Late last year, I promised I'd dedicate future installments of Annuity Analytics to providing guidance on specific products by "unraveling their DNA." In this column -- and the next few months -- I will fulfill this pledge by reviewing a number of popular or interesting Guaranteed Lifetime Withdrawal Benefit (GLWB) variable annuities available in the U.S. marketplace. And, although I've come across tens if not hundreds of different design combinations in the last few years, within the context of this column I plan to compare products across 12 unique and important dimensions. A summary table will provide a bird's-eye view of the main features, and will remain consistent across products and from month to month. In this month's launch, I discuss a recent joint offering by Fidelity and MetLife -- two powerhouses in the financial services industry.
In November 2009 Fidelity teamed up with MetLife to introduce a so-called "MetLife Growth and Guaranteed Income" (MGGI) variable annuity available for purchase directly by consumers. The two issuers have launched an aggressive marketing campaign (e.g., Wall Street Journal, New York Times) and have thus raised public awareness of the entire guaranteed "retirement income" space. This benefits everyone in the business. If you recall, Fidelity offered its own GLWB for a brief period before the crisis of 2008, but suspended sales of their product in mid-2009 as a result, it was rumored, of difficulties obtaining re-insurance and hedging for the embedded guarantees. With this new product, they have now returned to the market with a very strong and experienced partner, MetLife, leveraging its risk management and hedging capabilities.
How Does it Work?
Like any other GLWB rider fused on a VA chassis, the individual policyholder (ideally a pension-less retiree) deposits or rolls-over a sum of money -- actually, a steep $50,000 in the case of MGGI -- into an investment portfolio which is then allocated (usually by the individual) into a number of subaccounts that contain stocks, bonds and other generic and boring stuff. The investment portfolio then grows (or shrinks) over time, depending on the performance of the underlying investments. Any capital gains are tax deferred and eventually treated as ordinary income, as this is a variable annuity, after all.
Then, at some future date -- which is usually under the control of the policyholder -- the annuitant can start taking guaranteed withdrawals from the account. Think of this income like a systematic withdrawal plan (SWiP) at a nominal (i.e., not inflation-adjusted) non-decreasing level. The income is guaranteed to never decline for the remaining life of the annuitant and his or her (younger) spouse. Thus, in contrast to a SWiP, if the underlying investment portfolio (a.k.a. account value) ever reaches zero, the guaranteed income will continue so long as one member of the couple is still alive.
The guaranteed withdrawal rate is determined by the company issuing the GLWB and the time of sale. The guarantee amount is the product of multiplying a guaranteed rate by the guaranteed base, and is determined at the point of first withdrawal. In the case of the Fidelity MGGI, the rate is between 4 to 6 percent, depending on the age at initial withdrawal. Moreover, if the investment portfolio happens to grow even while undergoing these withdrawals, the guaranteed base might reset to a higher level and hence generate even greater withdrawals. As far as estate values are concerned, upon the second death, whatever is left over in the account goes to the heirs, with the requisite tax implications.
Things I Like:
One of the nice features of the Fidelity MGGI is the relatively low fees charged for both the guarantee and the investment component. The total drag is 290 basis points on the joint-life version, and 275 basis points on the single-life product. This is generally amongst the lower cost products in the GLWB world, which is consistent with Fidelity's direct-to-consumer, cut-out-the-middleman approach to personal finance. Indeed, I can't overemphasize the difference a (low) 3 percent fee makes relative to a (high) 5 percent fee. While the former allows one to "keep hope alive" that the investment portfolio will eventually grow over time -- net of withdrawals -- the latter generates a hurdle rate that can be almost impossible to overcome. Remember, also, that very often the insurance fee is charged as a percentage of the guaranteed base, which is equivalent to an even higher percent of the account value when the market is down. So, do the fuzzy math: A 5 percent product fee plus a 5 percent withdrawal rate is a 10 percent hurdle, ignoring some apples and oranges along the way. How many money managers can beat 10 percent year-in and year-out? Zero. In other words, it is unlikely you will ever get a raise on your income regardless of all the bells and whistles thrown in. So, kudos to Fidelity and MetLife for making a GLWB plus VA available to do-it-yourself investors.
Things I Dislike:
Unfortunately, the same do-it-yourself investor -- to whom this product is likely geared -- will not appreciate the financial straightjacket in which their investments have been placed. They have absolutely no control over asset allocation or managers, they can't pick their own funds, and they've essentially signed up for an investment portfolio that is 60 percent stocks, 35 percent bonds and 5 percent cash -- all at the mercy of Fidelity's VIP FundsManager Portfolio. And, although they might beat their benchmark, the behavioral arguments which favor minimal investment choice and discourage decisions, also support transparent and broad-based stock indices as opposed to active management. Moreover, building Fidelity's MGGI around a pure 60/40 index fund could have shaved another 50 basis points off the cost, which has greater appeal to the passive crowd.
On the guaranteed income side, Fidelity's MGGI offers relatively low and quite common guaranteed payout rates. The 4 percent at age 62 (early retirement) and 6 percent at age 77 (late retirement) is at the low end of the insurance pack. In addition, they offer no bonus for waiting prior to taking withdrawals -- something I consider a phantom interest credit, but nonetheless still of some value. Finally, the lack of guaranteed inflation protection and the inability to progress through guaranteed age bands reduces the appeal of the MGGI when compared to other offerings. Some competing products allow the retiree to get an income raise even if the account value hasn't reached a new high-water mark.
Of course, none of these highly-desirable features are available directly to consumers without a load or an intermediary, and they obviously cost more. So, if there is one thing that comes to mind when I review Fidelity's MGGI, it is the old maxim: There's No Such Thing as a Free Lunch.
Who is the Ideal Candidate?
If you are a fanatical Bogle acolyte for whom fees are the only things that matter, a 60/40 mix is all you want, and you appreciate the role and value of a GLWB in the retirement income portfolio, then this is the product for you. In fact, from a dynamic or strategic point of view, if markets perform extraordinarily well during the first five years of the policy, you can eventually exchange the product for another one with a possibly higher guaranteed withdrawal rate or better features. I call this a (costless) option to lapse, unlike a single premium income annuity (SPIA) in which you are locked-in forever.
However, if you have spent time in the 'wild' VA jungle and have been spoiled by the products manufactured by others in the recent past -- including MetLife -- and available exclusively through the advisory channel, you will yearn for the bonus, total investment flexibility and greater withdrawal rates available on other GLWBs. This is a cost-benefit analysis, pure and simple.
As much as I hate scoring variable annuities as if they were teenage contestants on American Idol, I am going to grade Fidelity's MGGI with a comprehensive 7.0/10. I'll check back with their design in the near future and perhaps revisit my marks if and when things change. However, as I tell my anxious undergraduate students at university, there is more to life than grades!
Moshe A. Milevsky, Ph.D. is an associate professor of finance at York University in Toronto, and Executive Director of the non-profit IFID Centre at the Fields Institute for Research in Mathematical Sciences. His latest book, entitled Your Money Milestones: a Guide to Making the 9 Most Important Financial Decisions in Your Life, was just published by FT/Pearson.