ADVANTAGE
COMPENDIUM
Volume 1, Number 4
Spring 2010
Annuity Guaranteed Lifetime Withdrawal Benefits
This edition looks at the past and present state of index and variable annuity guaranteed lifetime
withdrawal benefits (GLWBs) and compares them. It first shows the income growth guarantees, sample
age based payout percentages, and benefit cost of the major players in earlier times and today to get an
idea of how and whether these have changed. Second, the edition takes a hypothetical look at performance using the period from 1960 thorough 2009 to try to see how variable and index annuity GLWB
performance differ in different markets. The study does not list every annuity product with a GLWB
but is intended to show the major players in the variable and index annuity markets. My conclusions
are:
♦
Variable annuities generally offer weaker income growth guarantees than they did two years ago,
but most index annuities still offer strong guarantees.
♦
The age-based percentage payouts on variable annuity GLWBs tend to be similar at different ages
and therefore lower at advanced ages than index annuity ones. When compared with 2008 a few
variable and index GLWBs have cut the percentage paid out, but whether there is a trend to lower
payout percentages is difficult to discern.
♦
Variable annuity GLWB costs are up sharply. When I did my first report in 2007 the average current rider cost for a single payout was 0.55% with a maximum lifetime cost of 1.02%. In May
2010 the remaining VA carriers had an average current GLWB cost of 1.06% and an average
maximum of 1.57%.
♦
Index annuity GLWB costs are up modestly. In May 2010 index carriers had an average current
rider cost of .0.50% and an average maximum of 1%, only 0.10% higher than three years ago.
Generally the reason for higher index annuity costs were improved benefits.
♦
If you intend to receive 5% GLWB withdrawals, and your goal is to maximize the amount of
money going to your heirs, the variable annuity is usually a better choice than the index annuity,
but if you plan on withdrawing 6% or more and the first fifteen or twenty years of market movement resembles the ‘70s or ‘00s the index annuity results may be similar to or better than the variable annuity.
♦
If you intend to wait a decade or more to begin withdrawals index annuities with strong income
account growth guarantees should provide higher guaranteed income than variable annuities in
most market scenarios, especially if withdrawals begin at age 70 or later.
♦
If you believe your index annuity will average better than a 5% actual account growth, and you
intend to wait at least 5 years before withdrawals begin, the Lincoln Benefit and Lincoln National
GLWB designs should provide higher to significantly higher income than annuities guaranteeing
7% to 8% income account growth.
♦
A variable annuity with a GLWB does not turn it into a fixed annuity. A GLWB protects income
but not principal from market risk.
Page 2
Advantage Compendium
Spring 2010
GLWB History & Today
Hartford offered the first variable annuity with a guaranteed minimum withdrawal benefit (GMWB)
in 2002 (Hintze). The first VA with a withdrawal benefit that was guaranteed for the life of the annuity
owner (GLWB) was introduced in 2003 (White). By 2006 nine out of ten VA sales were in products
that offered some type of guaranteed living benefit. All of the innovations led to record 2006, 2007 and
2008 variable annuity sales.
VA Sales (in billions)
178.9
160.6
121.0
124.8 128.4
127.9
106.6
100.0
152.5
137.3
125.0
112.3
86.7
75.0
51.5
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Source: Index Compendium Mar 10; Marrion 8-06
Fixed annuity carriers did not offer GMWBs presumably because annuityowners were always
guaranteed that they could receive their principal as long as they met surrender period requirements.
The first index annuity carrier to offer a Guaranteed Lifetime Withdrawal Benefit was American
National Insurance Company in June 2006 quickly followed by AmerUs Group/American Investors
(now Aviva). By the end of 2006 seven index annuity carriers were offering GLWBs with many more
carriers preparing to launch. Also in 2006 AIG Annuity became the first stated rate annuity carrier to
offer a GLWB, but fixed stated rate competitors have been much slower to follow the GLWB parade
than fixed index carriers had been.
By early 2007 carriers on both the VA and FIA sides of the arena were creating more variations of
guaranteed withdrawal benefits. Many carriers enhanced the ability of the level of benefits to “reset” if
the account value rose, others allowed benefits to be cancelled and resumed, and there was talk of adding additional lives beyond the spouse to the income continuation benefit. Guaranteed withdrawal
benefits changed the focus of annuity market. The emphasis was no longer mainly growth, but safety of
income with potential preservation of principal.
The Storm Hits
My first GLWB study came out May 2007. In it I mentioned that a decade earlier several variable
annuity carriers had aggressively marketed Guaranteed Minimum Income Benefits (GMIBs) with commission incentives and very low costs to the consumer and that these GMIBs sprang up without a set of
minimum reserve guidelines in place. The result of these actions was when the millennium bear market
hit it caused Standard & Poor’s to issue negative credit-watch warnings on some VA carriers because
of the bear’s effects on their guarantees (Connolly, 2002).
Copyright 2010. Advantage Compendium is published quarterly by Advantage Compendium, Ltd., St. Louis, MO (314) 255-6531.
Editor, Jack Marrion. [email protected] Annual subscription rate: $440. Reproduction is not permitted without written
permission of editor. We do not provide investment, tax or legal advice. Information believed accurate, but is not warranted.
Page 3
Advantage Compendium
Spring 2010
The earlier study pointed out that another severe bear market could mean an owner of a variable
annuity GLWB could be demanding a 5% lifetime payout on assets that were worth 50 cents of what
they had been worth 18 months before. Ignoring this scenario variable annuities became more aggressive in offering GLWB benefits.
In 2008 another bear market hit and several VA carriers were caught not only guaranteeing what
could be an effective 10% payout on fallen account values but guaranteeing to increase that payout by
5% to 7% a year for every year deferred, all for an average annual cost to the annuityowner of roughly
0.5%. The main results on the VA side were by May 2009 several carriers stopped offering GLWBs
and all but carrier I researched significantly increased rider cost.
Since credited index annuity account values are immune from the losses of market downturns the
2008-2009 bear market should have had little effect on their GLWBs and yet a few carriers overreacted
and pulled their products off the market, all to return to the arena by 2010. However, the bond yield
environment posed another concern.
Bond Yields
7.00%
6.50%
6.00%
5.50%
Mar-10
Jan-10
Nov-09
Sep-09
Jul-09
May-09
Mar-09
Jan-09
Nov-08
Sep-08
Jul-08
May-08
Mar-08
Jan-08
Nov-07
Sep-07
Jul-07
May-07
Mar-07
Jan-07
Nov-06
Sep-06
Jul-06
May-06
Mar-06
Jan-06
5.00%
50% Baa, 25% Aaa, 25% T-Note 10 Yr
For much of 2005 investment grade bond yields remained in the 5% to 6% range with 10-year U.S.
Treasury Note yields staying between 4% and 4.5%. The effect of this low yield patch was index
annuities were changing their minimum guarantee from a stated rate of 2%-3% to a 1%-3% rate that
floated with 5-year U.S. Treasury yields.
By the time index annuity GLWBs appeared in 2006 bond yields had risen a bit. Index annuities
began offering ever stronger income growth guarantees with the knowledge that when market risk to
principal is removed it only takes average yields of 4%-5% to get a typical GLWB user to age 100
before they finally run out of their own money and need to dip into the insurer’s pocket.
However, as bond rates again fell in late 2009 and early 2010, and 10-year U.S. Treasury Note
yields fell below 2.5% some carriers began to question the effect these guarantees might have if interest
rates remained low. One result was in the spring of 2010 Aviva, Great American and Life Insurance
Company of the Southwest cut their percentage payout on at least some products, while some other carriers raised both the current and maximum cost for their rider.
Page 4
Advantage Compendium
Spring 2010
Accumulation Benefit or Bonus *
Most of the variable annuity GLWBs carriers initially provided a minimum, simple interest, growth
factor of 5% or 6% prior to withdrawals. By 2008 several carriers were offering 7% annual growth and/
or an automatic doubling of income account factor value if withdrawals were postponed ten years.
Today, most variable annuity carriers have cut back or even eliminated guarantees of income growth.
GLWB Income Account Factor Growth – Variable Annuity
2006-2007
2007-2008
AXA
5.00%
7.00%
Jackson National
5.00%
7.00%
John Hancock
5.00%
7.00%
Lincoln National
5%, double in 10 yrs
MassMutual
6.00%
6.00%
MetLife
5.00%
7.25%
Pacific Life
6.00%
7.00%
Prudential
7.00%
7.00%
VALIC
5.00%
5.00%
May 2010
4.0%-8.0% (floats)
7.00%
5.00%
5% no doubling
no guaranteed growth
no guaranteed growth
5.00%
6.00%
highest anniversary value
Index annuity growth factors witnessed a similar increase as they evolved, but generally avoided the
dramatic drops of variable annuities
GLWB Income Account Factor Growth – Index Annuity
2006-2007
Allianz (simple interest)
12.00%
American Equity
5.00%
Aviva
4.00%
Equitrust
Forethought
Great American (simple interest)
ING
Lincoln Benefit
Lincoln Financial Group
LSW
Midland National
National Western
North American Company
OMFN
RBC
2007-2008
10.00%
7.00%
7.20%
7.00%
7.00%
5.00%
6.00%
6.00%
10.00%
4.00%
7.00%
persistency increases
persistency increases
7.00%
7.00%
4.00%
8.00%
5.00%
5.00%
4.00%
8.00%
4% or 6%
4% or 6%
8.00%
May 2010
8.00%
8.00%
7.2% or 8.0%
7.00%
5% or 6% + Bonus
10.00%
7.00%
persistency increases
persistency increases
7% (8.15% Summer 2010)
7.50%
5.00% + 5% bonus
7.50%
4% or 6%
7.50%
* These tables are not meant to include the specifications of every GLWB a carrier might offer and
although intended to be correct are not warranted.
Page 5
Advantage Compendium
Spring 2010
Costs
The average annual cost of a variable annuity is 1.40% for mortality & expenses plus subaccount
management fees of 0.75%, for a total of 2.15% (Korn, 2006). When I did my first report in 2007 the
average current cost for a single payout was 0.55% with a maximum lifetime cost of 1.02%. This
meant a typical VA with GLWB cost 2.6% and might go as high as 3.2% if the annuityowner reset the
benefit. In May 2010 the remaining carriers had an average current cost of 1.06% and an average maximum of 1.57%. Using the same VA expense assumptions this means a typical VA with GLWB costs
3.2% and could go as high a 3.7% if benefits are reset.
GLWB Current & Maximum Rider Cost – Variable Annuity
2008-Current 2008-Maximum
May 2010-Current
American Skandia
0.60%
1.25%
no longer offered
AXA
0.60%
0.75%
0.80%
Genworth
0.60%
2.00%
1.10%
Hartford Lifetime
0.30%
0.30%
no longer offered
ING
0.50%
1.20%
no longer offered
Jackson National
0.35%
1.00%
0.95%
John Hancock Income
0.40%
0.75%
0.90%
Lincoln National
0.65%
1.50%
0.90%
Pacific Life
0.65%
1.20%
1.05%
Phoenix
0.75%
1.50%
2.50%
Prudential
0.60%
0.75%
0.85%
MassMutual
0.60%
1.50%
0.95%
MetLife III
0.50%
0.95%
1.00%
Sun Life
0.50%
0.50%
1.10%
VALIC
0.65%
0.65%
0.65%
May 2010-Maximum
1.10%
2.50%
1.50%
1.20%
1.50%
1.50%
2.50%
1.50%
1.95%
1.60%
1.30%
0.65%
Index annuity costs also increased, but for a different reason. Current costs rose typically because
income account growth factors improved. I’m beginning to see maximum costs increase as carriers
reassess their future liability.
GLWB Current & Maximum Rider Cost – Index Annuity
2008-Current 2008-Maximum
Allianz Simple Income
0.50%
0.50%
American Equity
0.45%
1.00%
American National
0.40%
0.40%
Aviva
0.50%
0.50%
Equitrust
0.50%
0.50%
Forethought
Embedded
Great American
0.40%
1.00%
ING
0.35%
1.00%
Lincoln Benefit
0.40%
1.00%
Lincoln Financial Group
0.40%
1.00%
LSW
0.40%
0.50%
Midland National
0.10%
1.00%
0.35%/
1.00%/
National Western
0.75% +5
1.50% +5
North American
0.50%
1.50%
OMFN
.35
1.00%
0.5%/ 0.6%
0.5%/ 0.6%
Enhanced
Enhanced
RBC
May 2010-Current
May 2010-Maximum
0.60%
2.00%
0.45%
1.00%
0.40%
0.40%
0.75%
0.75%
0.50%
0.50%
Embedded
0.40%
1.00%
0.35%
1.00%
0.40%
1.00%
0.40%
1.00%
0.65% (0.85% - 8.15% Growth Factor)
0.75%
1.50%
0.35%/0.75% +5
0.75%
.35
0.5%/ 0.6% Enhanced
1.00%/1.50% +5
1.50%
1.00%
0.5%/ 0.6% Enhanced
Page 6
Advantage Compendium
Spring 2010
Life Payouts
My 2007 study found two-thirds of variable annuity carriers guaranteed a flat lifetime payout of 5%
regardless of age and this pattern continued. A couple of carriers lowered their age 65 payouts, but they
were offset by others that increased age 75 payouts.
GLWB Initial Payout Factors – Variable Annuity
08-Age 65
08-Age 75
5.00%
6.00%
AXA
5.50%
7.00%
Genworth
5.00%
5.00%
Jackson National
5.00%
5.00%
John Hancock
5.00%
5.00%
Lincoln National
5.00%
5.00%
Pacific Life
5.00%
6.00%
Phoenix
5.00%
6.00%
Prudential
5.00%
5.00%
MassMutual
5.00%
5.00%
MetLife
5.00%
5.00%
Sun Life
5.00%
5.00%
VALIC
10-Age 65
5.00%
5.00%
5.00%
5.00%
5.00%
5.00%
4.00%
5.00%
4.50%
5.00%
5.00%
5.00%
10-Age 75
5.00%
6.00%
6.00%
5.00%
5.00%
5.00%
5.00%
5.00%
5.50%
5.00%
5.00%
5.00%
Index annuity GLWB factors remained virtually unchanged until this year when the three carriers
previously mentioned cut some payouts by a half percent. These cuts did not make these GLWBs
uncompetitive, but brought them into the middle of the competitive pack.
GLWB Initial Payout Factors – Index Annuity
08-Age 65
08-Age 75
5.00%
6.00%
Allianz Simple Income
5.00%
6.00%
American Equity
5.00%
6.00%
American National
5.50%
6.50%
Aviva
5.50%
6.50%
Equitrust
5.00%
5.00%
Forethought
6.00%
7.00%
Great American
5.50%
6.50%
ING
6.00%
7.00%
Lincoln Benefit
5.50%
6.50%
Lincoln Financial Group
5.50%
6.50%
LSW 20 yr
5.50%
6.50%
Midland National
5.50%
6.50%
National Western
5.50%
6.50%
North American Company
5.50%
6.50%
OMFN
5.50%
6.50%
RBC
10-Age 65
5.00%
5.00%
5.00%
5.00%
5.50%
5.00%
5.50%
5.50%
6.00%
5.50%
5.50%
5.50%
5.50%
5.50%
5.50%
5.50%
10-Age 75
6.00%
6.00%
6.00%
6.00%
6.50%
6.00%
6.50%
6.50%
7.00%
6.50%
6.00%
6.50%
6.50%
6.50%
6.50%
6.50%
Page 7
Advantage Compendium
Spring 2010
Controlled Asset Allocation
Although I’ve never hear a carrier say it this way, the purpose of controlling asset allocation is to
help the annuityowner’s assets last longer to decrease the insurer’s chances of having to perform on the
GLWB benefit. Because the index annuity structure doesn’t permit market losses the carrier should be
indifferent as to whether money is placed in a fixed or indexed account. The same reasoning does not
apply on the other side.
Every variable annuity I researched that offered GLWBs placed limitations on how subaccount
assets were invested. The carrier typically limits the subaccounts that may be used and requires a certain percentage of the assets to be placed in bonds, or may limit selections to different weighted bondequity balanced subaccounts. I found 20% to 40% of assets had to be placed in bond or fixed accounts
depending on the product.
Asset Allocation & Performance
I examined the annual returns of the S&P 500 with reinvested dividends over the last 50 calendar
years. I also calculated the calendar year returns of a mix of bonds consisting of 50% Baa rated, 25%
Aaa rated and 25% 10-yr U.S. Treasury Notes; the bond return data was from the Federal Reserve
Board. I then calculated the annual returns for three different portfolios. The 80/20 portfolio was 80%
S&P 500 returns and 20% bond returns, the 70/30 was 70% S&P 500 and 30% bonds and the 60/40
was 60% S&P 500 and 40% bond returns. From each of these I then subtracted 3.2% each year reflecting the current average variable annuity with GLWB rider costs reported earlier. Here are the year by
year results.
Pseudo-VA Annual Returns
30.00%
20.00%
10.00%
19
60
19
62
19
64
19
66
19
68
19
70
19
72
19
74
19
76
19
78
19
80
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
20
06
20
08
0.00%
-10.00%
-20.00%
-30.00%
60/40
70/30
80/20
This is meant to represent the stock and bond allocations required by choosing the GLWB rider in a
variable annuity. The S&P 500 is used as a proxy for all equities and my Aaa/Baa/Treasury mix is the
bond proxy. A 3.2% annual fee is deducted representing the average variable annuity annual expenses.
Over the entire 50 year period the results of the three allocations were close. The average return of the
60/40 mix allocation was 6.31%, the 70/30 mix was 6.59% and the 80/20 mix was 6.86%.
Page 8
Advantage Compendium
Spring 2010
VA GLWB Balances After 30 Year Periods
I then used these annual returns assuming a 5% GLWB payout in which $100,000 had been placed
at the beginning of the period; thus I subtracted $5,000 at the end of each year that reflected the year’s
gains or losses on the previous year’s account balance. I calculated how much money remained 30
years later. This exercise was performed each year beginning in 1960 with the last period starting in
1980 and ending in 2009.
Balance After 30 Years Ending In
$900,000
$800,000
$700,000
$600,000
$500,000
$400,000
$300,000
$200,000
$100,000
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
$0
60/40
70/30
80/20
No period ran out of money before the 30 years was up. The worst period used a 60/40 allocation,
started with $100,000 in 1962, and had $97,762 left at the end of 1991. The best period began in 1975,
used an 80/20 mix, and had $867,457 remaining in 2004.
VA & Index Annuity GLWB Balances After 30 Year Periods
I then compared the 60/40 variable annuity mix with two index annuity annual reset designs. The
60/40 mix was selected because it is designed to offer the greatest protection against negative volatility.
One index annuity assumes 100% of any index gain up to a 9% cap was credited and the other assumed
50% of any annual gain, without a cap, was credited. Negative years were treated as zero returns and
S&P 500 returns did not include reinvested dividends for the index annuity calculations, but reinvested
dividends were included in the variable annuity component.
The index annuity models were only competitive with the variable annuity periods that began in the
early ‘60s. The variable annuity balances, after all withdrawals and fees, were considerably higher than
the index annuity balances for periods from 1966 on, even though the index annuity examples used 9%
caps or 50% participation on annual-point-to point designs. This level of index participation has been
common in the past, but today’s participation rates and caps are roughly half of these percentages.
Page 9
Advantage Compendium
Spring 2010
Balance After 30 Years Ending In
$700,000
$600,000
$500,000
$400,000
$300,000
$200,000
$100,000
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
$0
60/40
FIA 9% Cap
FIA 50% rate
The implication I derive from this is if you buy an annuity with a GLWB and begin, shortly thereafter, taking a 5% withdrawal from both an index annuity and a variable annuity, that the variable annuity
should provide considerably more money to beneficiaries than the index annuity unless the first fifteen
or twenty years of the payout period resembles the ‘70s or ‘00s. The same results generally held true
when 6% was withdrawn instead of 5% except the effects of a poor initial decade lessened the advantage of the variable annuity.
This example assumed the GLWB was immediately used – withdrawals began at the end of the first
year – and was designed to show much money would have been left at the end of 30 year periods in the
past. For example, if you put in $100,000 in 1960 and took out $5,000 a year thereafter (not adjusted
for inflation) in 1990 you still had around $100,000 whether you picked our hypothetical variable or
index annuities. However, if you started in 1970 your index annuity balance in 2000 was $150,000 to
$190,000 while your variable annuity balance was $400,000 to $460,000.
But my research finds withdrawals very rarely begin soon after purchase. My belief is most GLWB
purchases are viewed as a type of retirement income insurance designed for future use. If this is true,
any guaranteed growth of this future income should be an important consideration in selecting an annuity, and this now examined.
VA & Index Annuity GLWB Income Account Balances After 10 Year Periods
Prior to the 2008 bear market several variable annuities guaranteed a minimum level of income
growth, typically 5% a year, for every year in which withdrawals were not taken. This was almost
always calculated as simple interest meaning after 10 years a $100,000 premium would have GLWB
withdrawals based on $150,000 (5% times 10); this is the same as a 4.14% compounded interest rate. A
few carriers said if no withdrawals were taken for 10 years the GLWB payout would be based on double the premium – equivalent to a 7.18% compound or 10% simple interest rate. In May 2010 many
variable carriers provide no guarantees of growth and of those that do the typical guarantee is 5% to
6% simple interest.
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Advantage Compendium
Spring 2010
Prior to the 2008 bear market several index annuities also guaranteed a minimum level of income
growth, but rather than going away they have remained, and in some instances increased their guarantees. In May 2010 several index annuity GLWBs guarantee compound income account growth of 7%
to 8% over as long as 20 years. It should be noted that a 7% to 8% compound rate over 10 years is the
same as a 9.7% to 11.6% simple rate. Put more simply, many index annuities guarantee double the
income account growth of variable annuities.
The last section took withdrawals over 30 year periods from 1960 on and found that variable annuities usually had a higher final balance than index annuities. However, what if your goal is to maximize
the guaranteed future income you will receive?
I took the same S&P 500/bond allocations as before, the same 3.2% annual expenses and concluded
what a $100,000 premium was worth in my pseudo-VA models at the end of 10 year periods ending
from 1969 through 2009. I then compared these totals with a consistent ten year ending value of
$200,000. The rationale for the $200,000 figure is several index annuities guarantee 10 year income
account growth of greater than 7.18% (the compounded rate needed to double money in 10 years –
10% simple interest). This chart compares the guaranteed minimum income account growth of many
index annuities with historical hypothetical growth of pseudo variable annuities.
Income Account Value After 10 Years
$400,000
$350,000
$300,000
$250,000
$200,000
$150,000
$100,000
$50,000
19
69
19
71
19
73
19
75
19
77
19
79
19
81
19
83
19
85
19
87
19
89
19
91
19
93
19
95
19
97
19
99
20
01
20
03
20
05
20
07
20
09
$0
VA 60/40
VA 70/30
VA 80/20
Index Annuity
Of the 41 ten year periods since 1960 the index annuity guarantee beat the VA account values 21
times. Once again the best performer depended on how the market performed. If the next ten years
resembles the ‘60s, ‘70s or ‘80s the index annuity should provide higher guaranteed income. If the decade looks similar to the ‘80s or ‘90s the variable annuity is the better choice.
VA & Index Annuity GLWB Payout Percentages
At age 65 the typical GLWB payout percentage is 5% on a variable annuity, and either 5% or 5.5%
on an index annuity. At age 75 the typical variable annuity remains at 5%, but index annuity payouts
typically increase to 6% or 6.5%. Differences in payout percentages impact the effects of income
account growth.
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Advantage Compendium
A 5.5% payout on $200,000 is $11,000. This is
equal to a 5% payout on $220,000. In the previous section I found that the index annuity income
account balance was higher in 21 ten-year periods. However, if the variable annuity payout percentage was 5% and the index annuity payout
was 5.5% the index annuity provided higher
guaranteed income in 24 of the periods.
The difference becomes more dramatic at age 75
because the vast majority of variable annuities
had the same 5% payout factor, while the vast
majority of index annuities had a payout factor of
6.5% at age 75. At 6.5% the guaranteed income
is $13,000 on $200,000, but it takes $260,000
with a 5% factor to produce the same income.
What I found was an index annuity guaranteeing
a 6.5% payout on $200,000 beat the variable
annuity in 32 of 41 periods when compared with
a variable annuity paying 5% on actual account
balances over the last 50 years.
Woulda/Coulda
The modeling results reaffirm other comparisons
involving index annuities and equity investments.
If the market performs well over time then equity
investments can significantly best the index
annuity. If the market has a prolonged period of
bad returns an index annuity may well be very
competitive, providing index annuity participation rates and caps increase from current levels. I
also did models using 5% variable annuity
expenses instead of 3.1%, increased the payout
from 5% to 6.5%, and did index annuity calculations using initial GLWB account bonuses of
15% or 25%. Although the individual numbers
changed, my overall conclusions did not.
If you begin taking withdrawals immediately the
variable annuity could result in much more
money going to the beneficiaries, unless we have
a long replay of the markets of the ‘70s or ‘00s.
The results are not as clear if you wait a decade
or more to begin withdrawals. Because many
index annuities offer much stronger income
growth guarantees than variable annuities, and
often guarantee higher lifetime payout percentages than variable annuities – especially at older
ages – the index annuity often produced higher
guaranteed income than the variable annuity,
Spring 2010
unless the bull market during the 10 year accumulation period was very robust.
Given the volatility of the last decade and concerns for the next, I can make a strong case for
using an index annuity with a strong GLWB
growth guarantee instead of a variable annuity if
the GLWB is not intended to be tapped for several years. However, if you will begin receiving
payouts in the next year or two the variable annuity is probably a better choice from an historical
perspective.
Product Tweaks & Comparisons
Many GLWBs can be easily compared. If two
annuities have 7% compound income growth factors and one has a payout at 5.5% and the other is
at 5%, the higher payout wins.
$10,000 income produced by a 5% payout on
$200,000 would only require $181,818 if the
payout factor was 5.5%
If there are two variables at play it is simply a
matter of solving one using the other as the reference point. Say your initial premium is $100,000,
your payout percentage is 5% and the first annuity grows at 7.2%. After ten years the first annuity GLWB income account factor is $200,000
which is multiplied by 5% creating a payout of
$10,000. If the second annuity has a payout percentage of 5.5% this means it would take
$181,818 to produce the same $10,000
(10,000/.055). Using Excel or a financial calculator we find that if the second annuity guarantees
a growth rate of 6.2% or better it will provide
more income than the first annuity due to the
higher payout.
Some index annuity GLWBs have offered an initial income account bonus of 10% to 25% combined with a lower annual guaranteed growth factor and similar calculations can be done to determine the income generated. If the annuityowner
intends to begin withdrawals within the next year
or two these GLWB bonus annuities can provide
higher payouts than other designs. All it takes is
a little math to determine which design is best for
a particular situation.
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Index annuities from Lincoln Benefit and Lincoln National are different than other GLWBs because
payout percentage growth is guaranteed rather than income account growth. For example, a 65 year old
that has owned a Lincoln policy for ten years might be guaranteed a payout percentage of 7.5%. How
does that higher payout percentage compare to a GLWB with a 7.2% guaranteed growth account factor
with the 5% payout resulting in a $10,000 payout after ten years? The comparison calculation is identical to the previous one. The growth account annuity guaranteed an income of $10,000 and dividing this
by the 7.5% Lincoln payout percentage means $133,333 is needed to produce the same $10,000. Our
financial calculator finds a 3% annual return over ten years on $100,000 in the Lincoln policy grows to
$133,333 and produces the $10,000 payout.
If you believe your index annuity will average 5% or better actual account growth, and you intend to
wait at least 5 years before withdrawals begin, the Lincoln Benefit and Lincoln National GLWB
designs would provide significantly higher income than annuities guaranteeing 7% to 8% income account growth.
Increasing Income Factors
A drawback with typical GLWBs is the initial payout income check can be the same amount as the
final one. However, some carriers will guarantee to increase payout amounts by 2% or 3% a year at
initial payout that is 1% less than level payouts.
$7,100
$6,300
$5,500
$4,700
$3,900
1
2
3
4
5
6
7
$5,000
8
9
10
11
$4,000 @ 2%
12
13
14
15
16
17
18
19
20
$4,000 @ 3%
The crossover point hits roughly a decade into the payout stream. Unless the annuityowner needs
the full payout today, or can find a more profitable use for the extra 1% gleaned from the level payout,
the increasing payout annuities may prove to be a better choice.
Does A VA With A GLWB Make Fixed Annuities Obsolete?
No, because one is trying to compare apples and oranges.
Some variable annuity proponents say a VA with a GLWB makes fixed index annuities and fixed
stated rate annuities obsolete. The argument is since a GLWB provides guaranteed payouts and often
guarantees simple interest growth of 5% to 6%, that it is essentially better than a fixed annuity because
it offers a higher minimum guaranteed rate and the potential for higher returns. However, this ignores
why people buy fixed annuities.
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Advantage Compendium
If you buy a stated rate or index annuity for
$100,000, the stock market drops 50%, and you
then cash in the annuity you will get back
$100,000 plus any credited interest, less any surrender charges. If you buy a variable annuity
with a GLWB for $100,000, the stock market
drops 50%, and you cash it in you will get back
somewhere around $50,000 less surrender
charges. A GLWB guarantees income but it has
no cash value.
If a consumer’s primary goal is to protect their
principal from market risk they should not buy a
variable annuity, with or without a GLWB,
because it will not give the protection. If a consumer wants the freedom to maintain access to
principal without market risk they should not buy
a variable annuity, with or without a GLWB.
The GLWB guarantees an income level and the
possibility of having money available in future
years if needed or at death. A VA GLWB should
only be compared with fixed annuities on the
basis of producing an income and offering this
lump sum possibility.
Do GLWB Fees Offset The Benefit
A paper offered by Fidelity International says “it
is hard to avoid the conclusion that the guarantees offered today through living benefits appear
expensive,” indeed, they conclude that savers
could give up half of their return to pay for a risk
that has a 1 in 70 shot of happening after 30 years
(Fraser, 2007). TIAA-CREF is even more biting
about variable annuity GLWBs saying that “If
market performance is similar to the past few
decades, the buyer is paying for an insurance feature that has little value” (Goodman, 2008).”
The arguments are directed against variable
annuities with GLWBs and their point is the fees
in a VA may even create the need for a lifetime
guarantee that would not be needed if the GLWB
was not used. The argument is if one placed
$100,000 in a 50/50 mix of stocks and bonds that
produced an annualized gross return of 6%, with
management costs of 1%, and you withdrew
$5,000 a year and died in 30 years, your heirs
would receive the original $100,000.
Spring 2010
However, if you take that same mix and place it
inside a variable annuity with a GLWB and total
fees of 3.5% a year your heirs would get zero
because you used up your money by year 29 due
to the additional fees paid.
The TIAA-CREF study also says “It should be
obvious that if the stock market performs well,
there is no value in this guarantee.” It could also
be argued that home, auto or term life insurance
has no value if there is no fire, crash or death
during the period covered; the question their
study looks at is “is it a fair cost.”
The two studies named argue that current variable annuity GLWB costs are too high because
the chance of usage is so low. Indeed, one study
says there has not been a single 30-year period in
the last 60 years where the GLWB benefit would
have come into play, although including Great
Depression years did generate scenarios wherein
the benefit was needed. Looking at a broader
range of years, only 15% of randomly generated
25 year periods would have used the benefit and
only 20% of 30 year periods did so.
There are three questions to the GLWB argument. The first is whether the benefit will ever be
used. Based on history and current mortality,
regardless of whether is it is attached to a fixed
annuity or a variable annuity, there is a very
small likelihood of the GLWB being used. However, there is also a very small likelihood that
ones house will burn down in the next year and
yet we consider it prudent to buy fire insurance.
A GLWB transfers longevity risk to the insurer
and should thus be treated with the same rationale one would use in buying any insurance,
which is will the cost be worth the benefit.
If the guaranteed income growth features on the
fixed annuity come into play then a GLWB cost
may be justified. If $100,000 is placed in a fixed
annuity at age 50 earning 5% it would grow to
$207,892 by age 65; a 5% payout rate would produce an annual income of $10,395. If the annuity
from that point forward averaged only a 3.5%
return the income would last until age 100.
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Spring 2010
However, if that same $100,000 was placed in an annuity guaranteeing 8% annual growth of the
value used to calculate the income, the same 5% payout produces a guaranteed payout of $15,861 a
year beginning at age 65. To make $207,892 last until age 100 when you are withdrawing $15,861 a
year requires a net annualized return of 6.89%. A net return of 6.89% mean there should be market
periods when the insurer will be paying the income and they should be compensated for this risk.
Variable annuity GLWBs do have a cost because there is capital markets risk of loss and mortality
risk, but the ultimate cost is really determined by the behavior of the annuityowner. If all of the VA
GLWB annuityowners invest their VA portfolios as aggressively as possible, maximize the lifetime
withdrawals in poorly performing stock markets, and then keep using the benefit until death, the
GLWB cost to the insurer could be much higher than the current rider cost. On the other hand, if the
annuityowners keep a percentage of their money in bonds, do not use the benefit or discontinue using
the benefit, the cost to the carriers might be zero.
Summary
Although the financial world has been talking about the great transition in the consumer world from
asset accumulators to asset spenders there is little evidence that this is actually happening. One of the
major reasons behind this is a psychological unwillingness to admit death and give up hope. However,
rational retirees know they will die, but they fear running out of money before they run out of time.
Guaranteed Lifetime Withdrawal Benefits take away the fear of running out of income and preserve
hope by letting the consumer keep control of the asset. Rationally, there is a very strong likelihood that
the benefit will never be needed with either a fixed or variable GLWB, but that likelihood still exists,
and the GLWB addresses this fear. Since the GLWB removes the fear of living too long it should help
consumers act more rationally in all of their retirement planning. GLWBs do not replace all other
retirement solutions, because a combination of financial resources is needed to ensure a successful
retirement. However, an annuity with a GLWB benefit probably deserves to be a part of that combo.
GLWB Parts
A decade ago a regulator remarked that index annuities were like snowflakes because no two were
exactly alike; the same can be said about annuity GLWBs. This section talks about the parts of
GLWB and what they mean.
Controlled Asset Allocation
Every variable annuity offering GLWBs places limitations on how subaccount assets are invested by
either requiring a certain percentage of the assets to be placed in bond funds or limiting selections to
different bond-equity balanced subaccounts. Index annuities generally do not have limits.
Payout Step-Ups (Resets)
Almost every variable and index annuity include a step-up feature that allows an annuityowner to
lock-in increases in principal value at predetermined intervals, which in turn increased the payout.
The annuityowner may turn down the step-up if an increase in the rider fee would result.
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Advantage Compendium
Spring 2010
GLWB Parts (continued)
Withdrawal Benefit Guaranteed Growth
Almost every index annuity and many variable annuities guarantee the payout will increase. The
guaranteed benefit growth aspect of GLWBs has seen the most marketing creativity and therefore
can be very confusing. Many of the GLWBs with high percentage annual growth will limit the initial guarantee to 10 years, others may use simple instead of compound interest, still others offer a
high initial benefit bonus, and a couple increase the payout based on how many years the annuity
has been owned. No one method is better or worse than another because it depends upon what the
annuityowner intends to do.
Fees
A few index annuities have embedded fees because the GLWB is an integral part of the annuity.
This does not mean the benefit is free. Guarantees cost money and an annuity with a GLWB should
have a lower renewal rate than one without the benefit. In other words, if two products are identical
except one offers an embedded GLWB and the other doesn’t, the one with the GLWB will have
lower caps or a lower participation rate at renewal time.
Most annuities charge explicit fees and these range from 0.10% to 2.5%. The initial fee is locked in
for the life of the contract, but may be increased if you choose to use a step-up or renew a benefit
growth guarantee.
Payout Percentage
Variable annuities tend to have lower payout percentages than index annuities. An index annuity
payout beginning in your sixties is generally 5% to 5.5%; in variable annuities the payouts are from
4% to 5%. Most index annuities pay 6% to 6.5% in your seventies while most variable GLWBs
remain at 5%. A few index annuities offer a payout that increases by 2% to 3% a year, but the initial
payout is 1% less than the flat payout option.
What if I take out too much?
All carriers reduce the protected account value on a proportional basis for excess withdrawals. For
example if the account value is $100,000 and your maximum guaranteed withdrawal is $5,000 but
you take out $10,000, the next year you would be guaranteed $4,750 (5% of $100,000 minus the
extra $5,000 withdrawn or $95,000 x 5%).
Minimum/Maximum Age
Several variable carriers require a minimum age of 65 to receive lifetime benefits, but some GLWBs
permit lifetime benefits at age 50 or as late as age 90 (but there comes a point where one may be too
old to benefit from a lifetime guarantee).
Starting and Stopping Payouts
Annuityowners may start and stop the withdrawals as needed, but there is not an economic incentive
to not take a withdrawal from a guarantee point of view, although the annuity cash value would be
preserved if payouts stopped.
The GLWB Owner Keeps Control
The annuityowner may choose to withdraw no more than a specified percentage of the value of the
annuity and the insurer guarantees that payout will be available for as long as the annuityowner
lives, even if the annuity cash value goes to zero. Unlike annuitization wherein the annuity value is
converted into an income the annuity with a GLWB remains a deferred annuity, which means the
annuityowner retains control and may stop and receive the current annuity value at anytime.
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Resources
Connolly, Jim. 2002. Due to market, VA benefits now giving issuers headaches; National Underwriter;
106.31: 52
Fraser, Simon. 2007. The nature of financial risk in retirement: Are guarantees the answer?; Viewpoint;
October: 17
Goodman, B. and S. Tanenmaum. 2008. The 5% Guaranteed Minimum Withdrawal Benefit: Paying
something for nothing?; TIAA-CREF Institute Research Dialogue; April
Hintze, John. 2006. New VA living benefits offer flexibility, control; Bank Investment
Consultant; 14. 3: 8
Korn Donald. 2006. The right rider: Boomers want guaranteed lifetime income, but don't want to buy
an immediate annuity. Variable annuity issuers think they have a solution; Financial Planning; 2:1
White, Rich. 2006. Why you should help clients evaluate GMWBs; Sales Insight - July, 2006
http://www.freeerisa.com/Insight/200607si.asp
Advantage Compendium Ltd.
(www.advantagecompendium.com)
is led by Jack Marrion, providing research and consulting services to insurance companies and
financial firms in a variety of annuity areas. He has conducted a broad scope of research ranging
from the behavioral economic reasons why consumers buy or don't buy financial products to producer and marketing company future industry impact models, as well as improving customer
retention and discouraging outgoing annuity exchanges.
His insights on the annuity and retirement income world have appeared in hundreds of publications including Best’s Review, Business Week, Kiplinger, Smart Money, The New York Times, and
The Wall Street Journal. In 2006 the National Association of Insurance Commissioners asked him
to address their annual meeting and teach regulators the realities of index annuities; in 2009 Jack
was asked to speak at the NAIC Washington meeting on how seniors make decision. He is a frequent speaker at industry functions and a columnist for Senior Market Advisor, as well as a regular contributor to National Underwriter. Best’s Review said he was likely to affect the course of the
industry.
Prior to forming Advantage Compendium, Jack Marrion was president and owner of an NASD
broker/dealer with offices in nine states, and formerly vice president of a life insurance company
and previously vice president of an NYSE investment banking firm. He has an MBA from the University of Missouri and his doctoral studies in the area of cognitive bias in decision-making form a
new paradigm in the marketing and development of retirement income products. Neither Jack
Marrion nor Advantage Compendium sell or endorse any financial product.
Summer Issue Focus: The winter issue touched on the effects of regulation on annuity
distribution but it didn’t examine the anti-annuity bias that seems to exist amongst some
securities regulators and politicians. We examine recent laws, regulatory actions and
anti-annuity public comments to see what challenges annuities may face from a regulatory and political perspective in the future and how that future may be changed.