If your clients have a variable annuity, there is a good chance their insurance company might be offering to waive any surrender charges and buy it back for more money than it's currently worth.
Severable variable annuity providers have made buyback offers in recent months, including The Hartford Financial Services, AEGON, AXA Equitable Life Insurance Co. and Transamerica Life Insurance Co.
These companies have not adequately hedged against losses and want to make sure they're able to pay out on future guarantees. While buying back an annuity may be costly to the companies in the short term, they hope to limit future losses ifgo askew and clients live longer than the firm’s actuarial tables suggest.
With a variable annuity your client generally is offered a selection of mutual funds or exchange-traded funds. As the advisor, you’re able to help manage the asset-allocation decisions to earn the best risk-adjusted rates of return.
By paying an extra annual fee of one percent or so, your client often can get a guaranteed lifetime withdrawal benefit of at least 5 percent annually regardless of how the investments perform.
Variable annuities also might carry a death benefit guarantee. That would promise heirs of the account holder an amount equal to the original account value or market value, whichever is higher. For additional fees many variable annuities contain other wrinkles, such as inflation riders, rate bonuses or penalty-free withdrawal privileges.
Buyout offers put wealth managers, who sometimes recommended these products, in a difficult position. Brace yourselves for some ticked-off older clients and a potential loss of business.
The Hartford says it is offering the buyout to 15% of its total account value on the hook for the lifetime withdrawal benefits. But this represents 45% the insurance company’s net amount at risk for lifetime withdrawal benefits. This means that you can expect policies heavily invested in stock funds, which carry the greatest net amount at risk to the insurance company, to be offered the buyout.
HOW THIS CAME TO BE
Say a policyholder has a 5% guaranteed lifetime withdrawal benefit and expects to get $5,000 in annual income: The present value to generate that income is $100,000. But if the account value is just $90,000 due to stock market losses, the insurer who failed to hedge properly is on the hook for $10,000 to pay the guaranteed income. Multiply this example by thousands of shareholders, and you can see why an insurer would look to get out of the business.
The exact terms of the buyout have not yet been revealed. Beth Bombara, president of Hartford's life runoff business, said in a November earnings call that policyholders would be offered more than their current account value. In other words, money would be added to policyholders’ account balances in exchange for giving up the lifetime income benefit.
The Hartford stopped selling annuities in April 2012. It shifted focus from life insurance and annuities to property and casualty insurance, group benefits and mutual funds. The exit was a blow to the annuity. The company topped distribution charts during the 1990s and the early 2000s. In 2002, it was the first company to offer a guaranteed minimum withdrawal benefit and the following year it was the number one seller of variable annuities.
The Hartford had a strong toehold in the broker-dealer network with more than 100 wholesalers. Its distributor Planco provided high quality service and education to advisors, says Rick Carey, a consultant and founding editor and publisher of Morningstar’s Variable Annuity Research and Data Service.
But after the 2008 stock market crash The Hartford, along with two other insurance companies, had to accept $3.5 billion in Uncle Sam TARP money to keep afloat. The insurers had problems hedging investments to limit the risk of making guaranteed lifetime payments to its policyholders.
“The irony is that individual variable annuities originally transferred investment risk from the insurer to the contract owner, making them a highly desirable offering from an insurer’s perspective,” said Jeffrey Dellinger, Fort Wayne, Ind.-based actuary and author of The Handbook of Variable Income Annuities (Wiley). “They required little capital to support them. The problem: Competition for market share led insurers to pile on more and better guarantees, which increased their risk.”
SHOULD CLIENTS TAKE THE MONEY
Carey says you had better help clients think long and hard about taking an insurer up on this offer. One big reason: Taking the buyout and then cashing out the variable annuity can trigger a big fatbill, particularly troubling as elected officials are pondering significant tax increases for next year.
Also, assuming a client is healthy and can reasonably expect to live a long time, a variable annuity with lifetime income may be too attractive to give up.
“Clearly The Hartford, and other insurance companies too, want to get out from under the liability of their promise of lifetime payments they made in order to get the client’s money in the first place,” says Jane King, a Wellesley, Mass.-based financial planner. “My first thought is that if an insurance company wants you to do something, you probably shouldn’t do it as they are primarily looking out for their interest and not yours.”
King says if a client invested in the annuity to receive a lifetime income stream, there is little else they could invest in to replace the income due to current low interest rates. You would have to conduct a present value calculation to determine where they could invest to earn the expected income stream.
So skip the buyout offer and stay invested? Not necessarily. Your clients could do a variable annuity 1035 tax-free exchange into a new variable annuity. This would let the client defer taxes, and still maintain a variable annuity with guaranteed income benefits. Problem: Fees on today's variable annuities are higher than they were 10 years ago, according to Morningstar.
Other factors to consider in deciding whether a client should surrender his or her variable annuity for a premium:
· Do they have other sources of reliable income to make up for the loss of variable annuity income?
· How will surrendering the annuity impact their taxes?
· The anticipated value of additional benefits from the annuity in the near future vs. what the insurance company is currently offering.
· How safe is the insurance company? The safest are rated A++ and A+ by A.M. Best, and have a good chance of keeping their promises for future income, whether they want to or not.