From the September 01, 2011 issue of Senior Market Advisor • Subscribe!

Annuities with Benefits

With pensions fading into the past and Social Security on shaky ground, carriers have devised new and imaginative riders on annuity contracts, all with the purpose of giving your clients a lifetime of income.

Wither the venerable pillars of retirement funds? The pension plans that represent one piece of the retirement income model are going the way of the $2 bill. Meanwhile, the Social Security program, another long-standing pillar, is wobbly at best. It's no wonder, then, that the buzz in the annuity world among investors, advisors and insurance carriers alike is about optional features that guarantee a lifetime income stream--living benefit riders.

"The emphasis is clearly on personal savings to create that guaranteed [retirement] paycheck," says Mark Caner, president of W&S Financial Group Distributors in Cincinnati. "The [annuity] world really revolves around living benefits," echoes John McCarthy, product manager, annuity solutions, at Morningstar, Inc. in Chicago, noting that living benefit riders--chiefly lifetime guarantee minimum withdrawal benefits (GMWBs)--now are purchased with some 85 percent of variable annuity contracts. "That's where all the effort and focus is going on the part of carriers."

Not surprisingly, much of the action with annuity contract riders focuses on GMWBs and other kinds of living benefits. But instead of inventing entirely new types of riders, carriers are innovating in more subtle ways, with new contract twists and wrinkles, many of them related to income and death benefit guarantees.

Here's a look at some of the most intriguing developmentson the annuity rider front:

The emergence of hybrid death benefit/living benefit guarantees. Last year, for example, the Phoenix Cos. introduced a rider called the Enhanced Guaranteed Income and Family Wealth Transfer Benefit (Enhanced G.I.F.T. Benefit) that combines guaranteed lifetime withdrawals with an enhanced death benefit for one charge.

Available on several of the company's fixed index annuities, the G.I.F.T. benefit has been "received very well" by investors, says Dana Pedersen, vice president for annuity product development at Hartford, Conn.-based Phoenix, mainly because it provides a strong death benefit guarantee for wealth transfer, then a guaranteed income stream for life.

"When the client is purchasing a product like this, they don't know exactly what their planning needs are going to be. [The G.I.F.T. rider] eliminates having to make an upfront decision between the death benefit [guarantee] and [an] income protection [guarantee]," she explains.

More robust GMWB step-up provisions. "Step-up numbers are creeping up to 6 percent, 7 percent, even 8 percent now, where before 5 percent had been the norm," McCarthy says. For example, a lifetime GMWB unveiled recently by Ohio National offers an 8 percent simple-interest step-up, while Jackson National's Lifeguard Freedom Flex GMWB allows investors to choose a step-up amount between 5 percent and 8 percent for 10 years, with the fee adjusted accordingly.

Then there's the Income Maximizer Plus rider available on Sun Life's Financial Masters variable annuities. What makes the rider unique among GMWBs, says McCarthy, is its so-called "Plus
Factor," an inflation hedge feature that increases the contract-holder's withdrawal benefit base (and lifetime income) by 2.5 percent (compounding interest) every year after the person begins taking lifetime income.

More long-term care options. Despite getting more favorable tax treatment starting last year, the pickings still are slim when it comes to annuity riders that allow access to contract funds to cover the cost of long-term care. But both McCarthy and Caner say more players could soon enter that space. "I would suspect that my company, along with many others, have already developed benefits like these, they just haven't launched them," Caner says.

Among those that already have launched, McCarthy points to the Long-Term Care Advantage rider offered by Lincoln National as noteworthy for its robustness of benefits. It pays a monthly amount for long-term care expenses up to three times the initial purchase amount, which must range from $50,000 to $400,000. The benefit costs 0.87 percent to 1.71 percent, depending on the options chosen, is capped at $1.6 million, covers a single life and applies only to non-qualified assets.

Moderating fees. Variable annuities and their riders are widely viewed by the investing public as "gas guzzlers," says Caner, because their fees make them expensive to operate. Caner says his company, Western & Southern Financial Group, and others are out to change that widely held perception with lower-fee annuities and riders. Case in point: Western & Southern's VAROOM, which stands for Variable Annuity for Roll Over Only Money. Its living benefit riders cost in the range of 60 to 80 basis points, and fees are calculated based on account value rather than benefit base, making them even less expensive, according to Caner.

More age-banded living benefits. Five years ago, recalls McCarthy, the majority of GMWBs offered a static withdrawal percentage (5 percent was a popular number) that applied throughout the contract-holder's withdrawal period. Nowadays, he says, perhaps two-thirds or more of GMWBs offer age-based payout bands. "Age-banding is a trend that has made these benefits a lot more flexible. They also allow carriers to much more precisely calculate what they are going to owe" to contract-holders over the duration of the guarantee.

What will annuity riders look like a year or two from now? What new directions will living benefits take? Given the lively competition among insurance company product development wonks to come up with the Next Big Thing in the annuity market, be sure to stay tuned.

New speculative wrinkles shift more rider risk to VA owners

From withdrawal and step-up percentages pegged to T-Bill performance to rider fees linked to market volatility, annuity providers are asking investors to take on more speculative risk when they purchase living benefit guarantees.

"What they're doing is saying, 'Instead of giving you a hard and fast number, that number is going to fall somewhere in this range, based on the performance of this benchmark,' " explains John McCarthy, who tracks variable annuity products for Morningstar, Inc. "It means the investor has to bear a little more of the uncertainty."

Among the ways carriers are passing some of the risk associated with withdrawal and income guarantees on to investors is by tying the actual fee they charge for a living benefit rider to a volatility index, as SunAmerica did in 2010 by linking fees for some of its VA riders to the VIX, the Chicago Board Options Exchange's index of S&P 500 equity volatility.

Insurance companies such as AXA and Allianz have also unveiled living benefit riders with withdrawal percentages and step-up benchmark rates tied in part to the performance of the 10-year U.S. Treasury note, according to McCarthy. So instead of being locked to a set number, those withdrawal percentages and step-up rates now may fall within a range or band.

"What it's basically doing is making it easier and less expensive for carriers to hedge these guarantees," he explains, adding that less costly hedging in some cases translates into less costly riders. "So it's not totally unbeneficial to the client."

However, McCarthy says he's unsure whether investors will embrace riskier living benefit riders. "Only time will tell whether this stuff will fly in the marketplace."

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