Higher Interest Rates Fuel Retirement Annuities
When the yield on the 10-year U.S. Treasury note recently peaked a few basis points above 3%, for many market observers, a psychological barrier had been breached. That closely watched benchmark bond hadn't exceeded 3% since July 2011.
"That's a pretty significant level," says Frank O'Connor of the Insured Retirement Institute.
Higher interest rates, of course, mean higher payout rates on annuities. For example, on Jan. 1, the annual payout on a $100,000 single premium immediate annuity for a 65-year-old woman issued by Principal Financial Group was $5,573. By May 15, it has risen by 5.1%, to $5,856. And the same annuity issued to a 70-year-old woman rose by 5.6%, to $6,473, according to the company.
But should advisers expect greater investor appetite for annuities? "You bet," says Sarah Wiener, assistant vice president of retirement at Principal. But the sales outlook has more variables than interest rates, she adds.
The link between prevailing interest rates on the kinds of high-quality bonds that insurance companies maintain in their portfolios and single premium fixed immediate annuity payout rates is perhaps most clearly evident because there are fewer internal moving parts. However, SPIAs have had traditionally a low market share relative to others in recent years, according to Wiener.
"The payout has to be high enough that people are comfortable enough with the fact that the decision [to annuitize] is irrevocable," she says. IRI data shows them at about 16% of all categories of fixed annuities.
Even so, IRI survey data indicates that fixed immediate annuities' market share has grown by 5% over the past five years. The combined total of all categories of fixed annuities, including deferred fixed annuities, grew by 23% over that period, at the expense of all categories of variable annuities.
But pricing on all annuities is positively impacted by rising interest rates; issuers are able to share with contract holders the benefits of higher-yielding bonds in the portfolios that fund fixed-indexed annuities, variable annuities and guaranteed lifetime withdrawal benefit contracts. "Rising interest rates essentially increase the minimum guaranteed lifetime withdrawal benefit," says O'Connor.
Buffer annuities, a hybrid between variable and indexed annuities, have been the biggest beneficiary of the interest rate/stock market performance environment so far this year.
The contracts that give owners higher upside potential along with some downside risk "are making strides in the marketplace, with consumers and advisers embracing the concept," according to the IRI.
Multiple variables
Other variables play into annuity pricing besides interest rates. For example, higher state-mandated insurance company reserve requirements kicked in at the beginning of the year, based on new actuarial standards that assume higher longevity rates. That added cost has to be passed on to annuity purchasers one way or another.
Another corner of the regulatory landscape that was disruptive to annuity sales - the Department of Labor's fiduciary rule - still created uncertainty, even though the rule was struck down by a federal court. In theory it could live to see another day. The rule would have imposed a fiduciary standard of care for variable annuity sales, but not for fixed annuities.
Stock market performance also impacts annuity payout rates, Wiener says. When equity returns are strong, annuity issuers' capital base is strengthened, which enables carriers to offer higher payouts.
Market volatility's impact
Regardless of payout rates, an uptick in stock market volatility in the short run can whet consumer appetite for annuities of all varieties.
And if volatility coincides with rising interest rates, that's a big plus for annuity sales.
Another factor that augurs well for annuity sales is demographics. "The number of baby boomers moving into retirement with large account balances in defined contribution plans is large and growing," O'Connor says.
And as for bond yield trends, predictions are hazardous at best. Principal Financial's economists' latest prediction for 10-year U.S. Treasury notes calls for yields ending 2018 in the 3%-to-3.25% range.
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