Variable Annuity Wasteland

One of the favorite products of many in the financial services community is the variable annuity. It is called an annuity because it offers annuitization, or income stream options, at some point in the future. The product is used as an accumulation vehicle during the annuity owner's earning years. One of the chief benefits of annuities in general is their ability to defer tax on gain until distribution. Finally, the variable annuity, or VA, allows the owner/investor to invest in the financial markets using mutual fund-like subaccounts.

At first glance, this is a nice starter package of benefits. Income options in the future, guaranteed by an insurance company, deferral of gain while the asset is growing, and the opportunity to participate in the financial markets makes for a wonderful story. In addition, the issuing carriers have upped the ante, primarily due to competition.

Many VA issuers provide guaranteed benefits in a couple of ways. One guarantee is an income guarantee. For example, if you deposit $100,000 in a VA contract, the issuing company might guarantee that regardless of whatever else happens, they will guarantee 5%, or $5000 per year, for your life. In some cases, they will extend this guarantee to your spouse as well. When this income starts, and whether and under what conditions it extends to a spouse, are contract specific benefits.

Another guarantee is a benefit step-up. With this benefit, the insurance company guarantees that the underlying value of your annuity will increase by a pre-determined percentage every few years. What the percentage is, and how many years between the step-up is again contract specific language.

These two benefits taken together, along with the standard VA benefits, make for a tantalizing package of benefits for many consumers. Whether the consumer has lost money in the market, doesn't have the temperament for investing in stocks, or simply has a long standing distrust of Wall Street doesn't matter. This combination of benefits, along with fear of the markets embraced by many consumers, has made for a target-rich environment for annuity sales reps, especially those selling VA's.

As a side note, those licensed to sell VA's, and in most states it takes both a securities and an insurance license to do so, are well compensated for their time. The gross commission, or in the broker-dealer world, the gross concession, can range from 3% to 5% at the low end, to 12% or 15% at the higher end. It is very common for the street level commission, or what's paid to the person sitting in front of you, to be 5% to 7% of the deposit. For a $100,000 deposit, that's a commission of $5000 to $7000.

Also, in case you are wondering, there is roughly a 1 to 1 relationship between street level commission and the number of years in the surrender charge. For example, if you are looking at a VA contract with a 7 year surrender charge, the street level commission is most likely about 7%.

Now, back to the company challenges. Insurance companies, in an effort to bring dollars in the door and to stay competitive, have continued to sweeten the benefit pie to both VA owners and VA sellers. So much so that in 2006, more than $184 billion was invested in VA's. In 2007, that number dropped to $160 billion, while sales of fixed annuities increased. At the end of 2007, there was more than $1.485 trillion invested in VA's.

Unless you have been on vacation in Siberia for the last eighteen months, you know that the stock market dropped in value by 35% to 45% in 2008, depending on which index you follow. Since most VA assets were invested in the stock market, the underlying values on the statements received by VA owners at the end of 2008 were substantially lower than they were at the end of 2007. Yet, because of the guarantees offered by insurance companies, the value available to contract owners hasn't necessarily dropped significantly.

The guaranteed values, and how they work, is specific to the contract and the company. However, it is safe to say that the issuing companies have more in liabilities than the contracts have in assets to support those liabilities. What I expect to see, over the next two to five years, are some of the largest insurance companies in the world going to their respective governments for handouts, because they have made promises they can't keep.

The top ten writers of VA business in 2007 were TIAA-CREF, RiverSource (Ameriprise), Jackson National, John Hancock, VALIC, Pacific Life, Skandia, MetLife, and Hartford. These companies, along with AXA Equitable and Allianz, have traditionally led the market in VA sales.

If you have questions, our recommendation would be to contact the company directly, talk to your selling agent, or better yet, find someone who can give you unbiased counsel about your situation.

Until next time....

Randy