The double whammy of continuing low interest rates and the aging population has made it increasingly difficult for insurers to keep up the rates of return on their annuities products. But, some financial advisors say, despite the shrinking payouts, annuities are in greater demand today than ever before.
Volatile investment markets have clients turning to annuities as a means of securing their retirement income, as they can’t rely on their equities investments, says Martin Reeves, assistant vice president of fixed annuity business with Toronto-based Sun Life Financial Inc. in Waterloo, Ont.
“With all the uncertainty in the market and the economy, [clients] still place a high priority on a guaranteed level of income that is risk-free,” Reeves says. “They still need a guaranteed minimum level of income in retirement, so that they can always buy groceries, pay rent and heating bills.”
Annuities are the only type of product on the market that can provide security on a lifetime basis, adds Asher Tward, vice president, estate planning, with Toronto-based TriDelta Financial Partners Inc.: “For clients who are worried about outliving their retirement income, annuities guard against that.”
Typically, the amount of an annuity payment — on a monthly or annual basis — is correlated to the yield the insurer earns on its investment capital pool, which includes products such as 10- and 30-year Government of Canada bonds. When the yield on bonds drops, so does the amount the insurer can offer a client buying a lifelong income stream, such as an annuity.
Since the downturn of 2008, which marked the beginning of the current period of low interest rates, payments from annuities have declined.
For example, a male client buying a Sun Life Assurance Co. single-rate annuity on Jan. 9, 2012, with a premium of $100,000 and a guarantee period of 15 years would expect to receive annuity payments of $503.46 a month starting at age 65. However, if that client had purchased the same product on May 30, 2002, he would receive $659.91 a month starting at age 65.
The outlook for annuities had suffered a blow this past September when the U.S. federal government unveiled Operation Twist, a program under which the feds will sell US$400 billion in short-term treasury bills from October 2011 to June 2012 in exchange for long-term government bonds. The initiative will result in the U.S. government driving up the demand for — and price of — long-term bonds. As these prices rise, the interest yield on those products will fall and, in effect, make long-term borrowing cheaper.
In turn, that will put further pressure on annuity payments, as insurers suffer declining yields on their investment assets, says Peter Wouters, director, tax and estate planning and retail insurance products and marketing, with Kingston, Ont.-based Empire Life Insurance Co.: “As Operation Twist unravels, payments will continue to hurt.”
Rather than continuing to shrink the payouts on variable annuities, Sun Life announced in December that it would stop selling those products south of the border.
Longevity risk has also added to the trouble insurers are facing with annuities. Clients who purchased annuities during periods when interest rates were at levels much higher than today’s — such as in the mid-1990s — are also living longer.
Thus, insurers have been forced to continue making payments beyond what their actuarial assumptions accounted for and doing so at a time when interest rates are much lower than anticipated.
But, from a client’s perspective, annuities have many characteristics — in addition to guaranteed payouts — that are appealing.
For instance, annuity payments are eligible for income-splitting. For couples, the partner in the higher marginal tax bracket can assign some of his or her annuity income to the partner in the lower bracket. This will result in a lower combined tax bill.
Also, some types of annuities offer an element of tax relief. With a prescribed annuity — purchased with non-registered monies — a levelled tax is applied to all income payments, even though the earlier payments will have earned higher interest. Says Reeves: “This allows a client to defer some of the taxes that he or she should have paid earlier on.”
Another feature clients usually add to their annuities is a guarantee period. The guarantee period ensures that if the annuitant suddenly dies, his or her estate will continue to receive payments for a period of time — typically, 15 years.
Some insurers have enhanced some features of their annuity products to boost their appeal. Sun Life, for instance, has extended the deferral period — the amount of time between the annuity purchase date and the date at which annuity payments begin — on some annuities. “The longer the income is deferred,” Reeves says, “the more interest can accumulate within the policy and the higher the payouts will be at a later date.”
Other insurers, such as Toronto-based Manulife Financial Corp., have not revised the features on their single-rate annuity products. Instead, Manulife continues to work to help its clients understand that although annuities add stability to a retirement income plan, they cannot be its main source of income, says Michael Ondercin, assistant vice president, guaranteed investment products.
“When markets are volatile, annuities add to security,” says Ondercin, “but they cannot account for all of the income a client needs in retirement. A proper retirement income plan is much more complex.”
Clients should understand that an annuity bought today will probably provide lower payments than one purchased a few years from now, when interest rates will likely be higher, says Wouters: “If interest rates turn around, so will these payouts.” IE