With 75 million baby boomers galloping into retirement, wealth managers are going to be spending a lot of their time deciding what retirement income products are best suited for their clients. Recent research shows variable annuities are not among their favorites. According to a Cogent Research study, advisors forecast zero growth in their use of variable annuities (VAs) through the end of 2009. Why? The inherent complexities of VAs, the industry migration to fee-based platforms (most variable annuities use a commission-based pay structure), and the fact that investors and advisors are sensitive to the high commissions on VAs (sometimes as high as 6 percent) are the primary reasons for their disinterest.
“That’s the only product for which advisors said usage would be flat,” says Bruce Harrington, managing director of Cogent Research, LLC. “And the study looked at mutual funds, ETFs and SMAs as well.” The Cogent study, titled “The Advisor Product Forecast,” surveyed 1,300 advisors (from national brokerages, independents, regionals, banks and RIAs) with average assets under management (AUM) of $60 million.
It’s not that advisors aren’t using VAs: 78 percent of advisors surveyed sell VAs. They are most popular in the independent channel, where 90 percent of advisors surveyed sell them, or have client assets in them, compared to just 27 percent of RIAs that do. The thing is, those who do use them don’t use a whole lot, and don’t plan to change that fact. The Cogent study found VAs accounted for only 7 percent of total advisor assets under management, putting them in fourth place behind open-end mutual funds, individual securities and SMAs. What’s more, they are expected to drop to fifth place behind ETFs by the end of 2009, says the study.
VAs are just too complex, with all of the numerous riders and benefits and features, which can vary firm by firm, say advisors and analysts. “The insurance products are the most difficult to keep up with,” says one advisor cited in the study. “The fine print is difficult for many clients, so you have to be very prudent with your choices.”
In addition, says Harrington, VAs haven’t kept up with recent industry trends, like advisor interest in lower fees and non-commission products. “Advisors are moving more towards fee-based compensation, and VAs really haven’t adjusted to that model yet,” says Harrington. “Compared to SMAs and ETFs—which advisors are essentially using as the building blocks of portfolios (and adding on whatever fee they feel is correct for the right client)—VAs have everything baked in, so you don’t have much choice.”
In any case, VAs are really only right for certain clients: Kay Shirley, a CFP with Financial Development Corporation, an RIA in Atlanta specializing in retirement planning, says she recommends VAs for clients who have very low-risk tolerance and want the capital preservation guarantees they offer—particularly first-time investors who are worried about running out of money. She also recommends them to people who are on the cusp of retirement and need a regular guaranteed income stream immediately. She also advises some of her clients to upgrade older annuity contracts in order to get certain spousal, death and income benefits that those older contracts didn’t offer.
Shirley says VAs can be summed up like this: “the Good the Bad and the Ugly.” The good are the guarantees and benefits they offer; the bad are the high fees (she doesn't use VAs that charge more than 3 percent) as well as the penalties for cashing out; the ugly is when a rep fails to disclose these fees to a client.
Maybe it’s time for variable annuity manufacturers to try some new innovations, or to better communicate to advisors how their products work. Otherwise the good may lose out to the bad and the ugly for this product.