Annuity Intelligence Brief

Transcription

1 Fall 2012 Volume 1 Issue 6 Morningstar Annuity Intelligence Brief News you can use about the annuity industry In This Issue: Top 5 Client Misperceptions About Variable Annuities 1 Restricted Beneficiary The Whys and Hows 2 of a Powerful Payout Option Research Insight: Living Benefit Exposure 4 What Do VA Carriers Have on the Line? Chart: Expense Averages as of Q Morningstar Ibbotson Research: Using VAs in 2 a Portfolio to Reduce Risk and Increase Income Top 5 Client Misperceptions About VAs Advisors Can Educate Clients With Plain-English Product Explanations Investment professionals who deal with annuities all the time become familiar with the features, terminology, and nuts and bolts of the products. But it s easy to forget that a client might be getting exposure to an annuity for the first time. When educating a client or prospect about an annuity, certain client misperceptions repeatedly cause confusion. Here is our list, based on feedback from advisors and home office professionals, of the most common misunderstandings about variable annuities, and some tips on how to present a reasonable explanation of the way an annuity works. 1 Misunderstanding Who Owns the Account Balance Once I hand my money over, it s the insurance carrier s and I have no control. Investors often think the insurance company owns the assets of a variable annuity account.this is an easy mistake to make, because that IS the case with immediate annuities. But be sure your client understands that in the variable annuity world, the account balance is held in a separate account in their name. It s not mixed in with the general assets of the carrier so if the carrier becomes insolvent, the investor still has assets held in their name in a separate trust. Note also that if the client decides to annuitize, that in fact IS a decision to hand over the account balance to the insurance company in exchange for lifetime payments. Continued on page 2

2 2 Continued from page 1 2 Failing to Grasp the Nature of the Investment My account value can t go down, since it s held by an insurance company. A client needs to understand that, even though the insurance company is offering a guaranteed product, the account balance still fluctuates. Indeed, variable annuities get their name because of the variability of the account balance, generally thanks to an equity or fixed income fund. It s an account exposed to the daily fluctuations of the investment markets. Many investors were shocked in 2008 to realize that their accounts dropped by 35%. Of course, they may have been pleased to learn that their guarantee didn t drop the same way. 3 Not Knowing What the Payments Represent I get interest and dividend payments from the insurance company. Some owners think withdrawals are interest payments from the insurer. Others think the payments are dividends. An advisor must be very clear about what the payments represent. If the client receives withdrawals, they come directly from the client s account balance and relate to the variable annuity contract they have established. The client is tapping into their own account that is invested separately. The client has not invested in the insurer itself, so dividends and interest are not an issue. 4 Thinking the Benefit Base Has a Cash Value My benefit base is worth a lot. I ll cash out of that. Many people think their benefit base is the same as their account balance. Not so. A living benefit does not guarantee the account balance. The benefit base cannot be tapped into as cash. The benefit base is a book value and is used solely to figure the guaranteed withdrawal amount.it should be considered, however, when evaluating whether a replacement is suitable. 5 Not Knowing How the Step Up Works My account value is guaranteed to go up by 5% every year. A step up is not a return on investment, nor does it increase the account value. Don t describe a step up in a fashion that confuses the client. If you say, Hey, 6% is good in this market, make sure you distinguish between the account balance and the benefit base. The step up is applied to the book value, not the account value. Make sure clients understand the difference. \

3 3 How Effective Are Living Benefits at Generating Income? Morningstar Research Indicates VAs Improve Income, Reduce Risk When Combined With an Overall Portfolio Advisor Takeaways: A variable annuity combined with a traditional portfolio increases income and smoothes volatility in an investment portfolio Clients can allocate more to equities using this method by replacing some of their fixed/ cash investments with a variable annuity, thereby increasing their upside potential Clients may generate more income from their portfolio when they mix in a variable annuity with a guaranteed living withdrawal benefit Total assets in variable annuity products topped $1.5 trillion at the end of A dominant driver behind sales of variable annuities is the guaranteed minimum withdrawal benefit. So, do living benefits actually help an investor? If so, how? Morningstar studied whether there is an advantage to including a VA with a lifetime guaranteed minimum withdrawal benefit in a retirement income portfolio. The results showed that when mixed with traditional investments, a lifetime withdrawal benefit improved the overall retirement income levels while smoothing out portfolio volatility. Here is how the Morningstar Ibbotson research team did it. First, they set up three different portfolios: Portfolio #1 A diversified portfolio of equity and fixed income investments (such as mutual funds). Portfolio #2 A variable annuity with a diversified asset allocation and a GLWB rider. Portfolio #3 A combination portfolio: some traditional investments combined with a VA+GLWB. Next, the team ran Monte Carlo simulations on the portfolios to test how much income was generated and how volatility was affected. Results? The comparison showed that the third portfolio, the combined option, exhibited distinct characteristics: Portfolio #3 generated higher income, on average, than the normal portfolio The combined portfolio was better at limiting downside volatility The combined portfolio generated more total income over the 30-year time frame The bottom line is that the guaranteed income from the VA+GLWB lowers the overall income risk. In addition, the combined portfolios have more equity allocation, which contributes to an increase in the total income. \ Notes: Retirement Portfolio and Variable Annuity with Guaranteed Minimum Withdrawal Benefit (VA+GMWB) Ibbotson Associates, Assumptions: a 30-year time horizon; investment portfolio that is 80% equity and 20% fixed income; systematic withdrawals of 5% of the non-va portion of the portfolio; fixed 5% withdrawals of the benefit base of the VA portion; mutual fund fees 2%; VA fees 3%. Investment returns are for the period. Note that in the third portfolio, a portion of the fixed income /cash allocation was replaced with a more aggressively allocated VA, which left the overall portfolio with a higher equity allocation than the original mutual fund portfolio. In addition, the VA included a lifetime GMWB rider.

4 4 Understanding the Restricted Beneficiary Option This Planning Technique Is a Convenient and Flexible Way to Distribute a Death Benefit Things to Remember: A restricted beneficiary must be an individual, not a trust or other non-natural entity. Restrictions can be removed after a set period of time or after the beneficiary attains a certain age. Distributions can be fully restricted, partially restricted, restricted currently but unrestricted later, or restricted via the election of one of several distribution options defined by the owner. Undistributed assets retain tax-deferred growth. This is a key advantage of the restricted beneficiary option. A beneficiary can elect to receive systematic withdrawals over life expectancy. When the beneficiary passes away, a lump-sum distribution is made. This option is not offered by all insurance companies. A common financial planning goal is to control the way assets are distributed to beneficiaries. The variable annuity can help in this goal, primarily by using the restricted beneficiary designation to define how an heir will receive a death-benefit payout. Naming a restricted beneficiary is a unique option available to variable annuity contract owners that enables them to direct the amount, frequency, and timing of a distribution just as if they had named a trust as owner or beneficiary. It s a convenient and flexible way to move an inheritance to a beneficiary. Functionally, a VA plus a restricted beneficiary will transfer assets efficiently, without probate, using specific guidance just like a living trust. Why Use a Restricted Beneficiary? Suppose a grandparent wants to leave a grandchild a legacy, but the child is too young to handle the assets responsibly. The adult can use a restricted beneficiary designation to define how much, when, and for how long the grandchild would receive payments from an annuity. Spreading out the payments over many years could help preserve the legacy and maximize the benefits. There are numerous other situations where an investor might want to control the distribution of money to an heir. The restricted beneficiary option is a useful tool to achieve that goal. Restricted Beneficiary Pros Protection. After the death of the annuity owner, a beneficiary may be vulnerable to making poor financial decisions for a time, so a restricted beneficiary designation protects a beneficiary from himself. Ongoing Tax-Deferred Growth. A beneficiary can stretch payments over their life expectancy, taking advantage of tax-deferred growth. Without a restricted beneficiary, typically the death benefit is taken either as a lump sum immediately, or as payments spread over no more than five years. Simplicity. In certain situations, the restricted beneficiary option may be all that is necessary to transfer assets, rather than going through the work to create a trust. Low Cost in the Short Run. It costs less than drafting a trust document, which can be cost prohibitive for a client with a smaller account balance annuity. Restricted Beneficiary Cons Duplication. Some clients don t need an annuity to achieve restricted payout if they can get it via an in-force trust. Expense. Using an annuity to achieve this payout method may be more costly over a long holding period than a non-annuity alternative. How to Complete a Restricted Beneficiary: 1 Check with your wholesaler or carrier representative to see if the company offers a restricted beneficiary option. 2 Complete a restricted beneficiary form for the beneficiary. 3 Name an individual as the beneficiary. 4 Carefully review the titling to ensure that the contract will pay out as intended. \

5 5 Estimated Exposure for VA Living Benefit Guarantees Drops For Third Year in a Row Trend Is Clear Even if Assumptions Are Broad In the past two years, several insurers have either exited the annuity industry or retrenched in response to tough conditions. Low interest rates and the high cost of hedging have created a difficult market in which to earn profits. Amid this activity, advisors have asked, How stable are carriers? and Are insurers overexposed based on the guarantees they offer? To help answer this question, Frank O Connor, a director in Morningstar s data group, performed research to estimate total variable annuity industry exposure. By totaling the initial investment dollars going into living benefit VA products, and comparing that number with the current market value of the underlying assets, we can determine how exposed the industry is. The table below shows that overall industry exposure maxed out in 2008 and has steadily dropped as equity markets recovered over the last three years. Admittedly, the estimate relies on fairly broad assumptions. The raw numbers might not be exact. But the trend is clear, and the overall scale of the swings indicates that industry wide exposure has dropped. \ Year Living Benefit Assets ($Mil) Living Benefit Guaranteed Amount ($Mil) Estimated Living Benefit Exposure ($Mil) , , , , , , , , , , , , , ,990 16, , , , ,815 4,216 The annuity industry s net exposure for living benefit guarantees peaked in 2008, and has dropped steadily over the last three years through the end of Exposure is defined as the total initial principal invested minus the current account value of the contracts. Assumptions: Calculation made May Assumes 90% of VAs sold with a living benefit rider. Average roll up is 7%. Sub-account asset allocation is 90% equity 10% fixed income. Sales and asset data from Morningstar as of December 31, Variable Annuity Fee Averages Contract Fees Subaccount Fees Total Average Expenses Average Living Benefit Expenses Per $25,000 Benefit Value* Guaranteed Minimum Income *Fee averages lag by one quarter because of data production schedules Guaranteed Minimum Withdrawal Lifetime Guaranteed Minimum Withdrawal Guaranteed Minimum Accumulation All Types % $ % $ % $ % $ % $ 4th Quarter rd Quarter nd Quarter st Quarter

6 6 Meet the Authors Kevin Loffredi, Vice President, Insurance Solutions Kevin Loffredi manages the development of tools and services for the insurance market, including the Annuity Intelligence Report, which is an easy-to-use, comprehensive tool for annuity research and sales that explains a very complex investment in plain English. He is a recognized expert in annuity contract titling, has been a keynote speaker, and has been quoted in publications such as Bloomberg, The Washington Post, Investment News, Annuity Market News, Ignites, and National Underwriter. John McCarthy, Product Manager, Insurance Solutions John McCarthy is responsible for product development, marketing, and strategic partnerships for the Annuity Intelligence Report. He also supports the business development and account management functions as they relate to annuity solutions. McCarthy holds a CPA certification, a master s degree from DePaul University, and a bachelor s degree from Illinois State University. Testimonials The benefit selector is saving us time and improving client service. We are able to sort through the hundreds of VA living benefits out there and really make sense of what s right for the client. Ethan Young, Annuity Product Manager Commonwealth Financial Network All in all, you folks have done a wonderful job in putting [the Annuity Intelligence Report] together it is a great value-add! We appreciate the constant improvements Matt Chiccuarelli, Annuity Product Consultant Commonwealth Financial Network For more information, contact Morningstar Advisor Software: Call our sales group: Vist our wesbsite: annuityintelligence We maintained a variable annuity search engine in house. It was taking our marketing and technology team over 100 hours a month to keep pace with getting all of the correct information updated and added to the system, not to mention the lag time for getting product changes added to the system. Adding [the Annuity Intelligence Report s] technology and daily updates has lifted a huge burden off our team. Wes Riemondi, Annuity Sales Manager NFP Securities, Inc. The Annuity Intelligence Report actually helped me close a piece of business already. An advisor turned in his first piece of business with us because of the expertise I displayed with the breadth of carriers out there, thanks to the Annuity Intelligence Report. J.G., Top Wholesaler, Independent Channel, Major Carrier For compliance, [the Annuity Intelligence Report] helps those who conduct suitability reviews. Our supervisors use the tool when conducting suitability reviews of sales. It has sped up the review process. It helps fulfill our regulatory training requirement under Rule Diana Giraldo Bank of America Financial advisors like having three products profiled on one screen rather than shuffling between carriers sales materials. They will have an easier time reviewing the annuity with their client at future meetings, since we recommend that our financial advisors keep an Annuity Intelligence Report of the annuity their clients purchased in the client s file. Features and benefits will be easier to review and will help to assure clients that their decision to purchase the annuity was sound. Vicky Stadick, First Vice President, Senior Annuity Specialist/Partner Relationship Manager Robert W. Baird & Co. Incorporated Morningstar, Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. Our mission is to create great products that help investors reach their financial goals. We offer an extensive line of Internet, software, and print-based products for individual investors, financial advisors, and institutional clients. For more information on the Annuity Intelligence Report or the Morningstar Annuity Analyzer, contact Morningstar Advisor Sales at Clients with product questions may contact Product Support at or product_support@morningstar.com 2012 Morningstar, Inc. All rights reserved. Morningstar and the Morningstar logo are either trademarks or service marks of Morningstar, Inc.