Eighty-seven percent of variable annuities sold in the third quarter of 2010 came with a guarantee, compared with an 89% election rate for 2009 as a whole. Some market leaders are seeing uptake rates north of 90%. This demand suggests consumers will continue to value VA guarantees. It's not hard to see why. Guaranteed income with optional living benefits encourage clients to stay invested in equities, while insulating them against market downturns.
As important as guarantees are, now may be an excellent time to expand your clients' understanding of these products, especially regarding potentially confusing topics such as investment options and fees. Your discussion should start at a high level, moving through what I call the DCA funnel, and then branch into one or more additional conversations.
Here's the essence of the high-level DCA discussion:
"D" stands for demographics. Impress on prospects the likelihood that they will live for a very long time. One point I make is the "Rule of 63/36," which means that for a 65- year-old couple, there is a 63% chance that either the husband or the wife will be alive at age 90 and a 36% chance that one will be alive at age 95. They may therefore need income for longer than they actually worked.
"C" stands for both costs and Congress. Make the point that seniors are on a fixed income, but their costs remain variable. When gas prices and healthcare costs increase, they get hurt. Ask them if they've made plans to protect their retirement income against inflation. Most have not, so be open to discussing how VAs can provide such protection.
The Congress factor illustrates that with record budget deficits and crushing total debt, taxes are likely to rise long term. For the first time in 10 years, advisors have a great opportunity to talk about tax deferral, which is the traditional strength of annuities. Ask your clients what they think will happen to tax rates and whether they have an interest in considering tax-advantaged investments, including VAs.
The "A" stands for assets in cash, qualified money and fixed income. Try to convince your clients that staying in cash forever is ultimately a losing strategy. The market has been rising steadily for months. Annuities offer them exposure with guarantees.
Ask your clients what will happen to their heavy bond investments when interest rates head north again, as they are sure to do. Answer: Bond prices will fall, shrinking the value of client bond portfolios.
With DCA as a backdrop, here are four additional conversations that will help clients evaluate whether variable annuities should play a role in their retirement income plan.
Conversation #1: Variable annuities help to limit risk and produce gains.
Most clients are driven by fear of future investment losses and regret over past losses. As a result, they may shy away from taking the measured investment risks necessary to achieve their retirement goals. Such emotions caused panicky clients to cash out of equities during the 2008 market downturn. But as usual, the market rebounded and these clients locked in their losses by selling at the bottom and missing the rebound.
Having access to guarantees not only makes clients more likely to stay invested long term, it also frees them to invest more aggressively, which may increase both their upside growth potential and the ultimate size of their retirement income stream. Despite this, advisors and clients often focus defensively on variable annuity guarantees ("protect my money") rather than offensively on the investment platform ("create future growth"). By encouraging clients to value both, you may increase their perceived value of VAs and enhance their ability to achieve their retirement goals.
Conversation #2: Variable annuities are too good to be free.
Variable annuity fees can be a touchy subject, and advisors can get defensive when discussing them. However, keep in mind that fees pay for death benefits as well as income and principal guarantees not available with other investment products. Investors transfer their risk to the insurance company, and insurers charge for this value.
When you consider the total package of VA benefits-guaranteed retirement income, investment growth and a death benefit-the fees make a lot of sense. In fact, we've heard some clients say that variable annuities are "too good to be true." I prefer to say they're "too good to be free!" So don't shy away from making a strong case for the VAs and disclosing all fees without feeling like you have to apologize.
Conversation #3: The variable annuities investment platform drives guarantees.
The popularity of guarantees often outshines the importance of the product's underlying investment platform. But a quality investment platform puts luster into a variable annuity's guarantees. By stressing investments alongside guarantees, advisors can facilitate growth when the markets are calm, and lock in gains when markets turn volatile. What should you look for? Here are some elements:
• Active Management: Many variable annuity firms have reduced risk by offering only index funds. There's absolutely nothing wrong with providing an index fund. But if your clients want active management, wouldn't you prefer to meet their needs? Plus, the ability to offer active management is the hallmark of a financially strong carrier-and a strong differentiator in the marketplace.
• Choice: When it comes to investment choices, more isn't always better. In fact, too many choices can end up being unsustainable-both for clients and the insurer. Instead, give your clients access to quality. Find a company that offers more than ample choices to cover the vast majority of client needs in your book. A blend of choices should ideally include:
— Traditional brand names offering tried-and-true asset management strategies, based on longer-term views of the capital markets;
— Tactical strategies from boutique and institutional managers, based on shorter-term views, that are otherwise inaccessible to retail investors;
— Quantitative strategies based on disciplined approaches to portfolio management;
— Alternative strategies based on investments that are less correlated to the stock market.
• Flexibility: There is a wide array of turnkey asset allocation portfolios that deliver diversification based on client goals, risk tolerances and time horizons. These should offer rebalancing to ensure your clients' money tracks their investment goals over time. And you should also have the flexibility to combine asset allocation portfolios to address specific client needs.
Conversation #4: Variable annuities empower average investors.
The investment platforms of the top carriers provide access to sophisticated strategies and highly targeted asset classes. At my own firm, for example, a consumer can allocate money to portfolios like AST Schroders Multi-Asset World Strategies or AST Parametric Emerging Markets Equity. Normally, only institutional investors would have access to these approaches. But the buying power and oversight of large investment management complexes allow advisors to put average clients in such investments.
In sum, guarantees have a lot of appeal in today's market environment. But don't let them monopolize the conversation. Explain features relating to the investment platform and external forces such as demographics, inflation and taxes. The more time you spend in client education, the more confident your clients will be about their retirement plan — and the more confidence they will have in you, their advisor.