Could an 'insurance overlay' help managed accounts in retirement?

With financial advisor-managed accounts expanding by the trillions of dollars, annuity issuers are pitching an insurance strategy designed to reduce the risk of outliving retirement savings.

A protective "wrapper" in the form of a contingent deferred annuity enables an advisor to keep client assets under their management with the investments of their choice while offering insurance against depleting the savings too quickly, according to Keith Golembiewski, the director of annuity research with industry research organization LIMRA. Insurance companies are beginning to roll out more contingent deferred annuities — which are in "the first inning of the game," as Golembiewski put it — in an effort to cater to more independent advisors who have traditionally avoided moving assets out of their managed accounts.

"That's potentially what we could see in the future, these wrappers around various investment options that could be more attractive," Golembiewski said. "This is where we really as an industry have to build engagement, build awareness and make sure you have that technology to start allowing the financial professional to potentially offer this solution."

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How contingent deferred annuities work

Accounts managed by advisors as opposed to an outside manager are on pace to reach $15.6 trillion next year from only $2.8 trillion in 2012, according to data from research and consulting firm Cerulli Associates cited in a white paper for advisors called "Solving the Decumulation Dilemma" by David Blanchett, a portfolio manager and the head of retirement research with an asset management unit of Prudential Financial. Contingent deferred annuities "address a number of the concerns financial advisors have shared over the years about some lifetime income products," and technological advancements have made the insurance overlay "an exciting and viable option in the field of longevity protected income," Blanchett wrote.

"For an additional fee, an insurance overlay brings the potential of lifetime income and protection to retirees, helping them manage the risk of outliving their assets or to more freely spend what they've saved," he wrote. "Unlike a traditional annuity, an insurance overlay does not require a retiree to sell all or part of their managed account portfolio to transfer to an insurance company. The retiree simply pays an annual fee for the overlay. If the protected portion of the portfolio is depleted during their lifetime, they continue receiving income for life, depending on the terms of their insurance overlay."

Last month, Prudential and collaborators Dimensional Fund Advisors and Fiduciary Exchange unveiled the firms' filing seeking approval for a contingent deferred annuity product. The insurance strategy could fit into a long-term retirement plan seeking to mitigate the clients' potential to run out of savings as they age, take a hit from lower investment returns in the early years after leaving employment or withdraw too little from their accounts to an extent that they're unable to maintain the same standard of living, the prospectus filing with the Securities and Exchange Commission stated.

What advisors should know about contingent deferred annuities

With the product, advisors and their clients would be able to set their level of withdrawals within certain parameters or annuitize the entire account value. The product comes with a "contract fee" based on a percentage of the account's value, although the prospectus didn't quote the exact figure and said that it could go up after three years to a prescribed maximum amount.

"Income protection is the only benefit provided by the contract," the prospectus said. "Unlike some other annuity contracts, the contract has no surrender value, cash value or death benefit."

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Those characteristics could bring more flexibility in the sense that the annuity manufacturers are "trying to provide insurance without control of the asset," according to Golembiewski. He cited guardrail restrictions in other products that mean, "You can invest in whatever you want, but you have to fit into some range, and there would be some fee to correspond to that."

In addition, the fact that the client wouldn't need to transfer any of the assets means a lot "less paperwork, less transactional work," which could help make the contingent deferred annuities more appealing to the clients of registered investment advisory firm advisors who typically "don't sell annuities in general," he added. With sales setting records for three straight years amid higher interest rates and a boost from newer product lines such as registered-index linked annuities, the contingent deferred annuities may be attractive to some advisors and clients.

"We've seen the RILA product really growing significantly in our space," Golembiewski said. "This could be one of the next waves of innovation and one of the next areas of opportunity for the annuity manufacturers, the financial professionals and the clients."