Boom Fades for Variable Annuities

For nearly a decade, variable annuities have been one of the hottest retirement savings products around--both in terms of sales and controversy.

The controversy shows no sign of abating. But sales of variable annuities are plummeting as falling stock markets, increased attention from regulators and a flood of lawsuits by disgruntled annuity owners take their toll.

That’s bad news for insurers that had pinned high hopes for profit on ever-growing sales of the popular retirement savings vehicles, which soared from near obscurity a decade ago to almost $1 trillion in assets last year.

Others cheer the trend. For many financial planners and unhappy investors, the fewer Americans who own variable annuities, the better.

“I detest them,” said Laura Tarbox, a Newport Beach financial planner who thinks variable annuities are suitable only for certain wealthy individuals.

“People are really not told the whole story, and once they realize what they’ve got they say, ‘Oh, my gosh, I want out!’ ”

Don and Julie Propp of Irvine wish they hadn’t purchased variable annuities for their individual retirement accounts four years ago. The Propps say they were misled about the nature and the cost of the annuities.

“What makes me so angry is that it’s really hard for us to get out of [the annuities] without paying a lot of money,” said Julie Propp, 54, a government secretary.

Industry proponents defend variable annuities, saying they are an excellent way to save for retirement--offering investors flexibility, tax deferment and protection of their principal if investors die while the stock market is down.

“Variable annuities have features that no other investment has,” said Tom Connor, general counsel for the National Assn. for Variable Annuities, a trade group.

A variable annuity is a combination of an insurance contract and an investment in which gains can grow tax-deferred. The insurance company selling the annuity guarantees that if the investor dies before withdrawing the money, his or her heirs will receive at least as much as the investor originally contributed--a feature known as a death benefit.

Meanwhile, investors can take advantage of stock market gains. They can allocate their annuity contributions among stocks, bonds or cash using so-called subaccounts that resemble mutual funds. And they can move their money between subaccounts without triggering income or capital gains taxes.

Variable annuities often cost more than comparable mutual funds, however, and usually have surrender charges that can make withdrawing money expensive.

Those disadvantages weren’t much of a deterrent for most of the 1990s, as the stock market soared, baby boomers tucked away more money for retirement and investors found their stock market gains could be protected from taxes in a variable annuity.

Insurance companies discovered variable annuities were good for their bottom lines, as well. Los Angeles-based SunAmerica Inc., which sold its life insurance business to concentrate on annuities in the late 1980s, racked up big profits and saw its shares soar more than 11,000% in the 1990s, making it the best-performing stock on the New York Stock Exchange.

Other insurers quickly followed SunAmerica’s lead, and assets of variable annuities exploded from less than $176 billion in 1991 to a record $973 billion last year, according to the VARDS Report, which tracks industry trends.

Now the tide has turned.

As the stock market has fallen over the last 18 months, so have variable annuity sales. Since peaking in early 2000, the amount of money contributed to variable annuities in the first six months of 2001 fell 21.2% to $57.7 billion, according to LIMRA International, an insurance industry research firm.

The fall is cutting into insurance company profits. On Aug. 7, financial services company Conseco Inc. cut its earnings forecast by more than 10%, blaming the weak stock market’s effect on variable annuity sales, while an analyst downgraded John Hancock Financial Services Inc. on similar concerns. Skandia, a Swedish insurance firm, reported that its second-quarter sales of variable annuities in the U.S. fell 56%, to $2.5 billion.

Investors Suing Insurers Over Annuity Sales

Meanwhile, companies are battling in court and with regulators over annuities sold during the boom times.

Consumer advocates and many financial planners had long complained they were seeing variable annuities sold to people who did not understand or who could not benefit from their features.

Variable annuities’ costs and complexity make them best suited for long-term investors, but some products were sold to people with short-term financial needs or to elderly people unlikely to live long enough for the tax benefit to outweigh the extra costs.

Other buyers didn’t even realize they were purchasing variable annuities.

The Propps of Irvine said they thought they were buying mutual funds when they purchased two variable annuities from SunAmerica in 1997 for their IRAs.

Don Propp, a disabled 50-year-old engineer, said their financial advisor falsely told them their accounts couldn’t lose money. The Propps say they weren’t toldthey were paying extra for a feature--tax deferment--that they couldn’t use because IRAs already are tax advantaged.

SunAmerica officials declined to comment.

The Propps are among legions of investors who have sued insurance companies over the sale of variable annuities in retirement plans.

Last year, American Express Financial Corp. paid $215 million to settle three lawsuits involving the sale of annuities and other insurance products to more than 2 million investors. Lawsuits are pending against SunAmerica, Nationwide Financial Services Inc., American United Life Insurance Co. and VALIC (Variable Annuity Life Insurance Company), a subsidiary of American General Financial Group.

The companies are fighting the lawsuits, saying annuities are an appropriate investment for retirement plans because of the protection offered by the death benefit.

The controversy has prompted regulators to step up their investigations of variable annuity sales.

The National Assn. of Securities Dealers launched a probe of annuities sales two years ago “after many years of benign neglect” of the industry, Andrew A. Favret, regional chief counsel for the NASD’s New Orleans office, told a variable annuity industry conference in late June.

What regulators found is that many companies hyped variable annuities’ advantages without discussing their possible disadvantages--or making it clear that annuities are an insurance product. Some companies had procedures in place to identify and prevent unsuitable sales, but others did not.

In February 2001, the NASD announced settlements with an agent and four companies--Prudential Securities Inc., First Union Brokerage Services Inc., Allmerica Investments Inc. and Lutheran Brotherhood Securities Corp.--for improperly marketing and selling variable annuities.

The fines involved were minimal--$10,000 to $32,500 per case--but the actions put companies on notice that regulators were watching, Favret said.

Another wave of enforcement actions is expected in the fall, he said, with more to follow.

The NASD is paying especially close attention to how companies promote variable annuities in tax-deferred retirement plans.

“We’re nowhere near taking a position that it’s per se unsuitable,” Favret said. “We are concerned about the routine selling [of variable annuities in retirement plans]. . . . We’d expect some degree of disclosure that it could be redundant in a qualified plan.”

Last Year SEC Issued an Investor Alert

The Securities and Exchange Commission took a stronger position. The SEC issued an “investor alert” in June 2000 warning that variable annuities’ costs may outweigh their benefits.

The SEC said most investors should avoid purchasing a variable annuity for an IRA, 401(k) or other tax-qualified retirement plan, and instead make the maximum contributions to those plans before considering an annuity.

But retirement contributions are big business for the annuity industry. More than half the money contributed to variable and fixed annuities in 1999 went into retirement plans. Of the $163.5 billion in contributions that year, $50.7 billion went to IRAs and $32.9 billion to 401(k)s and other employer-sponsored retirement plans.

Insurers say the increased regulatory scrutiny, and the sales declines, are temporary setbacks. Americans’ need for retirement savings will continue to feed variable annuity sales, said Connor of the National Assn. for Variable Annuities.

Regulatory scrutiny has helped responsible insurers review and improve many of their sales practices, he said.

American Express, for example, has greatly increased the legal disclosures given to each customer before a variable annuity purchase, said Paul Bruce, the company’s vice president for market conduct practices. The company also is improving its internal controls and reviews to catch unsuitable sales, he said.

The NASD’s Favret agrees that insurers seem to be taking the regulatory issues seriously.

“Our sense is a very positive response from the industry as a whole,” Favret said. “They want to fix the industry as much as we do.”