Variable annuities and variable universal life insurance have many bona fide, substantive distinctions. But developers are exploring ways to incorporate features of one type of product into the other.
We will look at this convergent trend here.
One current distinction between the products is in how they are sold. VAs are sold as money purchase, single purchase (by and large) investment vehicles. VULs, on the other hand, are sold primarily based upon death benefit and as a multi-pay vehicle.
Distribution also is significantly different. VAs sell very heavily in financial distribution channels such as wire houses and banks. In these channels, there is relatively little life insurance exposure.
Product designs are rather different, too. As a practical matter, VAs have focused on providing certain kinds of guaranteed living and death benefits. This is done partly to distinguish the products from investments such as mutual funds and partly to respond to the renewed awareness of investment risk.
Going forward, the next wave of product development–which is, in fact, already under way–will likely see life products developed with marketing and product features similar to those associated with variable annuities.
Many industry commentators, including attorneys Norse Blazzard and Judy Hasenauer who write regularly for National Underwriter, have commented on the inherent advantages that life insurance products have over annuities. These advantages include income-tax-free proceeds to heirs for both Modified Endowment Contracts (MECs) and non-Modified Endowment Contracts (non-MECs).
The life insurance advantages also include, very prominently, the ability to structure living distributions so that the policy owner will not incur income taxation as well (only possible in a non-MEC). This latter feature is a compelling competitive advantage for properly structured life insurances that emphasize retirement income.
One of the big challenges facing writers and manufacturers of VULs (and other life products as well) is how to demonstrate their financial efficacy. With very few exceptions, the reality today is that such demonstrations are based upon the assumption of a level gross investment rate. The demonstrations rarely present the quantitative impact of investment volatility.
Now, let us turn the focus to some current VA design features–the Guaranteed Minimum Withdrawal Benefit and the Guaranteed Minimum Income Benefit.
The GMWB. VA writers, rather than focus on presenting performance on different investment assumptions, have opted to develop guarantees that cover clients in case of adverse investment performance. That is, they provide a true underlying floor to performance.
The Guaranteed Minimum Withdrawal Benefit is one such feature and it promises a minimum withdrawal amount over a set period. For example, the owner can take a string of withdrawals, each equal to 7% of the initial investment, until the owner has withdrawn the entire initial investment from the contract.
There certainly can be variations in design. Some of these GMWB features might, for instance, promise even higher total payouts than the initial investment. That would, of course, influence the incremental cost–an increase in mortality and expense charges.
The GMIB. Another VA feature is the Guaranteed Minimum Income Benefit, which promises that the owner can annuitize an asset base after a specified number of years. The key is that the asset base is the larger of the account value and an accumulation, often at 5% or 6%, of the initial investment.
Buyers who choose this feature may therefore perceive they are guaranteed an investment return of the specified percentage, even though the only way to receive the value is via annuitization at what may not be the most favorable purchase rates.
The intriguing question to be asked is this: Can these 2 VA designs be restructured so they can be added to life insurance vehicles, VUL in particular? The answer is an emphatic “yes.” The same advantages that inure to VAs will apply to the life insurance product. That is, major investment downside protection now can be provided in the life insurance contracts.
The box on this page identifies some issues that developers need to address when going in this direction.
Although annuity and insurance offerings will never completely morph into one product design, the activities of the last few years have resulted in major convergence of designs and processes. These new features promise to accelerate the convergence further.
, FSA, MAAA, CLU, is president of Actuarial Strategies Inc., Bloomfield, Conn. E-mail him at [email protected]
Reproduced from National Underwriter Life & Health/Financial Services Edition, February 13, 2004. Copyright 2004 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.