The Days of Selling Annuities on Rate are Gone
It is difficult to sell retirement income products today. Fixed and indexed annuity rates, while competitive compared to CD rates, have left purchasers dissatisfied as of late. Who can blame them when they have memories of earning 10 percent at the bank?
Today, historically low interest rates have made selling a “return” a thing of the past. While fixed annuity rates are averaging a mere 3.5 percent, annual point-to-point caps on indexed annuities aren’t doing much better, averaging 4.75 percent. (Imagine trying to explain to your client that they could get 0 percent interest if the market goes down, but if it goes up, they could earn as much as 4.75 percent! What a deal!)
In light of these dismal rates, the income sale has been dominating the annuity market. The income sale has historically allowed insurance agents to guarantee their clients as much as 12 percent growth annually on the value that is used to create the client’s lifetime income stream. (Note that this value is not available upon cash surrender and that this guaranteed rate is not equivalent to a guaranteed annual return on the annuity’s account value.)
Not anymore. The roll-ups on annuities’ guaranteed lifetime withdrawal benefits are coming down and average only 6.87 percent growth on the income value today. While GLWB roll-ups will continue to offer relatively competitive rates compared to CD and fixed annuities, the income sale has left the building. The star is now the death benefit sale.
For years, all indexed annuities have offered a generous death benefit: the greater of the guaranteed minimum surrender value or the full account value. Recent trends in product development have expanded the death benefit options on these annuities. Here, we offer a primer on several types of enhanced death benefits (DBs) on indexed annuities.
DBs That Reduce the Beneficiary’s Tax Burden
Not long after indexed annuities were developed, insurance companies began marketing optional riders that would offset the gains on the annuity contract, in order to reduce the beneficiary’s tax burden. Most of these riders will pay out an additional 15-45 percent of the gain on the annuity in order to offset taxes. There is typically an annual charge for such a rider (e.g., 0.40 percent of the account value annually), and the rider must be elected at policy issue.
Guaranteed Minimum DB Riders
At the turn of the century, insurance companies developing variable annuities added optional guaranteed minimum death benefits (GMDBs) to the contracts, so that their agents could offer a death benefit guarantee on a “risk money product.” Adding a guaranteed element to an annuity that could lose all of its value helped to boost VA sales significantly. Several years later, companies in the indexed annuity market began following suit, despite the fact that indexed products are a “safe money product” with a guaranteed return of principal and interest. Generally, GMDBs on indexed annuities will pay out upon death the premiums paid accumulated at a rate of 4-6 percent. Often, there is a limit on the accumulation of the death benefit; accumulation may stop at age 85 or 90, when the accumulation reaches 140-200 percent of the premiums paid on the contract, or even a combination of both of these limitations. These riders almost always have an explicit annual charge (e.g., 0.60 percent of the account value annually) and also have to be elected at the time the contract is issued.
Enhanced DB via a GLWB Rider
Last year, a couple of insurance companies marketing GLWBs on indexed annuities offered a new twist on enhanced DBs: paying out the benefit base value of the GLWB upon death, with a minimum five-year period certain payout. Essentially, this meant that if a client purchased a $100,000 indexed annuity, and the market declined every year for 10 years, that the benefit base, or income value (or the amount paid out upon death), on these contracts would have exceeded $200,000. That’s a pretty good deal if someone is willing to take a five-year period certain payout! Today, only a couple of companies offer this option. There is no explicit cost for this enhanced death benefit, other than the annual GLWB charge. Keep in mind that in order to take advantage of such a benefit, the GLWB must be elected at issue on the contract.
Other Enhanced DBs
There are other types of enhanced death benefit on annuities other than those above. For example, did you know that any annuity with a premium bonus is essentially offering an enhanced death benefit? When the client purchases a $100,000 annuity with a 10 percent account value bonus, the death benefit payable on day one of the contract is $110,000. Not too shabby! Another type of enhanced death benefit is offered by a company that has an indexed annuity with a combination persistency/death benefit bonus. In the early years of the contract, the bonus is more heavily weighted to the death benefit, and in later years, to the account value. However, the total bonus on this product is always 10 percent. The “costs” for these types of enhanced death benefits are typically priced into the contract.
One needs to remember that if the client is truly in need of life insurance, a life insurance policy is the best solution. An annuity cannot provide as much leverage on the premium paid as life insurance can. In addition, life insurance proceeds are generally not taxable where annuity proceeds can be fully taxable. Despite the facts that underwriting can be a lengthy (and sometimes intimidating) process and it takes longer to get paid commissions on life insurance compared to an annuity, the sale must always be suitable. So, make certain you suggest life insurance whenever appropriate.
The National Association of Insurance Commissioners (NAIC) also has concerns about enhanced death benefits on annuities. Why? Any time there is an arbitrage between the cash surrender value of the contract and a secondary value (such as a death benefit value or benefit base/income value), there is the potential to sell the contract on a secondary market. Ever hear of stranger-owned life insurance? Imagine that, but on annuities. Plus, keep in mind that when a stranger purchases an annuity (like those guys on the commercials yelling, “It’s my money, and I want it now!”), the business will persist. That can be problematic, since all life insurance products have some level of lapse assumption built into the product pricing. Ultimately, this could cause problems for life insurers. So, love the enhanced death benefits while you can, as they may not be around long!
Sheryl Moore is president and CEO of AnnuitySpecs.com, an indexed product resource in Des Moines. She has more than a decade of experience working with indexed products and provides competitive intelligence, market research, product development, consulting services and insight to select financial services companies.
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