It’s crept onto your restaurant menu, into your pocket and your retirement portfolio, too. It’s called hybridization—taking distinct elements of one item and combining them with distinct elements of another to yield another distinct multifaceted product. Use that recipe in the culinary world and you get fusion food. Use it in the high-tech arena and the result is an all-in-one device called a smartphone. Apply it to financial and insurance instruments, and to annuities in particular, and the possibilities are seemingly endless.
The drive to innovate and deliver versatile solutions that address multiple client needs has put annuity providers in full hybridization mode. From the structure of the contract chassis itself, on down to other, more granular aspects of their products, insurers are borrowing and blending elements of various insurance and financial instruments to put a unique spin on their annuity offerings.
"Really what they’re doing," explains Tim Hill, FSA, MAAA, principal and consulting actuary in the Chicago offices of Milliman, an actuarial consulting firm that provides insurance companies with product development guidance, "is mining these features from other things and using them with annuities. That approach seems to rule the annuity marketplace today."
The result is an influx of specialized, sometimes complex products with hybrid structures, hybrid compensation models, hybrid benefits, even hybrid hedging strategies.
For advisors, this proliferation of hybrid annuity products and features means having a wider range of potential solutions to offer clients. But it also means more product education, observes Hill’s colleague Carl Friedrich, FSA, MAAA, also a principal and consulting actuary at Milliman. "There’s a real learning curve [annuity producers] need to climb when they’re working with some of these [hybrid] products."
Is it time you climbed that learning curve? To what extent might the current generation of hybrid products and features benefit your annuity book of business and your client base? Read on, then judge for yourself.
The annuity/long-term care insurance (LTCI) combination is one of the more entrenched annuity hybrids, though it remains a niche product. Typically built on a fixed immediate annuity chassis, this class of hybrid is designed to capitalize on provisions in the Pension Protection Act of 2006 that give tax-free status to distributions from combination annuities used to cover long-term care costs, and another that permits owners of life insurance and annuity contracts to move into a combo annuity via a tax-free 1035 exchange (benefits that apply only to non-qualified annuities).
The Long-Term Care Advantage rider offered by Lincoln National is among the most innovative and robust in its class, says John McCarthy, product manager, advisor software, annuity solutions, at Morningstar Inc. in Chicago. It pays a monthly amount for long-term care expenses up to three times the initial purchase amount. The benefit costs between 0.87 percent and 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.
"There’s a real learning curve annuity producers need to climb when they’re working with some of these hybrid products." -Carl Friedrich, Milliman
Some insurers lately have taken hybridization a step further with their annuity/long-term care combos, notes Friedrich, by introducing a product that offers couples joint long-term care coverage. Combo LTCI-annuities tend to resonate with clients who lack long-term care coverage and who either don’t want to purchase or can’t affordably purchase a standalone LTCI policy.
Despite the tax and leverage benefits, LTCI-annuity combos have been slow to find acceptance among distributors, advisors and investors, Friedrich says, largely because of the low-interest-rate environment and the learning curve. "It’s still very early in the lifecycle of this product," he adds, so there’s still time for growth.
HYBRIDIZING TO FORTIFY GUARANTEES
The fixed index annuity (FIA) has long been viewed as a hybrid of its fixed and variable cousins. But another instrument known as a hybrid annuity is also carving out a niche for itself. Essentially it’s an insurance contract that allows the investor to allocate funds to both fixed and variable annuity sub-accounts by purchasing units of a variable annuity and units of a fixed annuity.
AXA Equitable’s Retirement Cornerstone variable annuity takes a two-bucket approach, with one bucket made up of a non-guaranteed equity-invested sub-account (called the "Investment Performance Account") and the other (dubbed the "Protection with Investment Performance Account") comprised of guaranteed investments to underpin the contract’s optional income and death benefit guarantees. The owner has the discretion to elect when that guarantee kicks in, triggering an allocation of funds into the guaranteed sub-accounts, explains McCarthy, who also notes that while the benefit must be elected when the contract is purchased, the owner is not charged a living benefit fee until funds are transferred into the guaranteed sub-accounts.
Hybrid benefits can also be found in the FIA space, where the Phoenix Cos. offers a combined death benefit/living benefit guarantee via its Enhanced Guaranteed Income and Family Wealth Transfer Benefit (Enhanced G.I.F.T. Benefit) rider. Available on several of the company’s fixed index annuities, this optional feature combines guaranteed lifetime withdrawals with an enhanced death benefit for one charge. It’s designed for people with the dual priorities of wealth transfer and a guaranteed income stream for life.
HYBRID HEDGES AND OTHER NEW TWISTS
To afford investors access to derivative investment vehicles while protecting them from downside risk, AXA Equitable has integrated elements of a structured note into its Structured Capital Strategies variable annuity. It’s built primarily for investors seeking exposure to domestic, international and commodities indices over varying time horizons. Through the product’s structured investment option, contract holders design a portfolio from among 15 equity and commodity index-linked segment types, with upside caps and downside buffers customized to individual time horizons. The built-in downside buffer reduces the negative impact of market volatility to the first 10 percent to 30 percent of loss in index value, depending upon the investment option makeup. That’s balanced by a performance cap rate on upside appreciation.
Annuities with hybrid hedging strategies represent another new approach to managing risk, says McCarthy. As an example, he points to a new breed of annuity that imposes stricter asset allocation requirements on contract holders, essentially forcing them to invest a certain portion of assets in instruments such as futures, options and other derivatives that reduce the risk associated with certain annuity guarantees. Instead of insurers shouldering the entire burden of managing the risk associated with those guarantees, they’re pushing some of that responsibility downstream to the client and the advisor, he explains. "Really what it amounts to is having hedging mechanisms baked into the actual sub-accounts. They’re moving some of the risk off their books into the portfolio of the individual investor."
"Really what it amounts to is having hedging mechanisms baked into the actual sub-accounts. They’re moving some of the risk off their books into the portfolio of the individual investor." -John McCarthy, Morningstar Inc.
Hybridization is even creeping into annuity compensation structures. According to McCarthy, a handful of insurers have designed O-share variable annuities whose compensation approach combines elements of A- and B-share products. The O-share products to surface recently are mostly designed for specific broker-dealers, such as those developed by Prudential, SunAmerica and Pacific Life for Edward Jones. They carry a front-end sales charge like an A-share product, but spread that charge over a period of years. The charge decreases once the contract is held beyond the surrender period.
"It’s a nice pricing structure," says McCarthy, "for people who intend to hold the variable annuity as a long-term investment."
After all, the drive to hybridize annuities is about giving the people what they want.