(U.S. Treasury building, Washington, D.C. Photo credit: AgnosticPreachersKid.)
Annuities enjoyed a strong run in the 1990s as an excellent savings accumulation vehicle, particularly for those above qualified plan savings limits. However, the new millennium has not been so kind to annuities with persistent low interest rates and significant equity market volatility. Annuity interest may soon be resurfacing in the form of payouts this time, instead of accumulation.
If the annuity payouts renaissance happens, many factors will be credited, but July’s Treasury ruling allowing for the conversion of some 401(k) or IRA balances into longevity annuities may be the one push that gets those nearing retirement to think about how to best fund those long-term retirement years.
If you were on vacation in July, here is the short version of what happened. The Treasury Department and the Department of Labor culminated an effort that they started in 2010, when they jointly acknowledged that 401(k)s, though they are an excellent savings vehicle, are not well designed to provide lifetime income. As a result new rules were announced which enable employees to convert the lesser of $125,000 or up to 25% of their 401(k) balances to buy a longevity annuity. Additionally, employees are able make this investment change without worrying about the usual minimum age (70.5) distribution requirements.
Millions of employees will now have access to the opportunities that longevity annuities can provide them for lifetime income, through their employers. Insurers predict that many soon-to-be retirees and retirees between the ages of 62 and 70.5 will realize the advantages of payout annuities and convert some 401(k) or IRA balances. They will now be able to postpone payouts into their 80s and receive “return of premium” guarantees for heirs if they die before they have received all of their payments.
This is good news for employees, but it is also good news for employers, many of which had previously phased out traditional pension plans. Building annuity options into retirement plans helps employers return some of the stability and consistency of pension plans to their retirement options while keeping most of the responsibility and control with the employee.
What does this mean for annuity payouts technology?
Payout capabilities are going to need attention. For years now, since the beginning of Baby Boomer retirements around 2008, payout systems have been strained and increasingly inefficient. Retirees used to opt for a lump sum, relying upon pensions and Social Security for continual retirement income.
With the increased number of Baby Boomers retiring and longer life expectancies for their generation, there has been a rise in Boomers annuitizing to provide long-term income. This group expects a wide variety of annuitized payout options and with the new options, annuity sales are predicted to dramatically increase. According to LIMRA, income annuity sales are likely to double between 2013 and 2018, from $10.5B annually to $21B. The net effect is a double bubble for annuity insurers, with both retirees annuitizing and new payout annuities being purchased within 401(k) plans in record numbers.
The positive momentum of all of this annuity activity is threatened by the fact that both of these trends will tax older payout systems that weren’t built to handle the complexity, flexibility and volume required.
The causes of the strain are inflexible, disconnected systems. Accumulation systems aren’t often connected to payout systems. When a policy is annuitized, it is switched manually from the accumulation system to the payout system. There is a mini-conversion every time someone retires and decides they want to annuitize instead of receiving a lump sum payment. The more people annuitize, the greater the exposure of weaknesses in older payout systems.
In addition to being grossly inefficient, this inflexibility impacts customer service. As individuals have grown comfortable with equity market exposure, many have lamented the fact that they must take their full annuity out of the accumulation phase when they convert. For today’s younger retirees (65-75) who could still have outside income, they may want the ability to annuitize smaller percentages of their policy, while leaving the rest to accumulate for another decade or longer.
Newer payout technologies can better handle these service-oriented requests. They can also handle the conversion from accumulation to payout with ease because the service and payout functionalities are all contained within the same flexible system. Conversions are efficient and simple — often as simple as checking a box on the screen. Rules-based configuration allows companies to provide flexible options and meet what will be an increasing demand for new, more innovative payout products.
The “fringe” benefits of payout technology modernization
This push for new payout technology combined with a single system approach will help annuity providers develop not only better payout options, but also more innovative accumulation vehicles. A modern system will give insurers the ability to develop hybrid and combination products from a library of templates, lowering their risk and improving speed with their configuration capabilities.
In order to prepare for the operational impact of this Treasury ruling, insurers need to pay immediate attention to modernizing their annuity payout system capabilities. With the right annuity systems in place insurers can meet this new annuity challenge with both confidence and speed.