It is arguable that the most popular features to be added to variable annuities in recent years are guaranteed minimum withdrawal benefits. Many mainstream VA insurers have added these features to their products, which have proven to be extremely popular with producers and consumers alike.
In recent months, we have not been to a dinner party or cocktail reception where someone hasn’t asked our opinions on these features. It is indeed amazing how deeply the awareness of these features has penetrated the general investing public.
The prevailing attitude is that the GMWB permits a VA contract owner to “have his cake and eat it too.” One friend, a well-to-do physician, stated that he had bought a VA with a GMWB with over a million dollar premium. His only worry? That it was too good to be true.
Where else can this physician invest with the upside of participation in the stock market while at the same time being protected against the vagaries of down markets? The answer at the present time is nowhere. Yet this is not likely to be so in the not-too-distant future.
Most likely, virtually every major investment firm is busily working on providing a GMWB to customers who buy mutual funds, managed separate accounts and even hedge funds–all without requiring the client to become involved with a VA. We are not aware of any such guarantees having come to market as of yet. But we are busy developing the concept, and we are sure others in our line of business are doing likewise.
If the GMWB comes to market with non-VA investments, it will not be the first time that concepts developed for VAs have been adapted to the broader spectrum investment marketplace.
The rear-end sales load for mutual funds is such an example. The concept (legally characterized as the “contingent deferred sales charge”) was developed for VAs and came to market in 1979. Shortly thereafter, the CDSC was adapted to mutual funds and trillions of dollars of CDSC mutual funds have been sold since that time, as well as the majority of VAs with CDSCs.
Adapting a GMWB to non-VA investments presents a number of legal and actuarial challenges, not to mention the investment complications involved in guaranteeing a minimum payout that may run for decades in the future. It requires close cooperation among all of the technical disciplines involved in the guarantee.
Even such basic issues as determining the legal status of the guarantee when it’s not attached to an insurance product is a challenge. Furthermore, the determination of which regulators must be involved is often mind-boggling.
Taking the basic form of the guarantee–a mutual fund with a GMWB attached–the product seems simple on the surface. After all, it is a close relative to a VA with GMWB, particularly since most VAs have mutual funds as their underlying investment element.
However, once the GMWB is separated from an insurance product, it no longer is a feature that is “incidental” to the insurance contract. While it may be “incidental” to the mutual fund investment, mutual funds do not have the legal status that permits the attachment of a GMWB offered by the issuer of the contract.
Clearly, a financial guarantee against down markets can be offered by a mutual fund as an “incidental” feature. However, guaranteed withdrawals for life put the concept squarely in the realm of “insurance.”
If it is determined that the guarantee of lifetime withdrawals is an “insurance” feature, it will require that the GMWB be undertaken by a legal reserve life insurance company that assumes the longevity risk. Yet, the market risk component of a GMWB is more of a financial guarantee than it is an insurance guarantee.
Few insurers will feel comfortable assuming the market risk without the involvement of a financially secure third party that either can hedge the risk or has the capacity to absorb the risk through the use of creative investment strategies. The complexity of the reinsurance requirements for such a guarantee is, in itself, a substantial challenge to those who desire to develop such a product.
From a historical standpoint, there is little doubt that investments in the stock market, held for an extended period of time, should out-perform the GMWB level of guarantees. Unfortunately, “the devil is in the details.” Short-term adjustments in the stock market can wreck havoc on the provider of such a guarantee if the provider has not properly hedged the risk.
Moreover, the long-term nature of the guarantee means the providers of the guarantee must look into their crystal ball to predict market conditions decades into the future, as well as predict longevity trends.
There are additional problems to be solved. There are limited numbers of financial institutions in the world that are capable of assuming the market risk inherent in GMWBs. In addition, there may be capacity problems among these few financial institutions in finding the types of investment instruments that will permit widespread use of GMWB guarantees. The mutual fund universe alone is comprised of many trillions of dollars of funds under management. A limited capacity of investment instruments available to permit the GMWB to be safely offered may limit the amounts of mutual funds that can have the GMWB available, not to mention other non-mutual fund types of investments.
We are confident that the problems can be solved to enable the insurance industry to participate in this interesting development in the investment marketplace. Hopefully, it will spark other “crossovers” from insurance into the investment industry.