Variable annuities (VAs) have been consistent best sellers for the life insurance companies in recent years, as rising equity markets and guaranteed benefits increased their popularity. However, due to the economic downturn, it has become more volatile.
Insurers had been aggressive in offering these riders as they compete for market share as rising equity markets made them easier to fund. However, the current volatility in the equity markets is making variable annuities and their guaranteed benefits a tough sell for the life insurers this year.
A variable annuity is basically a tax-deferred investment vehicle that comes with an insurance contract, it is usually designed to protect one from losses in capital. Thanks largely to the insurance clause, earnings inside the annuity will be tax-deferred, and the account isn’t subject to annual contribution limits.
Variable annuities can either be immediate or deferred. With a deferred annuity the account grows until you decide to make withdrawals. And when that time comes (which should be after age 59 1/2, or if withdrawn earlier, you will owe an early withdrawal penalty) you can either annualize your payments which will provide regular payments over a set amount of time.
When a customer purchases a variable annuity, the insurer will invest the money in a portfolio of mutual-fund like assets. This strategy exposes the variable annuity to market fluctuations, whereby the annuity holder may see a potentially bigger payout when markets are rising, but may also risk less of a payout when markets are going down.
Insurers tend to offer a wide range of guaranteed benefits, such as guaranteed minimum withdrawal benefits. In this case, a holder can receive an income for life regardless of the value of the underlying account. Insurers may also offer a guaranteed minimum accumulation benefit, whereby the insurer will guarantee that the account will grow at a certain percentage.
Declining equity markets may also have a negative impact for those insurers with sizeable variable annuity businesses through accelerated deferred acquisition cost (DAC) amortization. Companies use DAC to defer the sales costs that are associated with acquiring a new customer over the term of the insurance contract. If a sustained decline in equity markets reduces estimated gross profits on annuities, an unlocking of assumptions may occur, causing DAC to amortize faster. Also, such changes in assumptions may lead to increased reserves for products with guaranteed minimum death or living benefits.
Experts maintain a neutral outlook on the life and health insurance industry and do not recommend broad exposure to the variable annuities for major investments. There are ways to limit one’s risk by spreading your money among several stocks protects you from a meltdown in one firm. Splitting your stash among annuities from two or more highly rated insurers reduces the odds that all your money will disappear in one go.