TRADITIONAL ANNUITIES
ARE GAINING GROUND AS FIXED INCOME ALTERNATIVES
John J. Harrell

John J. Harrell is Managing Director of Sales for Financial Institutions Channel for Symetra Financial. Symetra Financial Corporation and its subsidiaries provide life insurance, annuities, employee benefits and retirement plans through a national network of independent advisors and agents. For more information, visit Symetra.
 

WITH THE DECLINE in variable rate product sales, many bank representatives have shifted their focus toward fixed-rate solutions. This is in response to a changing mindset among customers. Still reeling from the effects of the downturn, many customers are fleeing to the relative stability of retirement products that are not susceptible to market swings.

As a result, fixed interest rate annuity sales have taken off at banks. Kehrer-LIMRA data show fixed annuity sales have improved each quarter since 2007. In the first quarter of 2009, these products represented 80 percent of all bank annuity premiums.¹

This renewed interest in fixed income is fueling a sales resurgence in another product as well: income annuities. First quarter bank sales of income annuities were 50 percent higher than one year ago—reaching nearly $2 billion.² Even as these products gain prominence as a fixed income alternative, the key issue for bank programs becomes how best to leverage the opportunity.

In the past, income annuities have suffered from the notion that they are too old-fashioned a product design and represent a one-time commission for the bank representative. Bank programs have also raised concerns about a perceived potential loss of future fee revenue owing to proportionately fewer investable assets in play following a large income annuity purchase. However, income annuities need not be a one-and-done proposition. In fact, with the use of a few effective strategies, the product can actually result in multiple sales opportunities—all while expanding the availability of a suitable customer solution in the current environment.

Laddering using income annuities

Many bank representatives are already familiar with fixed-income laddering using bonds. Bond laddering is essentially a method of fixed income risk diversification where a bank representative creates a portfolio of different bond investments and systematically staggers maturities and payouts to match cash flow needs. Yet taxation can negatively impact a laddered corporate bond portfolio as payments are taxed as ordinary income. Other types of bond payments, including those from municipal bonds, may not be taxed as ordinary income but can present other tax issues depending on the issuer and locale.

Non-qualified lifetime income annuities, on the other hand, provide similar payment stability but with the advantage of unique tax exclusion ratios. Taxes work differently for payments from an income annuity than they do for bonds. A portion of each income annuity payment is nontaxable because the product is considered to be providing return of the customer's original purchase, and it is generally only when an annuitant lives beyond life expectancy that payments start being 100 percent taxable as ordinary income. Obviously in the case of bonds, the customer's principal is returned at maturity. Furthermore bonds, as investment products, are still exposed to market volatility while annuities, as insurance products, are not. Particularly in today's market, uncertainty in bond yields combined with both default and call risks can undermine fixed-income planning using bond laddering.

An alternative

As an alternative, customers can choose to ladder payouts through a series of lifetime income annuity purchases. Specifically, this laddering strategy involves sequentially converting a portion of savings into different lifetime income annuities over five or 10-year increments in retirement. This helps customers realize income stability while mitigating the risk of losing ground to inflation or diverting too large a chunk of assets into a single annuity. Because purchases are spread out over stages, the strategy may also result in repeat annuity sales opportunities over the course of retirement.

In addition, there is an embedded actuarial advantage to laddering income annuities. The products tend to ensure higher monthly payments at each ladder interval as the customer moves through retirement. This is because lifetime income annuity payouts generally increase with the age of the customer, as they are structured based on remaining life expectancy. Typically, the older the customer is at purchase, the more the monthly income.

Another perception among some banks is that money tied up in an income annuity could undermine potential CD and other sales when interest rates recover. Yet it turns out that shorter-period income annuities are a viable option not just for stabilizing income now, but also for leveraging future sales of CDs. The annuity can work in concert, not competition, with CDs and other products.

This can be achieved by opting for income annuities with payments scheduled over a certain period instead of over a lifetime. The goal of this strategy is to shorten contract durations and consider CD or other product reinvestment at the annuity's different payment intervals.

For example, customers could structure an income annuity over a five-year period and select annual rather than monthly payouts to begin 12 months after the purchase date—particularly for those customers who are more interested in protecting savings than using an income annuity to help cover monthly living expenses. At each annual income payment interval, customers would then consider converting their payment into a CD if interest rates are in a better place. This strategy allows the customer to protect against market risk now while allowing for greater investment flexibility down the road. Additionally, the approach sets the bank program up for periodic check-ins over the course of retirement, rather than just providing an isolated asset conversion at retirement age.

Effectively managing assets at a time when markets remain volatile and retirees are increasingly wary of risk is a challenge. Bank programs should respond by diversifying their products and services beyond recent norms. Once considered behind the times, income annuities are now a product whose time has come. For bank representatives looking for safe harbors for their customers, there are few simpler or more attractive options today than income annuities.

¹Kehrer-LIMRA Report, Second Quarter 2009.
²Ibid.