U.S. insurers' sales of variable annuities rose 24% in the first quarter, led by policies that promise lifetime income and protect against market drops, at a time when investors are still wary of stocks.
The retirement products' growth is driven in part by concerns that another stock market drop like the one in 2008 could wipe out savings, said Moshe Milevsky, finance professor at the Schulich School of Business at York University in Toronto. Consumers "fear that the S&P at 1,300 is a mirage and it's going to go back to 700 for the rest of our lives," he said.
Annuities are insurance contracts that offer a steady stream of income. With variable annuities, customers can choose their investments such as stock and bond funds and the account value will fluctuate with the market. For MetLife Inc. and Prudential Financial Inc., the top two U.S. life insurers, the hottest product this year also offers a guarantee of income for life, even if a customer's account balance falls because of market declines. There's an annual fee for the rider, which averages about 1.03%, according to Morningstar Inc., on top of the regular annuity fees, which average about 2.51%.
The high fees mean that "the upside potential" in these contracts is "fairly limited," said Kenneth Masters, director of life insurance design and development for Pinnacle Financial Group in Southborough, Mass. "Would I have been better off saving 370 basis points and being fully in the stock market?"
About 96% of Prudential's record $6.8 billion in sales of variable annuities in the first quarter were policies that included a lifetime income guarantee. At MetLife, 80% of its $5.7 billion of products sold in the quarter carried a guaranteed benefit.
It's difficult for consumers to understand the conditions and limitations that come with the benefits of these guarantees, such as when an insurer can increase fees or restrict investments, said Milevsky.
Insurers may offer a rate of return such as 5% or 6% a year with these riders, which customers also may misunderstand, said Timothy Pfeifer, a consulting actuary and president of Pfeifer Advisory LLC in Libertyville, Ill. "Customers might be told that their policy will provide a 6% annual guarantee and think that sounds great. That is not a lump sum you can take out." The income promised for life can deplete if owners take out too much money or too fast, Pfeifer said.
Sales of variable annuities in the U.S. climbed to $39.8 billion in the first quarter, from $32.2 billion a year earlier, according to the trade group Limra. Investors have withdrawn $50 billion from U.S. stock mutual funds in the 12 months through April, according to Chicago-based Morningstar, a research firm.
Individuals have a "tall task" when trying to identify the differences among riders from various insurers, said Tom Idzorek, global chief investment officer for Morningstar Investment Management, a Morningstar unit. "Say you wanted to compare five products side by side, good luck."
With the rider, customers can invest in equities and "sleep at night," said Greg Cicotte, president of the sales and marketing unit of Jackson National Life Insurance Co. About 82% of contracts sold last year by Jackson National, based in Lansing, Mich., had a guarantee of lifetime income, Cicotte said. "If the market does go down, you know that the income you planned on for retirement is protected."
Individuals shouldn't put all of their assets in one of these products because "there are always unforeseen expenses," Masters said. "Usually they do carry some severe penalties if you exceed your guarantee in terms of taking money out."
Penalties may include surrender charges as high as 9% of the account balance for cashing out, according to Morningstar.
And taking out more money than is allowed in the terms of the rider may reduce the future guaranteed income, said Pfeifer.
The usual withdrawal rate on contracts with a rider is 4% or 5% a year at age 65, according to Ernst & Young. That percentage generally increases if customers wait to start taking out money. Some contracts allow withdrawals of 7% at age 85, data from the New York-based firm shows.
