After two years of depressed sales, variable annuity gross sales have rebounded in 2003.
Year-to-date variable annuity sales totaled $63.3 billion through June 2003, according to Tillinghasts VALUE Survey. That is an 11% increase over the same period last year.
This puts variable annuity gross sales on track to end the year at $124 billion, just slightly ahead of 1999 levels, though still well below the markets peak of $138 billion in 2000.
What is driving this recovery? Guarantees.
The variable annuity market has historically been very feature-driven. This continues to be true today. Consumers and distributors, skittish from the sustained market downturn and volatile equity markets, have migrated toward the guarantees offered in many variable annuities.
These guarantees range from the minimum credited rate in the fixed account to the familiar guaranteed minimum death benefits to the ever-changing guaranteed minimum living benefits.
Living benefits come in many forms. These include: the guaranteed minimum income benefit, which guarantees a minimum level of income at annuitization; the guaranteed minimum accumulation benefit, which guarantees a minimum account value at some point in the future; and the newest twist, the guaranteed minimum withdrawal benefit (GMWB).
Many companies characterize the GMWB as a “safety net.” It is targeted for moderate to conservative consumers perhaps nearing or in retirement. So how does it work?
The GMWB guarantees a minimum stream of income, equal to the return of the contracts principal (often referred to as the “protected amount”), provided it is withdrawn within specified limits over time.
Most current benefit designs limit withdrawals to 5% to 7% per year (noncumulative).
As with some living benefits features, the GMWB has no “waiting period” before the policyholder can begin taking the income stream. (However, one product increases the withdrawal limit to 10% if withdrawals are deferred until after the third policy year. The delay allows the company a period to charge policyholders for the potential cost of the benefit, and it also provides time for the market to recover from early drops in value.)
Keeping with the popular menu approach to variable annuity product design, the GMWB is most often offered as an optional rider, to be added at or subsequent to issue, for an additional charge.
For those riders added subsequent to issue, the then current account value becomes the protected amount for the minimum guaranteed income stream. Subsequent premium payments increase the protected amount for some products; others limit the protected amount to premiums paid within the first two to four contract years.
Some of todays products do not allow the policyholder to cancel or drop the GMWB rider once it has been added to the policy (unless the entire policy is surrendered). This restriction is designed to prevent policyholders from anti-selecting by canceling the rider in up markets.
Some products do, however, allow the rider to be dropped after it has been inforce for a specified period (generally five to seven years).
Some policies further enhance the benefit by offering an optional “step-up” in the benefit after a specified time–generally five years–to the then current account value. This allows the policyholder to lock in the contracts gains.
While this step-up option may increase the cost of the benefit, it makes the feature more valuable to the policyholder. That is because the guarantee can still provide significant protection even after a series of good market years, whereas principal protection alone would not have much value in this circumstance.
The annual charge for the GMWB is typically 30 to 45 basis points of the account value. Some versions charge as much as 45 to 65 basis points of the protected amount.
Many riders that offer the optional step-up feature also specify an explicit guaranteed maximum on the charge, ranging from 75 to 100 basis points. So, there is the potential to increase the riders charge in the future. One product offers to waive the rider charge on a nonguaranteed basis if withdrawal activity is minimal.
While several GMWB riders require participation in an asset allocation program or preclude investment in certain funds–often the most volatile or risky funds–several GMWB features have no restrictions and allow 100% allocation to equity funds.
Withdrawal limits under the GMWB are not cumulative, so if a policyholder does not use the maximum amount, it cannot be carried over to the next year. Instead, unused withdrawal amounts increase the length of the income stream. Annual withdrawals in excess of the GMWB limits generally are allowed, although generally reduce future guaranteed withdrawals. Withdrawals taken under the GMWB are taxed as an ordinary withdrawal from a variable annuity.
The newest innovation in living benefits is fairly complex. Many of the components of the GMWB exist to mitigate risk to the company and thus, the cost to the policyholder. Some exist to create an attractive and worthwhile guarantee.
Overall, the presence of GMWB would be expected to increase partial withdrawal activity over current levels. This can negatively impact insurer profitability, particularly if not factored into pricing.
For those insurers that offer it, the GMWB has become one of the most important product features on distributors minds. Recent sales results support this. Given this success, more insurers will likely follow suit, and benefit designs will likely keep evolving. This bodes well for future variable annuity sales.
Nancy M. Kenneally, FSA, MAAA, is a senior consultant with Tillinghast- Towers Perrins financial services practice in New York. Her e-mail address is [email protected].
Reproduced from National Underwriter Life & Health/Financial Services Edition, October 3, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.