A fevered debate has erupted over contingent deferred annuities, or CDAs. On one side are carriers (Prudential being one of them) and industry groups such as the ACLI that assert they are annuities. Challenging that view are MetLife and some state insurance officials that contend they are a financial guaranty product. Opponents also raise concerns about how insurers can properly reserve for a CDA policy, an issue seconded by Fitch Ratings. (MetLife declined to comment for this article.) Recently, a study group of the NAIC weighed in, saying CDAs are a hybrid of both.
But what exactly is a CDA? And are they in widespread use?
Simply put, a CDA is similar to a variable annuity, except the assets and/or funds underpinning the annuity are chosen not by the insurer, but by the policyholder (along with his financial planner). The ACLI defines a CDA as a “stand-alone living benefit that provides guaranteed lifetime income based on the value of assets held outside the insurance company.” Those assets could be, for example, mutual funds.
Beth Pickenpaugh, an actuary and financial planner with Gianola Financial Planning in Columbus, Ohio, defined CDAs as a blending of an annuity, longevity insurance and market volatility insurance. In an email exchange, she said she does not use CDAs in her practice. “But I recommend the longevity insurance piece‑basically a single premium deferred annuity that starts at a specified advanced age such as 80 or 85‑that is imbedded in a CDA as insurance against asset depletion.”
It’s because of that longevity component that Prudential views CDAs as annuities, says Bruce Ferris, head of sales and distribution for Prudential Annuities in Shelton, Conn. “They provide lifetime income streams, so they address longevity risk,” Ferris says. “By providing lifetime income, they are defined as annuity products because of the risks that they address and the requirements of managing those risks. It is clearly a point of discussion and debate in the annuity and insurance industry. I tend to view that as healthy because regardless of the outcome, the discussion is around how we can bring better solutions to consumers who are looking to meet the challenges of a secure retirement.”
Yet Ferris concedes that many financial planners are reluctant to utilize CDAs, or annuities in general, in their practice. “They either think they are too expensive, too complicated, or they’ll underperform,” he says. “I’ll leave that debate aside. But what they do value is working with clients, and helping them asset allocate, diversify and then manage risk for their long-term objections of both savings and retirement. And the idea of bringing an income solution to their business practice, I believe, is an opportunity to attract more interest because we’re looking to do business on their terms, not on our terms.”
One advisor who clearly advocates for CDAs is Rao K. Garuda, president and CEO of Associated Concepts Agency, Inc. in Cleveland and a founding member of First Financial Resources, which has 75 partners across the U.S.
Yet he concedes that CDAs are not in widespread use now. (LIMRA had no data on CDAs.) But with people living longer and the Obama’s administration’s aim to make annuities part of 401(k) plans, Garuda predicts their usage will increase in coming years.
Garuda says that a CDA could become part of an overall financial plan that addresses the concern of outliving one’s income during retirement. “People who live beyond their life expectancy really have no way of making sure there is income if they live too long. The CDAs are designed to cover that gap,” he states. “It’s going to become very popular in the future as people live much longer.”
In Garuda’s opinion, insurance companies are well equipped to back CDAs. “Whatever you want to call it, it’s a guaranteed product,” he says, adding that the guarantor is ultimately the insurance company. “Because of the reserve requirements, insurance companies are required to reserve all kinds of funds and they are being supervised by the commissioners of insurance,” he says. “There are a lot more checks and balances compared to any other type of investments. So that’s what makes it very desirable.”
But will CDAs become more desirable to consumers and advisors in the future? Pickenpaugh said the product’s growth has been overshadowed by controversy over its structure and tax status. But like Garuda, she foresees at time when their use will become more commonplace.
“I do expect to see an expansion of their use whether or not annuities are used more widely in 401(k)s,” she wrote in an email. “However, if annuities are increased in 401(k)s I can see a particular market for them there. With the past decade of market turmoil and current financial unrest in the global economy, investors are looking to find some degree of certainty in their financial futures. I can see them looking to their 401(k)s for this certainty since traditional pensions that, in effect, gave the same degree of certainty as a CDA have been increasingly replaced by 401(k)s.”
Such certainty is not without its cost, Pickenpaugh pointed out. “The cost‑premium amount‑for the longevity insurance piece and the market volatility insurance piece will be taken from the account of the investor’s assets. They will be paying for that insurance, whether it’s hidden in lower returns than would otherwise be credited to their account or taken out directly each year,” she wrote. “Whether investors will find this degree of assurance attractive even with the associated costs will hinge, I believe, on whether the economic uncertainties continue or abate.”
Those premiums, Pickenpaugh noted, must be substantial enough for the insurer to profit since it does not generally hold the underlying assets of the CDAs.
“In order to determine whether a product like this is a good deal, the purchaser would have to break out the costs of the underlying products and determine if they could accomplish the same thing separately,” she wrote.
Although he could not give specific numbers, Garuda adds that the younger a person is when they purchase the CDA, the lower the cost. “At younger ages, it’s very insignificant,” he says.
For more on the debate over CDAs as the NAIC continues to study the product, look for updates on LifeHealthPro.com and Elizabeth Festa’s article in the March issue of National Underwriter, Life & Health and Warren S. Hersch's feature in the April issue of National Underwriter, Life & Health.
And tell us what you think: Are CDAs the wave of the future or an underwriter’s nightmare?