How VAs foster investing with peace of mind.
How to bridge that chasm? Sources interviewed say that one time-tested strategy is to recommend a variable annuity backed by one or more guaranteed living benefits.
"As a general role, these guarantees enable clients to be more aggressive with equity investments," says David Morales, a registered rep and registered investment advisor with MetLife, New York. "So, a client who otherwise might have a 60-40 ratio of equities to fixed income might go with a 70-30 or 80-20 ratio when the investments are guaranteed."
Mitchell Kauffman, an independent financial planner affiliated with St. Petersburg, Fla.-based Raymond James Financial Services, agrees, adding: "The VA's guaranteed living benefit riders allow [clients] to be more concentrated in mutual funds than would otherwise be the case. [The GLBs] offer them peace of mind."
GLBs come in three forms: a guaranteed minimum accumulation benefit (GMAB); a guaranteed minimum income benefit (GMIB) and a guaranteed minimum withdrawal benefit (GMWB).
Generally, the GMAB guarantees the client's initial investment. At the end of the vesting period (typically 10 years), if the contract value is below that of the client's initial investment, then the VA issuer will make a one-time adjustment, adding the difference between the current contract value and the initial premium (minus withdrawals), back to the contract.
The GMIB generally guarantees an income level when the client annuitizes based on the contract's highest anniversary value (less withdrawals) and/or the premium payments accumulated at a guaranteed minimum annual compounding rate. This rate, which typically ranges from 4%-6% (less withdrawals), is guaranteed until annuitization, regardless of market conditions.
The GMWB guarantees a return of principal over time through systematic withdrawals. The amount of the withdrawal is typically about 7% of the principal annually for a period of 14 years. The annual withdrawals are guaranteed even if the contract value declines to zero.
Many insurers now offer such riders. In a November 2005 survey from Diversified Services Group, Wayne, Pa., 27 of 43 insurance companies, or 63% of those polled, said they offer one or more GLBs. Nineteen companies, or 44% of respondents, offer the GMWB. This compares with 40% and 37%, respectively, for the GMIB and GMAB riders. Additionally, 81% of the GLB products surveyed have a "step-up" feature that locks in market gains.
Clients who purchase these guarantees are not always without risk, experts point out. Many VA contracts require the client to hold the product for a period of years before the guarantee kicks in. But even when the guarantees are in force, there are limits to how aggressively the client can and should invest.
Steve Scanlon, a managing director for sub-advisory services at Alliance-Bernstein Investments, New York, observes that insurers generally require clients to subscribe to an asset allocation model to enjoy contract guarantees. Guided by the investor's risk tolerance level and financial objectives, the company will apportion investment dollars among asset classes, each class being assigned a fixed percentage.
A highly aggressive position might, for example, assign one-third of a client's portfolio to an international equities fund; smaller percentages to U.S. large-cap, mid-cap and small-cap funds; and still smaller percentages (if any) to money market and bond funds.
The asset classes should also correlate negatively to one another: When the value of one rises, the other falls. A portfolio built on such negatively correlated assets, reps say, will be less prone to market gyrations than another in which asset classes fluctuate in tandem. Over time, the portfolio should yield a higher return.
"A properly diversified portfolio is like a car with a V-8 engine," says Norm Mindel, an advisor and registered rep with Genworth Financial, Richmond, Va. "If the client is invested in eight asset classes, then, like the pistons in the V-8 engine, four will be up and four will be down at any given point in time.
Even when they're all down, a guarantee on the invested principal will provide a much-needed floor below which the portfolio won't fall in value, encouraging clients to stay invested. This willingness to ride out bear markets, says Scanlon, is key to achieving high returns over the long term.
"When markets decline, too many investors head for the hills, wanting to cash out," he says. "The VA with guarantees is such a powerful vehicle because, during that period when the market takes a turn for the worse, annuity clients stay the course."
Too few investors do stay the course, he adds, leading to inferior returns; and, as regards people who try to time the market, this leads to negative yields. Scanlon points to an April 2004 study from Dalbar, a Boston, Mass.-based market research firm, which examined the flows into and out of mutual funds from 1984 to 2004. Among the report's findings: Market-timers in stock mutual funds lost 3.29% per year on average over the 20-year period. And while S&P grew by 12.98% during this time, the average investor earned only 3.51%.
Given the twin benefits of the GLB-backed VA--downside protection and unlimited growth potential--one might ask whether the product can substitute for alternative vehicles. Mindel suggests, in fact, the product may "almost be treated" as the bond component of the client's portfolio. As with other fixed income assets, he adds, income derived from the VA should be used to pay for nondiscretionary expenses, such as food, health and transportation costs. The at-risk portion of the portfolio would thus cover discretionary expenses.
But prospective VA buyers need to bear in mind some caveats, sources say. Apart from the fine print in VA contracts governing terms of the GLB provisions, clients also need to consider the guarantees' potentially costly fees. They also need to weigh the VA's investment choices. While those choices are significantly greater today than in years past, some reps suggest there's room for improvement.
"Unfortunately, most VA [selections] are very thin in the emerging markets category," says Steve Kaye, a financial planner and president of American Economic Planning Group, Watchung, N.J. "I don't know any VAs that offer more than one emerging markets fund."
Jeff Motske, a registered rep at National Planning Corp., Santa Monica, Calif., adds that high-net-worth clients frequently need to leverage investment vehicles not found inside the VA. Among them: managed futures, hedge funds, commodities and real estate.
"By creating greater portfolio diversification, these assets help to lower [high-net-worth] clients' risk exposure and increase their opportunity for high returns," says Motske. "The average investor doesn't have access to these alternative vehicles because of the high minimum [deposits] required."
THIS ARTICLE FIRST APPEARED in the April 2006 issue of Registered e-Report, a free online newsletter of National Underwriter Life & Health edition. To subscribe, go to www.lifeandhealthinsurancenews.com.
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|Title Annotation:||FOCUS: RIDERS; Variable annuities|
|Comment:||How VAs foster investing with peace of mind.(FOCUS: RIDERS)(Variable annuities)|
|Author:||Hersch, Warren S.|
|Publication:||National Underwriter Life & Health|
|Date:||May 15, 2006|
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