People are buying annuities again, and for good reasons.
Not long ago, there was a steady decline in the amount of money flowing into annuities and there seemed to be no bottom. Annuity purchases, however, have rebounded and indications are the demand for annuities is likely to keep rising.
In the second quarter of 2018 (the latest data available), total annuity purchases increased about 15% from the first quarter, according to LIMRA. In 2016 the picture was very different. Annuity purchases were 7.6% lower than in 2015. The 2018 purchases are the highest in three years.
The conventional wisdom is the increase is attributable to the demise of the fiduciary rule regulations issued by the Department of Labor a few years ago. But I disagree.
Aging baby boomers and their desire for reasonable and reliable retirement income are behind the change of behavior. Surveys of retirement-age baby boomers indicate they no longer seek high growth in their portfolios. Instead, they express a desire for guaranteed lifetime income, safety of principal, and related qualities. Annuities meet those goals.
A peak behind the headlines also indicates demand from baby boomers seeking retirement income is the most likely cause of the sales increase.
First, let’s have a quick, high-level refresher on the different types of annuities. The most common types of annuities are:
Immediate annuities: You deposit a lump sum with an insurer and receive a promise of guaranteed payments for life or a period of years, whichever you select.
Deferred fixed annuities: Your annuity deposit is credited with interest each year. The interest rate often is determined by the insurer each year, though it could be based on a market benchmark.
Fixed indexed annuities: Your annuity deposit account is credited with interest each year, but the interest is determined by the performance of investment market benchmarks and formulas. For example, the interest might be a percentage of the return of a stock market index up to a maximum rate, such as 10% for the year. These annuities can be complicated.
Variable annuities: You choose from investments offered by the insurer. Your account is credited with the return of those investments minus expenses and fees.
The first three types of annuities offer guarantees. They guarantee principal. They also guarantee some level of income. Variable annuities on the other hand offer fewer guarantees and charge extra fees for riders that provide more guarantees, such as a minimum level of retirement income.
It’s no surprise that when we look at the details of annuity sales data, we find that the annuities with the highest sales growth are those with the most lifetime income guarantees and least risk.
Another reason annuity sales are increasing is that they pay more income than they did a few years ago.
Annuity earnings and distributions are based on current interest rates and the outlook for future returns. When the Federal Reserve was actively pursuing its zero interest rate policy and keeping a ceiling on yields, annuity sales were down. Those seeking retirement income didn’t want to lock in the low rates of a few years ago.
But interest rates on treasury bonds have climbed since July 2016, and that’s helped annuity buyers. Immediate annuities are paying higher guaranteed income than a few years ago. Fixed deferred annuities and fixed indexed annuities are paying higher yields and offering higher guaranteed rates.
After the Fed brought interest rates near zero, investors have been reluctant to lock in low yields for the long term. Instead, they sought income from riskier sources such as high-yield bonds, master limited partnerships, and more. As rates rise, annuities become a more attractive source of income.
Annuities also offer good alternatives to bonds when interest rates are rising.
When an investor owns bonds or bond mutual funds, the principal value of the bonds declines as interest rates rise. That’s not a problem if the investor owns individual bonds that are held to maturity. But rising rates can cause permanent losses in a bond fund or if the investor needs to sell an individual bond before maturity.
Fixed deferred annuities and fixed indexed annuities guarantee principal while paying interest. Also, the interest rates credited to the annuity accounts are likely to rise each year as market rates rise.
It’s easy to point to the demise of the fiduciary rule regulations as the reason annuity sales are increasing. Yet, financial firms were complying with the regulations before they faded away, and reports indicate that they’re largely keeping the new procedures in place.
It’s more likely that people are buying more annuities because they are the best way to earn guaranteed lifetime income, and the recent rise in interest rates allows them to generate a reasonable level of income.