rate over time and others that guarantee only the first year's rates, sold to the tune of $9.8 million in June, rising to $18.9 million so far in July.
Sales of immediate annuities and deferred-income annuities also climbed at Raymond James, reaching $5.4 million in June and $9.7 million in July.
“A slightly higher interest is driving it; it's amazing what an extra point or three-quarters of a point will do,” said Scott Stolz, president of Raymond James Insurance Group.
Working with annuities that credit interest requires lots of research on the part of advisers. For instance, some fixed-rate annuities will guarantee a steady rate of interest over the duration of the contract. Others will provide a higher rate for the first year, and then a different rate in subsequent years.
Clients seeking safety but who are open to the possibility of upward adjustments in the crediting rate may choose the latter, said Zachary Parker, first vice president for income distribution and product strategy at Securities America Inc.
However, there are caveats with either type of fixed annuity. For instance, if rates rise and other attractive opportunities present themselves, the client could be stuck with a fixed rate and will have to wait until the surrender period is up before thinking of alternatives.
With fixed annuities that can experience rate adjustments after the first year, there's also the possibility that the insurer could dial down the crediting rate on renewal in subsequent years.
“The better the upfront rate, the more skeptical you need to be on the renewal,” Mr. Parker said. “That product that starts at a 3.5% crediting rate and can be adjusted — you're at the mercy of the insurance company. They can adjust that rate downward.”
Security Benefit Life Insurance Co. is offering a fixed annuity that credits a steady rate of 2.25% over five years. The offering is the company's most popular in the bank channel, said president Doug Wolff.
“As you know, clients can suffer some significant market value losses investing in an open-end mutual bond fund when rates go up,” he said. “I think lots of advisers and investors haven't seen this increase in rates and this potential bear market for bonds.”
Mr. Wolff noted, however, that there will need to be an educational effort to get the word to advisers.
For the most part, advisers who are holding off on fixed annuities are doing so because they worry they're locking clients in at rates that are still too low.
“If you think rates will be higher, you'll look back and wish you didn't lock into this in the past,” said Richard Dragotta, an adviser with LPL Financial LLC. “The rates would have to be 5% in order for me to be interested.”
