The Annuity Match Game

If so, I don’t blame you. You’re probably familiar with the distracted, faraway look that clients get if you mention annuities or “insurance contracts.” You know that annuities are “sold not bought.” You know the regulatory baggage they carry.

On the other hand, you may also know that annuity manufacturers offer very compelling compensation rates. And not least important, you undoubtedly understand that annuities have an important purpose: They can move financial risk—market risk, longevity risk or the risk of a bear market right before or after retirement—from an investor to an insurer. There’s a reason why Americans put almost $300 billion into them each year.

The key to selling annuities, I’d argue, is to match the right contract with the right client at the right time. If that sounds easy or obvious, it isn’t. No two clients have identical needs, and annuities come in at least five varieties that have little in common but the word “annuity.”

In this article, I’ll describe those five most common types of annuities and suggest the best type of person to sell each of them to and when, ideally, to sell them. In order of sales volume, they are:

Moving up the age scale, you might sell a contract with living benefits (deferral bonuses and lifetime withdrawal benefits) to a 55-year-old near-retiree (1) to establish a rising floor (in contracts with “roll-ups” or deferral bonuses) under the value of a balanced portfolio that they intend to tap for retirement income and (2) to guarantee an income even if the account happens to hit zero before death. Older people buy VAs for the death benefit; it can put a floor under the amount that their beneficiaries will receive when they die.

Making sure a contract is appropriate for your client isn’t just good salesmanship—it’s the law. Under securities regulations, broker/dealers must review their reps’ VA sales to determine their “suitability.” If you exchange a client’s existing VA contract for a new one, for instance, be prepared to explain how the switch helped the client.

Like variable annuities with living benefits, they offer a combination of upside potential and downside protection. VAs, where the investments are mainly equity funds, emphasize upside potential. IAs, which are mainly bond investments, emphasize downside protection.

Lots of IAs were sold in the early 2000s, almost exclusively by insurance producers, after the Fed cut interest rates but before the tax-cut/Iraq war/housing boom kicked in. Then came the lawsuits over the mis-selling of IAs and the Securities and Exchange Commission’s short-lived threat to classify them as securities. That storm has largely passed.

The same folks who buy certificates of deposit (CDs) buy fixed annuities. When the yield curve is steep, fixed annuities tend to outperform CDs. That’s because insurers can get higher rates farther out on the curve, while CDs are limited to the short end of the curve. When the yield curve is flat, going farther out on the curve offers no advantage.

Depending on your client’s attitude toward interest rate risk, you could offer a guaranteed-rate fixed annuity, a nonguaranteed rate annuity (whose initial rate might drop after the first year) or a market-value-adjusted annuity (which offers slightly higher rates but assesses a penalty on withdrawals after a rise in prevailing interest rates).

SPIAs are purchased not as investments but as tools for turning a lump sum into the maximum possible income during retirement. They’re the only annuities that use mortality pooling to enhance the client’s retirement income.

Let me emphasize that SPIAs aren’t investments. If you frame them as investments, their “returns” will look both riskier and paltrier than mutual funds. If positioned as a personal pension or as a hedge against market volatility or outliving one’s savings, they’ll make much more sense to your client.

To sell SPIAs, turn their negatives into positives. SPIAs aren’t liquid, but they’re safe. To the extent that they have no cash value, they offer a larger payout rate. Yes, the client’s monthly income might be fixed. But inflation can be hedged by investing other assets more aggressively.

Retirees whose annual living expenses exceed their income from Social Security and pensions are likely to be receptive to buying an SPIA to cover the income gap. A client who is nervous about dying prematurely and forfeiting any unpaid premium can buy a smaller SPIA or one with 15 years of guaranteed payments.