Like any market investment, variable annuities (VA) are extremely time sensitive. However, unlike other investments and safe money products, variable annuities don’t seem to recover well at all when they lose. Even today many retirees and investors haven’t recovered losses in VA products to the levels they were in 2007.
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Many investment professionals often criticize variable annuity contracts, which are saddled with very high fees, mercilessly. They are thought to be expensive, ineffective, complicated and not nimble enough to navigate the challenging times we now live in. Add to this the deadly pro rata system, which is used to calculate guaranteed income and the death benefits, and sadly some clients can become trapped in products that underperform.
In horse racing terms, it wouldn’t be out of order to say variable annuities aren’t good come from behind runners, and once they lose their position they seldom regain it. It is precisely factors like these make it critical to evaluate any variable annuity contract you may have or are considering for the future. Like all investments, there comes a time to hold them and definite reasons to fold them! If you don’t it may become financially unfeasible to change, and you may become trapped. In this mode you may lose precious principal and deplete the death benefit you will eventually leave to your love ones.
A Huge Question of Timing
If you owned a variable annuity contract in 1999, you were likely pleased at your prior year’s performance, even though many variable contracts underperformed most mutual funds during this time. Twelve years later, however, the story was much different. Many of these same variable contracts were floundering below their 1999 levels. They had endured a crippling loss and never regained it all. Meanwhile, the regular market indexes and safer vehicles climbed back above their 1999 levels.
Even more problematic, many variable annuity owners who took income from these products while the markets were tanking saw their principal drop to insignificant levels, and they couldn’t take advantage when the bull market began anew. There were thousands of complaints to the SEC filed against variable products, especially prior to 2005.
In response to falling sales, and the market debacle of 2000-2002, the variable annuity industry added so called, “guarantee features.” These guarantees, assured contract holders that they would be able to take 5 to 6% of the amount they had originally put into the contracts yearly. Usually, this was for life, regardless of a declining overall balance in your account.
There was also a death benefit of what you originally put in at least, which would be paid regardless of market losses. Plus, if one wanted full restitution of their decimated principal, they could at some point annuitize the contract over a period of years. That’s where you’ll never get your principal back in a lump sum but you can get a check every year.
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But is this a good deal? Most say no way, and the guarantee wears thin compared to real guarantees of no loss of principal ever and getting your money back in a lump sum. But again, to be fair, a lot of this is a question of timing, and this factor is perhaps the most important for variable annuities.
For instance, if a policyholder purchased his or her contract in the midst of a strong bull market then it would appear these contracts really do well. If however, they purchased at the beginning of a bear market, or, during their ownership they entered a severe bear market, the performance of a typical variable annuity frequently becomes paltry and stagnant.
As one ex-variable annuity insurance executive with Pacific Life, Jacob Dinan stated, “The insurance companies are just not set up to manage their variable annuity portfolios to the extent really needed when things turn sour or go flat… That’s why they were crushed in 2000 and again in 2008.” These drops have actually put some variable companies under great duress and to compensate, some have increased fees by charging the maximum amount allowed by contract. Likewise, they raised the fees on new contracts and lowered the percentage you could take out per year on the guaranteed income side.
The problem with the pro rata calculation is that overtime, the principal death benefit and guaranteed income balances, can erode more quickly. They can even fall to the point that neither the contract holders nor their heirs can get a substantial lump sum from the contract. More insidious is that contract holders may eventually be forced to annuitize the contract, forfeiting all control and all the potential earning power of their monies.
For the above reasons I believe variable annuities are not optimum market vehicles for growth or the best option for principal protection and income. I think a far better strategy, is to keep things separate, simple, and clean. In my view the average retiree is much smarter if they go big with guaranteed monies in high rated bonds, indexed annuities, and some cash. That should secure your retirement no matter what. After that, you can be a little more aggressive using actively managed portfolios that offer everything from dividend paying stocks to exchange traded funds. Overall, this is a safer, less confusing, and more flexible approach that avoids the variable annuity’s main dilemma: they only do well in the best of times. This being the case, it is not unkind to always remember that variable annuities are in many ways, fair-weather products whose benefits tend to disappear very quickly in declining, flat or mediocre markets.
For the variable annuity, one must consider the the issues of timing, a track record of limited performance, high fees, pro-rata deductions and the market devastations of 2000 and 2007. All this history makes it critical that anyone in one of these contracts now should assess them thoroughly and be ready to adjust and change accordingly if they can. Because if they don’t, they might as well stop calling their contracts variable annuities and substitute the phrase “Voluntary Annuitization Vehicles.” Why? Because that’s what’s happening, people are turning over their principal and all the lifetime earning power of their money just for the option to do what most planners say never do! Annuitize!