Advisers, regulators crying foul as insurers seek alterations.
Ten years ago, folks leaving the workforce sought the best of two worlds when it came to their retirement savings: They wanted a guaranteed stream of income, along with the opportunity to capture market gains.
Back then, insurers were willing to give them that kind of security in the form of a product known as a variable annuity with guaranteed living benefits. Chief among the selling points was the fact that investors could raise their income potential sharply as stock markets rose, and their income would stay high, even if there was a downturn.
These days, however, insurance companies are backing out of providing retirees those benefits, either by blocking them from saving more money in these accounts or by forcing them into lower-returning investments.
Those changes have some financial advisers and regulators crying foul. And investors — including retirees who face a diminished income stream — feel that the rug has been pulled out from under them.
Such is the case for Edward Snodgrass, a 70-year-old retired developer from Lewis Center, Ohio.
Two years ago, he purchased a variable annuity from Nationwide Life and Annuity Insurance Co. Features of the annuity included the ability to boost his income base by 10% in simple interest each year.
Mr. Snodgrass had hoped to put $500,000 into the annuity over time to produce an annual income stream of about $32,500. But the insurer put a stop to that when it decided to deny additional contributions.
Now, Mr. Snodgrass can expect to get only about $16,250 out of the contract per year, a significant hit to his retirement income stream.
“I'm sure the insurer notified us, but not in the matter that I as the customer would pick up on right away,” he said.
“From the consumer standpoint, you're flooded with information and paperwork [from the company]. When things start changing, you don't pick up on it right away unless there are bold letters saying that this is going on,” Mr. Snodgrass said.
Comprehending insurers' rationale for taking such a sweet deal off the table requires a bit of history.
In the 1990s, the variable annuity was a plain-vanilla instrument, but it picked up interest in the latter half of the decade amid the stock market run-up. Purchasers could allocate their funds into mutual-fundlike investments inside the annuity, and any gains they earned were tax-deferred.
Living benefits
However, investor interest in variable annuities waned after the tech stock crash and the ensuing bear market early in the past decade. Insurers sought a way to get clients back into the annuity market.
Enter the variable annuity with guaranteed living benefits, a product that gave a reliable income stream regardless of how the underlying investments performed.
Insurers' use of living benefits effectively created a dual accounting system. Customers had an actual account value, which fluctuated with the markets. They also had a separate balance that represented the value of their lifetime-income guarantee, commonly known as a benefit base.
The value of the income guarantee could only go up as insurers raised it by a fixed percentage per year and even more if the markets performed well.
The catch, however, is that clients seeking a lump sum could have access only to their account balance, minus fees. The guaranteed amount wasn't available for a lump sum.
If the guaranteed-income value is higher than the account balance, the only sensible way to access the cash is through annual withdrawals that are limited to amounts spelled out in the contract.
Clients appreciated the peace of mind of having income regardless of how the market performed, and sales showed it.
In 2003, annual VA sales were $124.4 billion, according to data from Morningstar Inc.
Investors rode a rising market and raised sales to a high of $179.2 billion in 2007.
Following the Great Recession in 2008, investors ran away from equities and variable annuities.
Sales tumbled to $152 billion that year, according to Morningstar.
As clients' actual account values fell into the red and interest rates declined, insurers were still on the hook for providing lifetime income to those investors. So they have sought ways to curb their exposure.
Some of those methods included enacting provisions in their contracts that allow them to block future contributions to the annuity or that permit them to restrict clients' equity exposure.
Mr. Snodgrass was snagged by the former tactic. His adviser, Brian Fenstermaker of Envision Consulting Group LLC, has been working on a plan B.
The impact has been even more keenly felt for clients still working.
Colleen Rutherford, 56, is a registered nurse from the Villages, Fla., who rolled over a chunk of her retirement savings into a Prudential Financial Inc. VA that would have boosted her income benefit by 6% annually, based on the highest daily account value.
The insurer began blocking contributions to the contract last fall, leaving her and her adviser, Thomas Fross, a partner at Fross and Fross Wealth Management, searching for alternatives.
“It's a huge part of my retirement income,” Ms. Rutherford said. “The companies say that people need to save more for retirement, but when you do that, they throw a roadblock in your way and change the rules so you can't contribute anymore.”
The changes haven't been great for advisers, either.
“It's frustrating and it affects the ability to help the clients,” said Mitchell Kauffman, an adviser at Kauffman Wealth Services, a firm that is affiliated with Raymond James Financial Services Inc.
Risk management is the key behind insurers' actions.
“Most annuity products work because at the most basic level, there is a risk-spreading aspect. You have so many people that you can use mortality tables and predict life expectancy,” said Michael Kitces, a partner and director of research at Pinnacle Advisory Group Inc.
“When you insure retirement income the way living benefits did, you're not spreading market risk, you're concentrating it,” he said.
Prudential pointed to the economy as a factor in its decision.
“The decision to suspend acceptance of additional purchase payments was made as a direct result of the persistent low-interest-rate environment that has impacted our industry,” Prudential spokeswoman Lisa Bennett said.
Nationwide, which issued Mr. Snodgrass' contract, noted that the right to limit additional contributions was spelled out in its contract.
“This option is within the guidelines of the annuity contracts,” spokesman Dace de la Foret said. “We do not have any additional changes planned in the short term but will continue to monitor our risk level and, if necessary, will make changes as appropriate.”
Much of the controversy has been centered on insurers' decision to trigger obscure provisions in their lengthy contracts. Those clauses warn that the insurer reserves the right to limit contributions or to make other types of changes after the client has been sold the product.
Regulators aren't amused by the insurers' actions.
“The concern is whether you are changing the deal on the investor,” said Michael Kosoff, branch chief at the Securities and Exchange Commission's Office of Insurance Products.
Amendments made to the contract years after it was purchased “frustrate the reasonable expectations of the investor,” said William J. Kotapish, assistant director of the Office of Insurance Products.
These changes have also raised the ire of consumer advocates.
'Changing the terms'
"You have the insurers selling long-term retirement products and then changing the terms midstream. It makes it difficult for consumers to have faith in their ability to fulfill these promises,” said Birny Birnbaum, executive director at the Center for Economic Justice, a consumer advocacy group.
“Regulators aren't doing their jobs when they're approving these things,” he said.
Other observers take the view that even if these clauses are buried in the contract, they are still adequately disclosed to the client.
“The issue is that if this is a surprise to you, it's because you didn't read this carefully when you bought it,” said Moshe Milevsky, an associate professor of finance at the Schulich School of Business at York University. “Anyone who played in this arena should have taken a look at these provisions and warned clients about it.”
The onus for ensuring that a good deal continues to be a good deal years down the line is still on the adviser and the client.
“[Advisers] shouldn't stick their toe in half-heartedly,” Mr. Milevsky said.
“You have to know the products, or you stay away,” he said. “You don't dabble in it.”
