The Real Story on Group Variable Annuities
by Mark Hackl

More than ever, employers are looking for a retirement savings vehicle that will give employees ample opportunities for long-term growth through quality investment options. The retirement landscape is changing. The Baby Boomers are coming; people are living longer; the long-term viability of the Social Security program is in question; the number of defined benefit plans is dwindling; and healthcare costs are soaring for all Americans -- the elderly in particular. The Pension Protection Act of 2006 will be another catalyst to make defined contribution plans the primary retirement vehicle for most Americans.
The group variable annuity is one of the most com-monly used investment vehicles for retirement plans, particularly for smaller-sized employer groups. They provide significant flexibility for the sponsoring employer.
      Not all annuities are created equal, so it is important to select the appropriate annuity for a company’s plan. Many claim that group variable annuities are not a good option for employer-sponsored retirement plans. To the contrary, the group variable annuity is often a superior funding vehicle to meet the needs of the employer and employees with respect to their defined contribution pension plan.

Myth Versus Fact

      Myth #1: Annuities offer no additional benefits to retirement plans because employees already enjoy tax deferral in their qualified plan.
Fact: All employer-sponsored retirement plan funding options offer tax deferral benefits, including annuities.
      Myth #2: Annuities are expensive, costing between 1% and 2% on top of the mutual fund expenses.
      Fact: The reference is typically to a mor-tality & expense charge. Some group variable annuities incorporate little, if any, mortality & expense charge. The mortality contingencies in the current generation of group var--i-able annuity contracts are not significant.
      Most group variable annu-i-ties do charge an asset fee, which covers the cost of the -insurance company’s services, such as technical assistance, Web access, investment education, plan-required recordkeeping, participant recordkeeping, and expenses associated with the sale and distribution of the product. Annuity pricing can generally be tailored to each plan and the asset charges are usually below 1%. Asset charges are not inherently expensive or inappropriate; they are merely a cost-shifting mechanism from employer to employee.
      We would not have products that charged an asset charge if we were all fortunate enough to have an employer that paid for all costs of our defined contribution retirement plan. The employer would cut a check for all costs each year. Many small employers can only afford to offer a retirement plan if the costs are shared with employees. The employee cost share portion is usually charged as an asset charge in the group annuity context.
      Myth #3: All annuities provide death benefits, which is an expensive way to obtain life insurance.
      Fact: Most group variable annuities in the market do not contain a death benefit, and hence, have no risk charge or mortality & expense for this feature.
      Myth #4: The fund lineups of variable annuities are often poorly constructed and contain the insurer’s own inferior funds.
      Fact: Not all insurers manufacture their own funds and these funds are not inherently inferior. Many insurance companies have mutual fund subsidiaries that manage the money for the insurer’s proprietary mutual fund complex.
The insurance industry was the first to pioneer a multiple manager product wrapped in an annuity contract. It permits easy and efficient movement among different families of funds. Products from mutual fund companies have often contained a requirement for significant utilization of the fund company’s funds. Many still have this requirement. Annuities feature diverse and carefully selected lineups of investment options from several of the most well-known and well-respected fund managers.

Additional Facts

Distribution systems have relied on the agent, broker, or financial advisor for access to the employer. This intermediary is invaluable in giving the employer advice on plan design, vendor selection, enrollment support, and ongoing plan operations, particularly in the small case group market. This intermediary-based distribution has costs, which are built into the product expense structure. The advisor’s compensation and the resulting contract pricing can be tailored to meet the advisor requirements based on the level of service provided to the employer. It’s a very flexible product platform.
      Group variable annuities often have an interest-rate bearing account with guarantees provided by the insurance company as one of the investment choices. This option is often called a “guaranteed account” or a “fixed account.” Of course, the guarantee is only as good as the insurer, so it is important to know the financial health of the insurance company offering the group variable annuity. No other investment option that’s typically provided in a defined contribution account can offer a guaranteed rate of return.
      Many group variable annuities are not registered securities with the Securities and Exchange Commission. But the annuity, itself, is not required to have a prospectus or be sold with one. This offers significant savings over other types of funding vehicles. But the group variable annuity world is not unregulated. Group variable annuities are filed with the state insurance departments for approval. All underlying mutual fund options in the separate accounts have prospectuses. It can result in expense savings versus other available funding options.
      We will soon embark on a period of unprecedented pension spending as the Baby Boomers spend their nest eggs. The risk of outliving their nest egg will be at the top of the Baby Boomer’s list of concerns. Those who choose a systematic withdrawal program or construct a laddered bond portfolio or any other structured payout option will have no protection against living too long. Annuitization can provide this protection. An annuity provides a guaranteed income stream for a lifetime.
Innovative product solutions blend the accumulation features of the group variable annuity contract, the downside investment protection in the last several years before retirement, and lifetime income features with access to the account value for unexpected financial needs. Only annuities can provide his kind of protection and insurance.
      The Baby Boomers have changed society at every turn. They will also revolutionize the way we think about retirement; the way we live our retirement; and the way we finance retirement. The next five years will be a period of unprecedented product innovation. Annuities are very well positioned to provide the guarantees and assurances for a secure financial retirement plan.
As with other employee benefits, the group worksite is an efficient and cost effective means of delivering these benefits. The future looks bright for group variable annuities that link the flexibility of a group variable annuity with respect to investments; service and price; the guarantees that can be offered in an insurance contract, such as fixed accounts and longevity protection; and the efficiency of worksite delivery.
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Mark Hackl is vice president of Defined Contribution Pricing and Product Development for Lincoln Employer Markets. He is a graduate of Eastern Illinois University with a degree in Mathematics. He is a Fellow of the Society of Actuaries and a member of the American Academy of Actuaries. He is a registered representative with Lincoln Financial Distributors, Inc.
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Lincoln Financial Distributors Inc. (LFD) is the wholesale distribution organization of Lincoln Financial Group. Lincoln Financial Group is the marketing name for Lincoln National Corporation and its affiliates.