Variable annuities hit middle age going strong

Though some birthdays may be more widely celebrated, the 40th anniversary of the first widely sold variable annuity this May will have its share of grateful party hearties.

Fixed-dollar annuities, believe it or not, have been around for a couple of millenniums. But the variable form, now the favorite retirement investment of millions of Americans, wasn’t devised until the early 1950s, originally to help poorly paid teachers keep up with the cost of living when they retired.

Particularly since the mid-1990s, the still-controversial investment, which blends features of insurance and mutual funds, has boomed. From humble beginnings, U.S. sales of variable annuities have hit almost $100 billion a year.

Annuities are basically insurance policies that pay off over a period of time, rather than all at once. Insurers agree to convert lump sums or money accumulated from regular premium payments into a guaranteed income stream, typically for the life of a retiree. With fixed annuities, the insurer takes on all risk and usually invests that lump sum in conservative investments. Retirees can count on a fixed-dollar amount, no matter how long they live, or whatever happens to the economy.

“What started it off was inflation,” recalls Roy Higgins, former national marketing director, education markets, at Aetna Investment Services Inc., and a member of the Reston, Va. National Association for Variable Annuities Hall of Fame, which honors significant contributors to the industry. From 1942 to 1952, the cost of living rose almost 80%.

Most retirement schemes were defined-benefit plans, in which the employer made the investment decisions and employees received regular fixed payments when they retired. With no inflation adjustment, real income dwindled over time.

Few ordinary wage slaves built up funds for retirement by playing the stock market. Individual retirement accounts wouldn’t come along until 1974.

So retirement planners and academics launched a research crusade. And one influential University of Chicago study supported investing portions of retirement funds in stock to counter inflation.

Variable annuities allow retirees to put some of that lump sum in higher-risk stock funds, bonds and other investments with the hope of getting back more if those investments grow. But this also means that the retiree is taking on risk.

Financial planner John D. Marsh was an early convert. In 1955, he created Variable Annuity Life Insurance Co., or Valic, the first company to offer variable annuities nationwide to the general public.

fought the good fight

He now is considered the father of variable annuities, but with other early promoters, he had to battle investment and insurance companies, as well as the Securities and Exchange Commission.

They wanted the new retirement instruments to be labeled securities, which would require SEC supervision and higher operating costs. Promoters wanted expenses kept low.

In 1959, the Supreme Court sided with Mr. Marsh’s critics, deeming variable securities to be securities.

“So the big thing was: Should we go forward?,” recalls Mr. Higgins, a colleague of Mr. Marsh from the earliest years.

Mr. Marsh was like General Patton: He knew where he was going, and damn it, he was going to get there. Mr. Marsh even named his daughter Valic (she let it be known that she preferred Val).

Mr. Marsh would eventually launch his dream through Aetna’s broad distribution system. By the mid-1990s, increasingly risk-tolerant retirees en masse were ready for the variable annuity.

The annuities still have their critics, though. The assumption that retirees will pay taxes on their annuities at rates lower than those of their working years, or at rates lower than the capital-gains rate on a mutual fund, is no longer true for many.

In addition, no-load mutual funds typically cost less because they don’t carry mortality and expense charges or sales commissions.

But defenders say retirees get their money’s worth for these higher fees. “That controversy is unfair,” says A. Scott Logan, a founder and former president of Wood Logan Associates, a subsidiary of Toronto’s Manulife Financial focused on selling variable annuities. He notes that typical variable annuities end up charging fees about 0.6% above comparable mutual funds.

“But you’re paying for exactly what you get,” he contends, in the way of extra features. Indeed, modern variable annuities provide such life insurance-style assets as death benefits, locked-in floors for payment amounts, ceilings on administrative charges, plus, of course, guaranteed lifetime income.

Joseph McKeever, a partner at Davis & Harman in Washington, who specializes in life-insurance product taxation, questions the tax-rate complaint. “Tax-deferral is a powerful tool; when you apply it to a stream of income, it really works miracles.”

“I think it’s the best product that we sell,” declares Doug Hibbard, vice president of product management and sales at New England Financial in Boston. “I like the tax deferral and I like the fact that you can have a variable payout, depending on the market performance of your underlying funds. I have three variable annuities.”

For his part, John Marsh, who died in 1985, also ate his own cooking: He took a sizable chunk of his own retirement in a variable payout.