With population ageing globally till 2050, one would expect the sales of annuities to be experiencing strong growth, if not booming sales. However, this is not the case and this article looks at the reasons why.
Traditionally, market-linked annuities, also known as variable annuities, have been used as a way for individuals to fund their retirement. These instruments provide tax advantages and contributions are unlimited — two aspects that have made variable annuities attractive for some as they plan for the future.
And yet sales of these market-linked annuities are declining in the U.S. market. So far in 2022, variable annuities have performed poorly, and leading providers have reported significant slumps. Lincoln National Corp, for example, reported a fall of 15.8% in total sales for Q2 of 2022, largely due to the variable annuity decline.
Why is this? Well, while variable annuities have been perceived
as attractive options for retirement planning, they are far from perfect. For
instance, the product itself is inflexible. You won’t be able to withdraw any
of your committed capital following the purchase of an annuity once the initial (short) surrender period has expired.
Annuities can also be very poor value for money, providing substandard returns for investors, particularly in poor economic conditions such as a low interest rate environment or volatile investment markets. If interest rates fall, for example, the capital component of annuity returns falls along with them. Equally, if the equities markets decline, the market-linked or investment component of annuity returns falls along with them. This makes annuities and guaranteed income investment products unsuitable for low-interest rate environments — while the monetary amount of the return may stay the same or even increase, the return in real terms may be low.
The same is true when bond rates and bond yields are low. This is because bonds tend to be important components within fixed investment products. If bond prices decline — like they have been recently — this is bad news for annuity investors, essentially putting paid to the long-held belief that bonds represent a reliable investment pathway.
Perhaps one of the key factors behind the decline in variable annuity sales are the low-risk alternatives that are now available to investors. Other investment products are growing in popularity while variable annuities fall away — products that started with the US Managed Funds model, offering better returns without significantly increasing risk exposure.
Exchange-traded funds (ETFs) are the latest such alternative. These investment instruments have been rapidly gathering pace in recent years, basically offering a “set and forget” low-cost approach for those who are not so keen on managing their own investments. ETFs are a form of derivative, offering relatively low cost investments that are passively-managed, being tied to an underlying asset or basket of assets to a market index or another asset.
Users now have an increasing range of choices when it comes to ETFs — choices that cover the type of asset and asset basket, as well as the indexes and markets the fund is tied to. Hedging is also possible through long and short ETFs, further boosting the flexibility of the portfolio. This is why many insurance carriers now offer “Buffered ETFs” as a simplified form of the structured investment product, with index-linked market upside returns alongside capital downside protections. While these unilateral products do offer some protection, they rely on rising markets in order to deliver returns.
Building on this, we predict that insurance carriers will soon begin to offer fully structured products, or structured notes, to retiree customers and those saving for retirement. The key advantage of these products will be their adaptability to market conditions. In other words, these will not be unilateral or uni-directional products and can, instead, achieve returns whether the market is rising or falling.
These products can be designed and structured in a variety of different ways, and we expect to see increasing diversity in the options available to investors. Fintech firms like Stropro in the Australian market (www.stropro.com) and Halo Investing in the U.S. (www.haloinvesting.com)
are already working to democratize these products by making them available via their digital platforms to retail investors and self-managed
retirement/superannuation funds, rather than ringfencing them for high net worth investors, private banking clients, family offices who are clients of investment banks and professional investors . Retail investors can select the level of returns they want and the product guarantees and level of capital protections they wish to benefit from, and Stropro or Halo can develop or curate a structured product around these basic investment parameters.
With a more granular nature than traditional forms of investment, these structured products provide both increased flexibility and opportunity. For example, investments in financial services and property assets tend to perform well when interest rates are rising, while utilities and precious metal commodities provide returns even in broadly negative market conditions. When market conditions shift — like they are currently in the face of high inflation, low but rising interest rates and market volatility — retail investors and investment managers can pivot far more
easily to more defensive positions in order to protect their clients.
Investors planning for retirement will be able to connect with a number of different advantages when they choose structured notes.
The product guarantees vary between product issuers, but can protect the investor’s income, providing a defence against sequencing and longevity risks for retirees. Meanwhile, capital protection guarantees can be used to manage and defend against market volatility.
The investment provider or product issuer will build the investment product in response to the investor’s specific needs. This means expected returns and risk exposure are clearly defined and fully transparent.
With a structured note, investors can achieve returns whether the market is in a bull or a bear cycle. This is because the instrument is not tied to a specific market but is instead a derivative, drawing value from a diverse range of indirect sources which can be differently correlated or even uncorrelated, to market performance on an underlying asset.
Structured notes can be delivered as a direct or actively managed product, a capital-protected product, a fixed coupon note, or a product based on quantitative/algorithm strategies or trend/momentum strategies.
All of this means structured products essentially transform risk into defined financial outcomes, drawing upon derivatives rather than direct investments in specific assets and markets. In turn, they represent a viable alternative for retirees looking to protect their income for the future and an important part of a developing retirement strategy. There are caveats of course. There will generally be a capital lock-in requirement for at least the first year, and potentially up to seven years, and this lack of liquidity will need to be taken into account. However, these products still provide more flexibility than the more traditional annuity option.
At Futureproof, we are working to provide investors and retirees with a more effective alternative as they plan for the future. As well as working on the Equity Preservation Mortgage™ — an instrument designed to provide fit-for-purpose retirement funding — we have invested in Stropro as our structured specialists and product partner for the AUS market. This enables us to extend the benefits of income guarantees and capital protections to retirees who use take out our Equity Preservation
Mortgage™, diversifying its underlying asset mix alongside more traditional risk-free and low risk but higher-yield asset classes.