The hot pace of inflation, and the resulting higher interest rates, have changed the retirement income landscape in some important ways. Along with a record 8.7% Social Security cost-of-living increase this year, we’ve also seen much-improved rates of return on safe fixed income products such as certificates of deposit.
But the shifting economic scene also has had a notable impact on one often-overlooked product area: annuities.
Higher interest rates and market volatility helped drive a record increase in annuity sales in 2022. Total sales surged to $310.6 billion, 22% higher than 2021 and 17% higher than the previous record level set in 2008, according to LIMRA.
“It was a very unique year in the individual annuity market,” said Todd Giesing, assistant vice president of LIMRA annuity research.”We saw interest rates rise very quickly during the year, which helps sales of all annuity products. At the same time, equity markets saw a lot of stress, so investors were looking for protection.”
The increased pace of annuity sales could continue if interest rates remain high and equity markets remain volatile.
Along with market conditions, demographic trends also have contributed to the growth in annuity sales, Giesing notes. “We have more people who are near or at retirement ages, and people tend to get more conservative with their investments as retirement approaches.” But the pandemic also played a role, he says, by boosting the number of people entering retirement involuntarily.
In last month’s column, I noted that most Americans underestimate longevity risk. I recommended focusing on Social Security optimization and portfolio drawdown strategies with clients—an approach that I think should be primary, for reasons I'll discuss below.
But growing worry about longevity and lifetime income also could be a driver of the surge in annuity sales.
A recent LIMRA survey found declining confidence among pre-retirees that they will receive enough income to meet their living expenses. Just 44% expect income from Social Security, traditional defined benefit pensions or annuities will be sufficient; that’s down from a peak of 58% in 2017. (LIMRA surveyed current and future retirees aged 40 to 85 with at least $100,000 in household investable assets.)
Last year, the major standout category was fixed rate deferred annuities, which provide a CD-like guaranteed return for maturities ranging from three to 10 years. Sales more than doubled in 2022 to $112.1 billion - and fourth quarter sales were a whopping 241% ahead of the comparable 2021 fourth quarter. Fixed indexed annuities, which add downside protection, also had a record quarter and year.
Higher interest rates help insurance companies to earn more on their own portfolios, and they are able to pass the higher returns to buyers in the form of greater payout rates. At the peak of the pandemic, fixed rate deferred payout rates averaged around one percent, Geising notes, but had jumped to nearly 4% at the end of last year. And those are just the averages - some of the more competitive products were topping 5% last year, he notes.
Where are the sales coming from?
Rollovers from workplace retirement plans into Individual Retirement Accounts are roughly half of the new business, LIMRA statistics show.
Most annuities are still sold on commission. But fee-based sales, typically made through Registered Investment Advisors, are a trend worth watching. Currently, fee-based annuity sales are a small segment of overall annuity sales - less than five% according to LIMRA.
DPL Financial Partners has played a leading role in developing this market, building out a platform that connects insurance carriers with advisors. The company aims to offer low-cost annuity products without the bells and whistles often found in commission-sold products, and which can make them expensive and difficult for clients to understand.
DPL launched five years ago with six insurance carriers and 15 products—today more than 20 carriers are on the platform selling 70 products. David Lau, founder and CEO of DPL, says the company crossed the $1 billion mark in sales last year, and he expects that to double in 2023. DPL has a membership model for RIAs, charging anywhere from $1,000 to $5,000 annually; roughly 6,000 advisors have joined.
“There have been massive improvements in the availability of products that RIAs can use in client portfolios,” says Lau. Typically, advisers are using the platform to replace fixed income assets.
“I like to say that the root of all evil with annuities is the commission,” he adds. “It literally is the cause of every problem you might have with annuities - surrender periods, bad sales, practices, complexity. When you eliminate that, you’ve got a great structure.”
Still Primary: Social Security Optimization
My suspicion is that most RIAs will look to optimize clients’ Social Security benefits before considering an annuity—as they should. Social Security remains the best type of annuity income you can buy—the word “buy” refers to the cost of meeting living expenses while you wait to claim. That purchase can be made from wage income if your client continues to work, or from portfolio drawdowns - which can be a good strategy.
Delayed claiming is an especially good deal for women because the percentage increases in benefits are the same for both genders. That’s not true for annuities (or long-term care insurance, for that matter), which are priced differently for men and women based on their expected longevity. This means that most women will receive a comparatively larger lifetime benefit by delaying their claim.
Moreover, the extra benefits that come from delaying Social Security filings are actuarially fair, in that no extra cost is borne by the system due to participants’ claiming the benefit at different ages. Social Security’s annuity “pricing” also benefits from the system’s efficiency—there are no marketing, management or risk-bearing costs.
Oh, and by the way—automatic inflation protection is built in at no extra charge—as we were reminded by that huge 8.7% Social Security cost-of-living increase this year.
Mark Miller is a journalist and author who writes about trends in retirement and aging. He is a columnist for Reuters and also contributes to Morningstar and the AARP magazine.