Retirees who thought buying an annuity was the last investment decision they’d ever have to make are having to go back to the calculators one more time.
The Hartford is the latest annuity carrier to offer the customers it fought hard to capture incentives to take their money and go home.
It turns out years of volatile markets and the lowest interest rates in history have turned these once-lucrative contracts into more liability than they’re worth.
Anatomy of a buyback
The Hartford slammed the brake on new variable annuity sales back in April as it unwound its life insurance business.
“The insurance companies invested typically in bonds,” explains Edwin Lichtig of California consulting firm Pension Income, LLC.
“If interest rates go up, the value of bonds goes down, which may reduce or even eliminate their financial cushion. And interest rates have nowhere to go but up. That’s a risk they’re not prepared to take.”
The problem is the optional Life Income Benefit rider that promised retirees who signed up for it at least 5% a year for the rest of their lives.
When the market was doing well, that innocent-looking add-on earned the Hartford a cozy 0.75% annual surcharge in exchange for guaranteeing a level of income well below what the underlying investments were earning.
Now that 5% has become a pipe dream, the profit center has the potential to cost the company dearly, which is why they’re offering people a lot more than the contracts are currently worth to take their cash and walk away.
“We are paying a premium above the current account value,” says Barbara Bombara, who’s running the buyback for the Hartford. “When we look at the offer that we’re making, we do think this will be attractive.”
Anyone who wants to surrender their Lifetime Income Benefit annuity can do so with no penalty and get the full surrender value plus up to 20% of the base on which the Hartford calculates annual payments.
A way for the sick to cash out
I’m no insurance agent and as you know, annuities can be insanely complicated.
Still, for most, taking the offer should translate into a one-time lump sum payment well above what their account is currently worth.
The question is whether the short-term bonus is worth giving up the long-term guarantee.
On the surface, you’d might as well stay where you are if you don’t need the cash right now and don’t think you’ll be able to earn better than 5% anywhere else over the rest of your life.
Age and health also play a huge role. The average Hartford annuity holder is 67 years old, which statistically entails another 15 years of payments for men and 18 years for women.
If that hypothetical client needed to tap the guarantee every year, they’d be able to sleep well knowing they would get a total of 75% to 90% of their principal out in 5% installments no matter how poorly the market performs.
Older-than-average retirees or those with medical problems that might impair their lifespan probably have less time left and so the remaining lifetime value of the guarantee is lower.
But in general, unless you don’t expect to need the guarantee more than another four years, the 20% bonus isn’t going to make up for the security the Hartford is asking you to give up.
And if you’re younger, you earn a 10% tax penalty for taking the lump sum before age 59-1/2, so the immediate value of the offer is halved right away.
Liquidity for the creative
On the other hand, if you can locate a richer income stream — maybe something “alternative” that can deliver more than either stocks or bonds — the 20% bonus can be a nice kicker.
Plenty of people are buying guaranteed pension income from government and military retirees, for example, at an imputed yield of 6%.
“Think of this as similar to what Hartford is doing with its annuity holders,” says Edwin Lichtig, who runs Pension Income, LLC.
“The difference is that instead of having your retirement income stream bought out, you’re the one offering someone else a discounted lump sum today in exchange for the future value of their monthly checks down the road.”
Roll the extra 20% into an arrangement like that and you could actually lock in 44% higher income than what the Hartford’s annuity promised.
It may not be a lifetime guarantee, but while the cash is flowing, it’s definitely a lot better than what Treasury bills or even the most sophisticated CD ladder is paying right now.
And to be on the other side of the deal may be the sweetest part of all.
If everyone eligible for the Hartford offer signs up, the company is out maybe $1 billion now, but it also gets to retire a whopping 45% of its net assets at risk — which comes down to a full $3 billion and change.
Taking that potential liability off the books also frees up reserve capital the Hartford needs for other operations like meeting its obligations after Hurricane Sandy.
It’s a win for the carrier.
Whether it’s a win for the annuity holders depends on their situation and their ingenuity, and of course on the markets.
Scott Martin, senior editor, The Trust Advisor