Garth Bernard, FSA, MAAA, is Vice President in the Retirement Strategies Group at MetLife. He is a staunch and articulate advocate of immediate annuities and he holds strong views on why these products have not been used more extensively.
Macchia: Garth, although immediate annuities provide income-generation which the consumer cannot outlive, they still represent only a small percentage of overall annuity sales. Why is this so?
Bernard: I think we first have to beak it down into what are the things that advisors have pre-conceived notions about, and what are the things that consumers may have misconceptions about. I think the issue really comes down to the advisor having preconceived notions about income annuities. Because, when you look at the consumer’s actions you see that the consumer follows the advice of someone that they trust. So, if that trusted advisor does not recommend an income annuity, or, in fact, suggests that an income annuity not be used, then obviously the consumer is going to walk away with a similar perception.
So I suggest that change really starts with educating the advisor on dealing with some of these preconceptions. Some of those would include- in fact, the first one is always lack of liquidity. But, to me, that is a notion that is based in the accumulation paradigm because the real question is, what is more critical when you get to the distribution phase? Is it control of assets? Or, is it reliability of income? The answer is to not jump to an obvious conclusion. Let me put it in perspective. Here stands Garth who is now 85 years old. He’s run out of assets so he only has Social Security to rely upon now. But, guess what? He started off with a million dollars and he was in control of his assets the whole time! Wouldn’t that be ironic?
This is exactly the issue advisors face when they project the accumulation paradigm into the distribution phase and maintain their focus on this need to control assets. The other thing that’s at play, to be frank about it, is compensation. In fact, you and I know that advisors refer to annuitization as “annuicide.” But when you move into the distribution it’s different. Let’s forget about annuitization, let’s look at the reality. If advisors were getting paid under the basis of assets under management- asset trails- they would already be facing a declining compensation pattern because the client is using those assets under management. The question is how long it would take to decline. Advisors are not looking at a level or increasing amounts of trail income in the distribution phase. So they have to rethink all of the notions that were familiar to them in the accumulation phase and start re-looking at them with a new pair of eyes. And the insurance industry needs to generate new compensation patterns including income trails. When this happens advisors will be much more open to rethinking the value of income annuities. When advisors start converting their asset book over to an income book, as their clients age and transition into retirement, they could get paid on income. And that way, even if the assets disappear, the income doesn’t. In fact, the income is very clear and present.
Macchia: What about advisors who say that, strategically, annuitizing assets when interest rates are relatively low is akin to locking in below market levels of income? Do you give any credence to that objection?
Bernard: Well, they may have a point if you think of this as allocating most of your assets to this one product. In other words, if you were annuitizing 100% of your portfolio, that would be a valid concern. But no one would ever want to put all of their eggs in one basket. Secondly, even when interest rates are low – like today – if advisors actually look at the numbers, they would find that a 65 year old will receive an 8% income stream relative to the deposit. That’s still substantially higher than they could otherwise sustain in a pure investment vehicle – and that’s reliable income.
What do investment advisors typically advise when they use pure investment vehicles? The withdrawal range tends to run from about 3% to as high as 6%. Again, we’re talking about an income annuity even in a low interest rate environment starting at around 8% for age 65. The rate goes up for older ages. So I don’t agree that locking in the income at low rates doesn’t make sense. For a portion of your assets, it could make a lot of sense. If you look at some of the research that has been done, for example by Peng Chen of Ibbotson and Moshe Milevsky, they wrote a landmark research paper which led to what I call Ibbottson’s income allocation model, where they demonstrated that the only way to reach the efficient frontier in the distribution phase, the only way to maximize income for a given investment risk tolerance and legacy requirement is to allocate a portion of your assets to an income annuity.
Macchia: So your point is that the efficacy of income annuities in income distribution planning is already academically proven and beyond reproach.
Bernard: It’s academically proven, and it’s unmatched.
Macchia: So the real issue is that the industry is facing more of a marketing challenge?
Bernard: It’s definitely a marketing challenge and it starts with educating advisors, getting them over their preconceived notions. Income annuities, because they provide unmatched leverage, allow you to do more with less. Therefore, you’re more likely to have assets left over to meet other retirement needs after you’ve taken acre of the income goals. So, including income annuities in the portfolio is likely to provide a better solution for the client in terms of meeting the broad retirement needs.
Macchia: What about what the industry needs to do?
Bernard: I think that the industry simply needs to have the courage to step up to the plate and start telling the income annuity story. Because consumers get it. Think about it. We know that they do due to their reactions to Social Security and employer sponsored DB plans when they feel those programs are threatened: “Don’t cut my Social Security benefits!” When DB plans are frozen or taken away, people feel that their rights have been violated, they feel violated. So that’s how we know that consumers get it. Perhaps it goes beyond having courage – if we don’t, someone else could try to step up to the plate and take the franchise from us. They could try to take the mantle from us.
In fact, we’re not really wearing the mantle and we should be, and if we don’t wear it someone could walk up to us and say, “Give me that! I’ll proudly wear that mantle because it fits!” It’s already started. In my remarks at the recent NAVA Marketing Conference I pointed out that one of the executives at Mellon Bank had written a paper for the CFA Journal that says the investment world should create a mortality pool. Wouldn’t it be a crying shame if the industry, which legally owns the mortality pooling franchise, refused to have the courage to speak about something that only they can deliver and something that consumers need, fails to adequately educate the insurance advisors about them – only to have somebody come along and rip the rug our from under them. This is a strategic issue for the industry: we have the franchise now – what if it is decided that we shouldn’t have it exclusively?
Macchia: One of the places where I have seen SPIAs become very useful is in combination with other retirement strategies; perhaps in a laddered asset strategy, or combined with a variable annuity, or in a systematic withdrawal portfolio. And that one of the intellectual arguments for combining in this way is that you’re taking a portion of the client’s assets and turning it into absolutely guaranteed retirement income which may allow the client to put an even higher percentage of the remaining assets into more aggressive investments, which over the long term may provide more overall income. Do you subscribe to that?
Bernard: I fully subscribe to the effectiveness of packaging for positioning income annuities in the retirement income solution. In fact, we were talking about some of the more common objections to income annuities. One of the biggest areas of misperception is the area of context. If you go down the path of a product solution, that’s where you end up in knots. The most effective context in which income annuities should be used is in the context of maximizing income and protecting income with a finite set of resources. You cannot solve this retirement problem with a single product. That’s where the packaging notion comes from – that income annuities are most powerful when used in combination with other vehicles including pure investments and deferred annuities. It’s not about a single product, or about having all your money in pure investments, or all of your money in a variable annuity, or all of your money in an income annuity. It’s a combination of those things. That the income annuity should be a part of the overall strategy is not in question. The only question is how much.
Macchia: If the percentage of the total assets allocated to the immediate annuity is so critical to determine, how will advisors be provided the tools they need to assess that?
Bernard: That’s one of the things as insurance companies think about how they address this and step up to the plate, we have to build those tools. It is possible to build those tools, and it is relatively easy to build those tools. The reason that it hasn’t been done to this point is that people haven’t focused on it. I’ll giver you an example. In the accumulation phase, one of the critical questions is how much of your assets should you allocate to stocks and bonds? Just about every provider offers asset allocation models to address this question. They’re ubiquitous.
To do it, you first have to define the problem, understand it, focus on it and build the tool to solve it. The same thing applies here. We can’t just ask the question. We have to help the advisors by providing them the tools, the firepower that provides the answers to those kinds of questions.
Macchia: So is it fair to say that unless and until the industry steps up to the plate, as you describe it, and provides not only those analytical tools but also the communications and marketing tools that advisors truly need, that SPIAs probably are not going be very successful?
Bernard: That’s absolutely correct. That would be true of any product that could potentially assist in financial solutions. Until someone steps up, puts a spotlight on it and delivers what’s necessary- not just the products but the analytical support tools and the communications support tools including education- those products will not be used and recommended in solutions. Advisors won’t know how to do it, or would not be able to do it easily.
Macchia: Is it fair to say that this is an opportune time for one of more life insurance companies to step up and show leadership in this area?
Bernard: It’s high time that they showed not only leadership but courage.
Macchia: Isn’t it true that when the industry introduces products and, from the very first day, doesn’t provide advisors and consumers the correct context in which to view them, namely a real accurate explanation of what the products’ true value is, that we find ourselves in a situation like we have today; some products are under utilized, some products are over utilized, and some products are mis-utilized?
Bernard: Yes, I agree with that. The process of selling….. there may be an expedient method. You always speak to today’s issue at hand. You talk to the consumer about that specific issue, you position the product around the issue and then you deliver that product. But you may not fully articulate to them all of the power of the product and how it can be helpful or appropriately utilized beyond the current stated need. So it really comes down to being able to tell more than just the transactionally-focused story rather than the most expedient way to make the sale. It takes time and it takes effort to tell a bigger story. But that’s just what’s needed for retirement solutions. So it behooves us to find ways to help the advisor tell the entire story, without jeopardizing the ability to close the sale on the immediate need. We have to find ways to tell more powerful, more articulate, more complete stories around the solutions that we can provide.
For example we almost never tell the complete story about deferred annuities. Deferred means later. Annuity means income. But we continue to primarily talk about the accumulation aspect of deferred annuities.
Macchia: Is it fair to say that the insurance industry in comparison, say, to the investment industry has done a poorer job of communicating its inherent value to both advisors and consumers?
Bernard: That’s a tough one. Here’s my take. The investment industry sells “first order” financial instruments and the insurance industry sells risk management financial instruments, or “second order” financial instruments which, almost by definition are more complicated. So, it’s almost as if the investment industry has an advantage in that they have a simpler concept to explain.
Here’s the simple example. The investment industry has to explain “a stock.” The insurance industry has to explain what is analogous to “an option on a stock.” “Stock options” are inherently more complex than “stocks.” This makes it even more critical that the insurance industry find ways to communicate more effectively. We face a bigger challenge and thus need more communication firepower to meet it. In other words, it is more important that the insurance industry be better communicators.
Macchia: How would you like to end this interview?
Bernard: When advisors rethink income annuities and annuitization in the new light, they may come to this realization: “why did we not see this? … it was in front of us the whole time!”
The views and opinions expressed by Mr. Bernard are his own and not those of MetLife Financial or any other entity of individual.