There's a bright spot in the otherwise lagging annuity market.
Fears of federal fiduciary rules and paltry investment yields dealt a double blow to the annuity market overall last year, as sales dipped 8%. Amidst the gloom, however, the lone bright spot was structured annuity sales, which rose 26% to $9.2 billion year over year, according to LIMRA’s Secure Retirement Institute.
LIMRA does not yet have first-quarter 2018 data, but its analysts expect structured annuities to continue to grow.
Structured annuities are relatively new instruments, with earliest data available for 2014. They’re designed to provide some upside potential yet limit investment risk, a parlay that has led to their recent popularity.
“Since 2011, we have seen the individual annuity market shifting toward products that have more accumulation features, versus income features,” says Todd Giesing, director of annuity research at LIMRA. “Structured annuities have filled a gap in the market for individuals who are searching for yield yet want to take some risk out of their portfolio.”
As is the case with many types of annuities, structured annuities come in a variety of forms, with different features. Indeed, they even come with different names — they’re also known as buffered or hybrid annuities. Details vary across issuers, which include Allianz, AXA and CUNA Mutual.
Generally, these are deferred annuities in which account value may build up, untaxed until there’s a payout. Clients can choose the layer of protection they desire; they might want to be protected against a 10%, 20% or even 30% loss, for example.
“All of the structured annuity products offer a component where the credit rate is determined by the performance of a market index,” says Giesing. “Some of the products also offer an option to invest a portion of the funds in sub-accounts with no downside protection.”
There usually is a cap on return, so clients may not get the full value of a positive index move, especially in years of strong bull markets.
There usually is a cap on return, so clients may not get the full value of a positive index move, especially in years of strong bull markets. “Cap rates will vary, by contract and by current market volatility,” says Shane Gurganus, an investment advisor representative with Capitol Financial Solutions in Charlotte, North Carolina. The firm uses Signator Investors as its broker-dealer.
“Hypothetically, a structured annuity with a six-year term and 10% downside protection might offer returns up to 70% of an index gain over that period. Increasing the downside protection will result in a lower cap on gains,” Gurganus says.
Particularly if clients choose modest amounts of downside protection, Gurganus adds, the long-term returns from structured annuities might exceed long-term returns from fixed index annuities.
As a tradeoff for forgoing full index gains, investors are cushioned against severe losses. Suppose, in the above example, the underlying index is down by 15%. The insurance company would absorb 10 points of that loss, so the client’s loss would be only 5%.
Given their nature, should structured annuities be classed as fixed or variable annuities, or true hybrids?
“This is a valid question,” Giesing says. “These products provide a downside shared risk component requiring these products to be registered with the SEC, yet some of them do not provide true sub-account offerings. Due to the ability for investors to experience a loss in these products, they are considered to be variable annuities.”
Viewing them as a type of variable annuity, what do structured annuities add to the marketplace, compared with the other VAs advisors can bring to clients?
“Structured annuity products offer market protection through their buffers/shields,” Gurganus says. “This is different from most variable annuities, which typically have full market exposure, based on the investment allocation of subaccounts.”
Brett DiPasquale, an advisor with Capitol Financial Solutions, notes, “With a structured product, the client can still go up with the market but can choose a level of downside protection and also choose the term in which the investment is measured. With the downside buffer of a structured annuity, the insurance company is absorbing that amount of losses over the period of the contract.”
As for the potential drawbacks of structured annuities, advisors point to limited investment choices, caps on potential returns and possible surrender charges. There are fees, which come with most forms of annuities, but structured annuity fees may be lower than the fees of other forms of VAs.
Nevertheless, not everyone classes structured annuities as a low-fee entrant.
“From what I've seen, some structured annuities have steep fees, as there may be direct administrative fees, investment management fees and other fees that can vary with performance,” says David Gaylor, president of Tradewinds Financial Group in Sidney, Ohio, and founding partner of Suwanee, Georgia-based advisor training firm 3-Mentors. “The fees for other types of annuities, such as fixed index annuities, may be lower. Some structured annuities even have a front-end load. I'll never understand paying something like that to buy an annuity.”
Investing in a structured annuity may involve various choices for advisors and their clients. How much downside protection? How many years should the contract cover? Astute advice can lead to informed decisions.
“When I explain structured annuities to clients, I discuss in detail the way the product works, what it can and can’t do, and go over several different examples,” says Gregory Bosch, president of Bosch Financial in Cedar Rapids, Iowa, which is part of AXA Advisors network. “One important step is highlighting scenarios reflective of the client’s unique situation, using real results for different investible indices over the past 35 years.”
Such results, according to Bosch, are included with the product prospectus for some structured annuities.
Jim Robinson, an LPL investment advisor representative with Schulfer and Associates, a wealth management firm in Stevens Point, Wisconsin, positions structured annuities as “protected growth” vehicles.
“I tell clients they offer an opportunity to participate in some upside when markets do well,” he says, “with the ability to manage the downside so there will not be a protracted, painful recovery period.”
Structured annuities may work best for clients who are less than 10 years from retirement or already retired, Robinson has discovered. “They know they won’t be spending all of their assets over the next six to 10 years, so they can park some assets in a structured annuity,” he says. “These clients understand that the stock market has more positive than negative years, but they don’t have enough years to recover from a big hit. I also have used structured annuities as a proxy for part of a client’s bond portfolio, to seek yield in a non-aggressive investment.”
DiPasquale reports that prospects for structured annuities may be clients who have purchased a VA with an income rider and are paying high fees, but whose investment objectives have changed.
To Bosch, structured annuities might be a good option for certain clients between ages 45 and 70. “Often, these clients have experienced investment gains in the bull market,” he says. “They know they still need to accumulate assets and stem the impact of inflation, but they don’t want to take undue market risk as they near retirement.”
