Two realities may be combining to increase the level of public receptivity to annuitization in the form of a guaranteed stream of income over either a stipulated period or life. The first reality is that aging “boomers” are increasingly concerned about outliving their assets. The second is the expectation that the recent dramatic decline and volatility of the markets is going to be prolonged. Guarantees have taken on new meaning, and that is what synthetic annuities are all about.
Synthetic annuities can be described as a guaranteed deferred annuity contract that has “unbundled” the insurance guarantees from the assets by which the value and the duration of guarantees are measured (the “measuring assets” or “benefit base”). The guarantees are for a specified stream of withdrawals from the measuring assets followed by a stream of payments for life when the measuring assets are depleted by certain permissible causes. To date, the separate measuring assets have been either retail mutual fund shares or the holdings in a private investment advisory account.
Notwithstanding the heightened interest in synthetics, there are several major unresolved tax, regulatory, and pricing issues on the path to launching a successful new product that addresses the two realities. Pending action by the IRS, the companies now offering synthetic annuities are taking the positions: (i) that a synthetic product is an annuity for tax purposes and (ii) that the synthetic product link does not affect the current favorable capital gains and dividend treatment of the income from measuring assets. It remains to be seen whether the IRS will ultimately agree. The regulatory issues include the frequently disabling burdens of the reporting requirements under the Securities Exchange Act of 1934 and its coupling with Sarbanes-Oxley, which may or may not be resolved depending on the fate of proposed and pending Rule 12h-7. Finally, the prime pricing issue for insurers is the same decline and volatility of the markets that is capturing the boomers’ attention. The insurers must factor in the costs of their hedging transactions, and the potential strain of their reserving requirements, while trying to price the guarantees at saleable levels.