A tumbling stock market and higher interest rates are forcing consumers to buy annuities.
According to LIMRA, a trade group for the insurance industry, annuity sales in the third quarter of 2022 approached $80 billion, just beating the $79.4 billion record set in Q2. It’s an impressive 27% increase over last year.
As in 2008, purchasing decisions seem largely driven by concern about stock market volatility and recession possibilities.
If you recall, the S&P 500 stock index officially entered a bear market in June and has remained low since. Due to this, investors holding U.S. bonds, which typically serve as a ballast during bear markets, have lost almost 16% of their assets in the past year.
As the Federal Reserve increases borrowing costs to tame inflation, some economists fear that it may tip the U.S. into a recession if it goes too far. A 50 basis point increase in short-term interest rates was announced by the Federal Reserve in December. Increasing expectations of future hikes by the central bank increased concerns that the economy will slip into recession.
But, that’s been welcome news for annuity sales.
“Continued equity market declines and rising interest rates drove investors to continue seeking protection and purchase fixed-rate deferred and fixed indexed annuities at record levels in the third quarter,” said Todd Giesing, assistant vice president, LIMRA Annuity Research. “Our forecast suggests that protection products will continue to propel growth in the annuity market for the next several years.”
Annuities Had a Record-Breaking 2022
Fixed annuities are especially on a tear.
In the third quarter, LIMRA reported total fixed-rate deferred annuity sales of $29.8 billion, 159% higher than the third quarter of 2021. As noted in the report, this was the best sales quarter for fixed-rate deferred annuities ever recorded.
However, in the third quarter, fixed indexed annuity (FIA) sales reached $21.4 billion, up 25% from the previous quarter. This beat the previous quarterly sales record of $20 billion. For the year-to-date (YTD), FIA sales were $57.4 billion, up 22%.
Even RILA sales rose 13% to $10.5 billion in the third quarter. Sales for RILA were $30.9 billion in the first nine months of 2022, up 9%.
But, that’s not all.
A return to pre-pandemic levels has been achieved by income annuities. During the third quarter, single premium immediate annuity (SPIA) sales were $2.5 billion, an increase of 58% over the previous year. A total of $6.0 billion has been generated by SPIA so far this year, a 28% increase over the same period last year. There were $600 million in deferred income annuity sales in the third quarter, an increase of 18%. Sales at DIA were $1.5 billion, up 3% YTD.
Unfortunately, traditional variable annuity (VA) sales continued to decline. Traditional VA sales dropped 37% to $13.7 billion in the third quarter, the lowest quarterly results since 1995. Sales of traditional VA products totaled $48.5 billion YTD, down 25% from the same period in 2021. In 2022, LIMRA predicts traditional VA sales will fall by more than 20%.
But, will these annuity trends continue into 2023?
How Rising Interest Rates Impact Annuities
Before we answer that question, let’s take a look at how interest rates affect annuities.
For immediate annuities and fixed annuities, interest crediting rates usually rise with interest rates. In general, insurance companies earn more in bond yields when the Federal Reserve raises interest rates. As a result, they can offer their customers higher rates.
It is challenging to make big financial decisions due to constantly changing financial conditions. This makes long-term retirement planning complicated, especially for those with limited financial knowledge.
At the moment, interest rates are on the rise. As a result, debt is becoming more expensive. For example, the cost of getting a mortgage or a personal loan will be higher. On the flip side, annuities, which are low-risk financial products, can yield a higher profit.
Does the Federal Reserve Rate Affect Annuity Interest Rates?
Recently, the Federal Reserve (also known as “the Fed” or “the central bank”) raised interest rates. By doing so, they hope to reduce inflation, which occurs when prices rise.
Are those benchmark interest rates linked to annuity interest crediting rates?
There is a possibility that that rate might affect the interest rates annuity companies offer on their products. However, it doesn’t always have a direct impact.
Long-Term Bonds Determine Annuity Rates
Typically, the company that sold you the annuity invests your funds in very safe investments like corporate and government bonds. During the course of the year, the annuity company pays your annuity interest and keeps the remainder to cover their expenses.
Interest rates are influenced by the bond yield, which is the rate at which bonds return their value. Annuity companies can offer a better interest crediting rate for annuities when bond rates increase because they make more money on their investments.
Federal Reserve Benchmark Rate Doesn’t Affect Long-Term Bond Rates
In addition to investing in long-term bonds, annuity companies are affected most by long-term interest rates on bonds.
Short-term and variable interest rates are affected by the Fed rate. As a result, the rates for bonds annuity companies are most likely to invest in aren’t affected.
There is Still an Effect of Interest Rates on Annuity Rates
Even though Federal Reserve interest rates do not directly affect annuity interest crediting rates, they can still have a general impact. Insurance companies can offer higher interest crediting rates on their annuities when interest rates rise, as bond yields typically do as well.
The higher the interest rate, the more money you earn on your annuity. Whenever you’re ready to retire, you’ll have more wealth in your account as a result of earning interest. In retirement, you can also expect more income if your annuity account value increases.
When interest rates are low, annuity rates typically remain low. As a result, annuitizing reduces your income and earnings. Annuitize simply means to make periodic payments in retirement from your annuity instead of a lump sum.
In short, annuity rates differ from the Fed’s benchmark rate. However, they usually follow one another.
What May Happen to Annuities if Interest Rates Rise
Annuity rates generally rise when the Fed rate goes up. However, the exact effect varies by annuity type. Listed below are the main types of annuities and how interest is credited.
Fixed Annuities
Interest rates have a direct effect on fixed annuities, which are insurance contracts paying out a guaranteed rate. As rates increase, “investors can get a better payout for the same premium,” says Philip Chao, principal at Experiential Wealth in Cabin John, Md.
In contrast, fixed-indexed annuities (FIAs) are based on market indexes, such as the S&P 500, which provide a fixed rate of return. There is usually a limit on losses if the index falls, and the contract holders benefit when the index rises.
However, the amount of index gain that’s credited to the FIA can change. The cap rate, which represents what percentage of index gains are credited to FIAs, can be raised if the insurance company’s general account grows. Interest rates are expected to rise, which will result in insurance companies’ general accounts increasing.
“Shoring up the balance sheet enables insurers to offer more attractive annuities,” explains Karl Wagner III, a partner at Biondo Investment Advisors in Milford, Pa.
This applies to all types of annuities. Eric Henderson, president of Nationwide Annuity in Columbus, Ohio, states: “Rising interest rates allow us to offer increasingly competitive products.”
Chief investment officer Jayson Bronchetti of Lincoln Financial Group, an annuity provider headquartered in Radnor, Pa., adds, “The new money yields of our investment portfolio also increase, which is a positive contributor within the overall annuity rate-setting process.”
Variable Annuities
You can also expect higher crediting rates on registered index-linked annuities (RILAs), a type of variable annuity (VA).
Variable annuities tend to be more correlated with equity markets. The assets of a traditional VA – not the RILA type – are held in subaccounts that resemble mutual funds. In addition to falling equity markets, rising rates will also adversely affect their performance.
“If you absolutely knew that stocks would have a loss, I suppose a fixed annuity would be better [than a variable annuity],” says Wade Pfau, director of the Retirement Income Certified Professional designation program at the American College of Financial Services in King of Prussia, Pa. The exception, he says, is for VAs without a guaranteed living benefit rider, which, for a fee, ensures a separate income payout.
“Rising interest rates will give insurance companies more flexibility to increase payout rates on living benefits,” adds Giesing.
At the same, the future direction of equity markets is impossible to predict. “It sort of depends on whether the rise in bond yields is more or less than the anticipated rise in bond yields that are already priced in,” says Joe Tomlinson, an actuary and financial planner currently based in West Yorkshire, England.
The Inflationary Effect on Annuities
“Inflation can have a real impact,” Giesing told Investment News. “When you think about the cost increases we’re seeing today, it absolutely is hitting the pocketbooks of Americans. You can see it at the grocery store. You can see it at the gas pump. It is everywhere.”
Inflation can have a significant impact on retirement finances even when it is normal. For instance, the Center for Retirement Research at Boston College found that spending for retirees decreases by an average of 12% over 20 years, although that affects people with lower wealth more significantly. According to researchers, retirees spend less due to necessity over time.
“This is a prime time to talk to clients, especially those that are five to 10 years from retirement, about the ability to build protection,” said Kelly LaVigne, vice president of advanced markets and solutions at Allianz Life. “When inflation goes up, it’s very difficult for everyone, but for those on fixed income it’s more difficult.”
As a result of the Fed’s move, fixed annuities, variable annuities with guaranteed benefits, and others can offer more attractive features.
“We know that if inflation goes up, the Fed is going to act. They’re going to increase interest rates … That’s good for the insurance companies as a whole,” LaVigne said.
“You might be able to move a traditional fixed client into a fixed indexed product, simply because it will give them a little bit more opportunity to at least mitigate the risks associated with inflation.”
The use of products that increase payments over time can be helpful, but they are typically less expensive than fixed annuities, he said.
Despite the fact that many people are holding annuities that were bought when guaranteed benefits were at their peak, it is unlikely that VAs will return to pre-crisis levels of optional riders. As interest rates dropped, many insurers regretted offering VAs with very competitive features prior to 2009.
“The days of those income wars or benefit wars are pretty much over,” LaVigne said. As an industry, “we really have learned our lessons from the past.”
In addition, insurers are now interested in buffered annuities – registered index-linked annuities (RILAs), which limit an account’s growth potential while also protecting it from losses. Previously, demand for these products has increased rapidly, driven by market volatility and general uncertainty. In recent years, annuity providers have added RILAs to their product offerings in great numbers.
Unfortunately, LIMRA projects that RILA sales will be flat in 2022 after three years of 30% growth.
What is the Annuity Forecast?
“Rising interest rates will allow insurers to improve crediting rates while protecting the principal investment from equity market volatility, making these products more attractive to investors for the foreseeable future,” noted Giesing. “As a result, LIMRA projects 2022 FIA sales to reach as high as $76 billion and increase each year through 2026.”
Moreover, LIMRA predicts that income annuity sales will increase by more than 10% in 2022 and continue to grow steadily through 2026.
However, a market report from S&P Global has a drastically different outlook.
Because of the high bar set by sales, the momentum annuities have enjoyed in recent years is likely to diminish in the next few years.
“The combination of difficult year-over-year comparisons and increasing distance from the two most compelling growth catalysts the business has experienced in many years — a heightened focus on end-of-life planning amid the pandemic and a favorable federal income tax change — will drag on the pace of expansion,” the report predicts.
In spite of a strong year in 2021, the annuity industry has seen record-breaking sales after the Fed rate hike.
It is also true that rising rates encourage surrenders, which has a negative effect.
“Growth rates in 2022 and into 2023 will be tempered to some extent by rising surrenders as annuitants seek out products with more favorable rates and more attractive features,” according to the report.
Demographic changes and market volatility are also contributing to the industry’s attractive rates. Because of increasingly erratic volatility, consumers are scared away from direct investment in equities.
“We anticipate growth in first-year and single premiums, which serve as a measure of new business production, to more than offset a drop in renewal premiums,” the report says.
Additionally, a key element in growing a business is the injection of private equity cash.
“The impact of these transactions can be viewed in multiple ways,” the analysts wrote. “In the ordinary individual annuity business, for example, the share of gross contract reserves ceded to reinsurers rose to a new high of 18.7% at year-end 2021. It had been less than half of that amount as recently as 2017.”
Are Annuities a Good Investment Right Now?
Considering annuities’ current interest rates, is now the right time to buy?
Yes, it is possible.
You may want to keep in mind that “timing” the market is extremely difficult. But, in the world of insurance, annuities are long-term products. Aside from tax benefits and guaranteed retirement income, they also have steady growth over time. In addition to providing a guaranteed lifetime income, they are a great choice for individuals looking to grow their nest egg.
Ultimately, your financial goals and circumstances will determine whether they’re right for you. Investing in other types of investments, for instance, might be better if you’re looking for short-term growth.
It is currently possible to expect annuity rates fixed between 3.60% and 5.25% for a term of 2 years to ten years. And, that’s pretty solid. So, purchasing an annuity isn’t a bad idea if you’ve maxed out your other retirement contributions. But, don’t be afraid to talk to a financial advisor or other personal finance professional if you’re uncertain.
Getting Started with the Right Annuity
If you have an annuity, rising interest rates could be beneficial.
In general, insurance companies’ bond yields increase as interest rates rise. This means their annuity crediting rates are going up, too. As annuity rates rise, your funds accumulate more quickly, giving you more to enjoy when you retire.
It is particularly important to keep in mind that interest rates have a major impact on immediate annuities and fixed annuities. Fixed-indexed and variable annuities, which are typically tied more closely to the stock market, are less likely to be affected by them.
FAQs
1. What are annuities?
Annuities are contracts between you and an insurance company where you get a fixed income for your lifetime.
An annuity can be bought either once or over time. In the same way, your payout might come as a lump sum or in installments.
2. Why do people buy annuities?
People buy annuities for two main reasons: guaranteed income in retirement and tax-deferred savings. For either reason or both, you might want to consider an annuity.
Guaranteed income.
A lifetime guaranteed income annuity may be a good option for you if you:
- Want to receive a guaranteed lifetime retirement income.
- Need to diversify your retirement portfolio.
- In retirement, you won’t be able to cover your basic living expenses such as food, transportation, healthcare, and housing, with other sources of guaranteed income, such as Social Security.
Tax-deferred savings.
You may be a good candidate for an annuity if you meet the following criteria:
- You’ve maxed out your other tax-advantaged retirement savings options, such as your 401(k) or IRA.
- You’re interested in maximizing your retirement savings with tax advantages.
- It is expected that retirement funds will be withdrawn once you reach age 59 ½. Remember, withdrawing before that may result in tax penalties and other withdrawal fees.
- It is likely that your tax bracket will remain the same in retirement or even lower than it is now.
3. What factors influence annuity income?
Several factors will influence how much income you receive from an annuity.
- Gender. Men usually get higher income annuities due to their lower life expectancies.
- Age. Your income will be lower the younger you are, as you will have a longer life expectancy.
- Features. If you have a lot of guarantees, your income will be lower. The payout rate of an annuity that guarantees an income for a set period of time is lower than one that stops when you die, for example.
- Interest rates. You will receive more income if you purchase your annuity at a time when rates are relatively high. If you purchase multiple annuities over time, you can reduce your risk of buying at the wrong time.
4. Can I lose the principal in an annuity?
Perhaps.
Your principal, or the money you give to the insurer to fund your annuity, is guaranteed with fixed annuities. Also, your initial investment is protected when the market falls with fixed-indexed annuities.
According to the U.S. Securities and Exchange Commission, variable annuities can lose money, including your original investment. This is because the value and returns of a variable annuity are tied to your investment options. As such, you may lose money if those investments fail.
5. How much does an annuity cost?
The amount of money you put in your annuity is up to you. This can range from $10,000 to $1 million or more, depending on the type of annuity you choose.
There are, however, a variety of fees and commissions associated with annuities. It’s usually more expensive to buy complex financial products.
Compared to variable or indexed annuities, fixed annuities have lower costs. This is because fixed annuities pay at a predictable rate and aren’t affected by stock market fluctuations.
