The death or the proliferation of the variable annuity?Article added by Steven Delaney on September 9, 2009
Steven Delaney

Steven Delaney

Chalfont, PA

Joined: November 15, 2007

A magazine came to my office recently, and the lead cover story was "Variable Annuities Now? -... Absolutely!"

People may like CDs, mutual funds, ETFs, REITs, bonds, options, hedge funds, or a combination thereof -- and it is a personal choice, right? However, maybe we should stop and think about what exactly makes up a variable annuity (VA), and consider the merit of continuing to market them as we have in the past.

VAs, the way they may be presented and sold, and the way advisors think about them, is perplexing. Here comes a weird analogy: VAs are akin to an individual facing sexual identity issues. We have all seen the programs on The Learning Channel (TLC), where people have always considered themselves trapped in the wrong body. They feel, think, and sometimes act as a female, yet they are trapped in a male body, or as a man trapped in a women's body. A variable annuity is a bunch of mutual funds trapped in an insurance contract. This is not quite true, as the VA itself has weird feelings about their true identity. Why? Because the mutual funds inside these VAs (sub accounts), are not freely chosen by the individual who has decided to place their life savings in this product, the person who likes the idea of trying to rip the cover off the ball, but at the same time, hedging themselves with some insurance behind this strategy.

Anyone with experience in the VA marketplace understands what I am talking about. The companies and the advisors presenting these products speak of "the market's upside potential and the safety that living benefits provide." Not really. Those on the inside of this marketplace know more about the true identity of these products, and those on the outside think these VAs sound great.

Well, they do sound great, and they could be great, but once you peel off the fancy wrapping paper, you may not have what you thought you had, and you may be wishing you could return your VA to the John Hancock, Metropolitan, or Prudential department store. But you can't, you're stuck with a gift you didn't really want. In fact, upon further investigation, the VA has a terrible return policy, as cash refunds are only available within a 10 day to 30 day time frame. And you just got your statement -- one year later. At that point, the VA may be worth 50 percent less than what you initially deposited. Not only that, you couldn't sell it on eBay if you wanted to, because even though you put in $100,000, the account value is down to $50,000, and when you take into consideration a 9 percent surrender charge, the real value is $45,000. As a last step in this exercise, throw in 3 percent in costs/fees just to maintain what you have now versus 12 months from now, and your market sensitive investment must generate performance of a net 3 percent.

So far, so good? No! It's worse than that? Yes, because the products have ISRs (investment selection restrictions). OK, is that bad? Well, it's not good because now the company imposes artificial caps on market returns. So, if the consumer or the registered rep believes that the stock market historically returns 10 percent overall, which, of course is false, would a moderate return be 4 percent, 5 percent, 6 percent, or 7 percent? How so? Well, you cannot swing for the fences, you do not get the full upside of the market when you do not get to choose from a full menu of investment choices. You can't choose whatever you want on the menu, you have a limited menu -- chicken or pasta, but no steak or seafood!

You may not be free to choose amongst the Russell 2000, Nasdaq, blue chips and/or emerging market stocks, hoping to ride the global recession all the way back to your original $100,000. You are forced into an "optimized" or "selected portfolio." If the VA company is on the hook for these 5 percent, 6 percent, and/or stepped up living benefits, income benefits and phantom values -- which would provide an income stream that cannot be outlived -- they will not allow you to put them at further risk of not being able to fulfill their promise. Your client is thinking, "And I own one of these?" Yep! "But aren't I guaranteed 6 percent, and if the market does better, I get a step up in value?" Ahhh, not exactly. "But, that is why... I said yes to the advisor... that is why I decided to place my life savings in a variable annuity." But, that is not how it works. "Yes it is!" No, I am sorry sir, that is not how it works. You may want to go over the working of your variable annuity policy with the advisor who sold it to you, and he or she can explain it better, or explain it again.

One more thing: To get your money back, you have to take the living benefit guarantee over time. So, it is going to take some time, depending on the client's age when the living benefit is exercised. So, are VAs really that bad? Well, since everyone reading this article has a calculator on their desk, or attached to their belt, you tell me! You put in $100k, intending to accumulate or decumulate; you are $50k away from where you started at the end of year No. 2, you need the market to come back by 100 percent, and then consider fees. The market must more than double, and it may, or it may not, and you may have 5, 10, 15, or 20 years to wait. Or, again, you may not. If you buy a VA, as a 45-50 year old, you are stuck with this product for the next 15 to 20 years. And then, if the market did not regenerate your initial investment, your original principal, allowing you to walk away with what you put in, you have the choice to walk with your account value, or exercise the living benefit for another 10, 15, or 20 years.

So, "Variable Annuities Now?" Well, I don't know... you decide. Keep in mind that products are not good or bad, but right or wrong for a particular client or situation. VAs may be the absolute best decision for a particular client. Good luck!

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