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Closing the gap.

Increased longevity means more are at risk of outliving their assets. Deferred-income annuities is the industry's response.

It's easy to imagine a product design meeting that led to the newest version of longevity insurance.

On his first PowerPoint. an actuary showed a graph that traced the growth of U.S. life expectancy, from just more than 69.7 years in 1960 to 78.7 in 2010. On a second slide, he showed two graphs side-by-side: the one on the left showed a 9.7% total U.S. population growth from 2000 to 2010, while the one on the right showed a 15.1% growth among 65-and-older population during the same period.

This increased longevity, the economist who followed the actuary pointed out, comes with a downside. An increasing number of this 65-and, older set are at risk of outliving their retirement savings. For many, there's a gap between what they need to live comfortably and what was provided by their savings, Social Security and defined benefit income (if they had it). She passed around a handout based on data compiled by the Boston College's Center for Retirement Research that estimated that the share of households at risk for not having sufficient assets for retirement at age 65 had increased from 31% in 1983 to 51% in 2009.

Meeting participants had heard that the government was about to produce a study that underscored what they knew already: Purchasing annuities was one way to protect retirees from the risk of outliving their assets. Of particular promise, the 2012 study by the President's Council of Economic Advisors said, was a special class of deferred annuities the council referred to as longevity annuities. These were typically purchased at retirement and began paying later in life.

Product's History

The first pure longevity product was introduced in 2004. A variant of conventional deferred annuities, in which deferment durations tended to be shorter, a typical purchase might involve a $33,800 lump-sum payment at age 65, which would result in guaranteed-for-life payments of $1,000 per month for life starting at age 85.

"It was a great concept that looked good on the white board in a meeting with actuaries and scientists," said Gary Baker, president of the U.S. Division of Cannex, which compiles data about financial products. "But it never really translated well over the kitchen table. It was a horrible story to the average investor: You give me money and maybe you'll start seeing it in 25 years."

"What has evolved today is that some distributors are finding success in marketing these types of products to somebody who may be in their mid-50s, the same type of people in a 401(k) plan who would be looking to do catch-up provisions. They see retirement right around the corner and they realize they didn't save as much in their 401(k). It's a way to also build a personal pension."

"The financial crisis of 2008 forced investors and savers to rethink how they save for retirement," said Jim Mumford, first deputy commissioner of the Iowa Insurance Division. "I think people realized they cannot merely rely on the stock and bond market accumulation for lifetime income, but rather need lifetime income products that provide a guarantee of income. This change in consumer thinking and consumer demand is driving much of the product innovation we are seeing now."

Only a handful of carriers offered these products in 2011, but now there are nine carriers, with eight additional companies planning to introduce them, according to Jafor Iqbal, associate managing director of LIMRA Retirement Research. According to LIMRA, sales of deferred-income annuities grew from about $200 million in 2011 to more than $1 billion in 2012. Total sales of both immediate and deferred-income annuities grew to $8.7 billion in 2012, a small but bright spot in the total $220 billion annuity market which otherwise remained flat in 2012.

This growth was attributed in part to the addition of new consumer-friendly features, some of which require buyers to accept lower deferred annual payouts. These additional features include the ability to make multiple contributions before the income start date; the ability to change the income start base, cost of living adjustments, and limited liquidity features.

"All of these features," said Jeremy Alexander, president and CEO of Beacon Research, a research firm that tracks annuities, combined "to make consumers more comfortable with a DIA purchase decision."

While sales of deferred annuities have grown, these sales are dwarfed in quantity by sales of variable annuities with guaranteed living benefit riders. Although sales of variable annuity sales have gradually declined to $35.5 billion from 2012 to the first quarter of 2013, 84% of purchasers of variable annuities elected some sort of guaranteed living benefit rider. These optional riders allow minimum withdrawals from the invested amount in the variable annuity without having to annuitize the investment. The amount that can be withdrawn is based on a percentage of the total amount invested in the annuity.

Theoretically, these GLBs have two principal advantages over deferred-income annuities: They are more liquid and they allow purchasers to invest part of their annuity's value. "Either you want liquidity or you're looking for a guarantee," explained Cannex's Baker. "Guaranteed living benefits are a way to help bridge the gap and to offer the best of both worlds."

Stan "The Annuity Man" Haithcock, an independent producer and annuity commentator, believes one possible reason variable annuities with GLBs post sales that exceed deferred annuities is because of the higher commissions producers earn by selling GLBs. He says the commission structure of deferred annuities can be up to 40% less than that of variable annuities with GLBs.

According to a study by Morningstar Inc. and the Insured Retirement Institute, fees average 1.032% annually on a $25,000 investment. That fee, IRI indicates, is on top of contract and mutual fund expenses that averaged 2.49% in the fourth quarter of 2010. In addition, a study by Advisor Perspectives, a financial planning research publisher, found that a 60-year-old with a GLB had only a 9.5% probability that the product would provide superior performance to a passive account.

"When you're buying a living benefit rider on a variable annuity, you're not buying guaranteed income; what you're buying is an option to take guaranteed income," said Ross Goldstein, managing director of New York Life. "And in general, that optionality has a cost. The cost is that it offers a lower guarantee than a deferred-income annuity, but also provides market access and differing liquidity. So if you're really in the market for a guaranteed income, you'll find that a deferred-income annuity offers about 40% more guaranteed income than a variable annuity offers."

Dina Lumerman, MetLife's vice president of retail annuity products, says that each of these products have their strengths. "I think the mindset is shifting to not just focusing on one product, but focusing more on a cohesive retirement plan. So it's not that one product will address all needs; it's about having a cohesive plan to address the various needs. And deferred income annuities really do the best job at maximizing money today for future income later."

According to LIMRA's Iqbal, the average purchaser of deferred annuities is 59 and is deferring income for seven or eight years.

"Much of what is being invested are qualified dollars. Customers want to use what they've saved for retirement for a guaranteed income stream in their retirement years."

Haithcock said in his experience, people who buy these products "are very highly educated, high IQ, high net worth investors that understand transfer risk. They're not looking for a one-size-fits-all product. They are not looking for multiple benefits. They're looking for one benefit and that's solving for longevity risk."

The Future

Although deferred annuity sales have increased dramatically since 2011, there are several factors that can inhibit further growth. One is how the product is framed. Selling these products as a stand-alone, all-or-nothing lifetime guarantee is a tough sell. "People generally have a tough time relinquishing control of their assets in return for something like a guarantee. But if it's allocated as just a portion of the overall nest egg, then it's easier to adopt," Cannex's Baker said.

"Annuities," wrote LIMRA's Alison F. Salka in a recent article entitled Mitigating Behavioral Risk, "are perceived as more attractive when they are viewed from a 'consumption' frame: More people viewed an annuity favorably when it was presented as a specific monthly paycheck for life."

Salka is LIMRA's corporate vice president, retirement research.

Consumers tend to want to live off their guaranteed sources of income, whether it's their Social Security check or their pension, and try to retain those assets because they don't want to see them dwindle over time, said New York Life's Goldstein.

"So what we think the biggest opportunity in terms of growth of the market is [positioning a deferred annuity] as helping people live more fulfilling retirements. If you can convert a portion of your assets into an income annuity, you're essentially giving yourself a raise in retirement but still retaining the remainder of your assets for a rainy day or for your heirs or whatever you're planning on doing with your money."

A second obstacle to sales is the perception of advisers that they'll somehow be compensated less than from their sales of deferred annuities versus other products. Some advisers perceive that they'll earn less because of one-time commission on a deferred annuity sale, versus opportunities for additional down-the-line commissions for other types of annuities.

A third obstacle is current required minimum distribution rules, which especially affect investors who want to roll over their IRAs or 401(k) assets into a deferred annuity. Under current rules, people who roll over these assets into longevity insurance need to take required IRA minimum distributions by age 70 1/2. The Department of Treasury and the IRS have outlined a proposal that would modify these requirements and facilitate the purchase of deferred annuities that begin at an advanced age.

Despite these obstacles, it seems certain that the market for these products will continue to grow.

"More and more people are looking at these products the way they should be--as a non-correlated asset, similar to gold in a portfolio, that solves the specific [need] for the risk of outliving your money," Haithcock remarked.

Key Points

* The Trend: An increasing number of those 65 and older are at risk of outliving their retirement savings.

* Industry Response: Nine carriers offer deferred annuity products and more are planning to enter the market.

* Sales Obstacle: Some financial advisers believe they'll be compensated less from sales of deferred-income annuities versus other annuities.

Lifetime Payouts By Age And Gender

According to LIMRA's Jafor Iqbal, the average purchaser of deferred annuities is 59 years old and defers income for seven or eight years, while the average purchaser of an immediate annuity is 73.

Here are illustrations of lifetime payouts from a $100,000 immediate or differed annuity from New York Life, according to age, gender and deferral period. If the client opted for a guaranteed premium return option, the payout would be reduced by 6% to 10%, according to New York Life.

Age   Gender   Deferred Until   Annual Payout   Payout Rate

10    Male     50 Years               $29,440        29.44%
10    Female   50 Years              $27,645         27.65%
58    Male     9 Years                $11,414         11.41
58    Female   9 Years               $10,210         10.21%
65    Male     Immediate               $6,721         6.72%
65    Female   Immediate               $6,380         6.38%

Source: New York Life
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Author:Lewis, Angelo John
Publication:Best's Review
Date:Oct 1, 2013
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