VA Living Benefits: The Good, The Bad And The Truth

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About 6 years ago, one of the most prominent variable annuity product innovations first appeared: optional living benefits.

These features quickly responded to a market that wanted it all: to benefit from stock market opportunity while, at the same time, limiting investor risk. Not long after rollout, they began changing the way investment professionals were selling annuitiesby combining the VAs tax-deferred benefit with a new focus on protection with growth for clients. Today, many annuity manufacturers are working hard to differentiate their living benefits offerings and increase annuity sales as a result.

That makes this a good time to examine the complete living benefits picturethe good, the bad and the truth

The Good

Living benefits offer real protection to investors who seek it. In fact, there are now a variety of living benefits from which to choose:

A safety net that ensures a reliable, predictable minimum lifetime income stream in retirement.

Assurance that at least the principal invested will be returned in full over time via withdrawals.

The guarantee of a future value and the ability to lock-in gains from strong market performance.

In addition, living benefit guarantees can provide a cushion against the real villain for retirees: poor investment performance early in retirement.

The best way to demonstrate the impact of poor early portfolio performance is to show it. The table on this page details 2 outcomes for an investor who retires with a portfolio of $600,000 and plans to withdraw $30,000 per year (adjusted for inflation) for 30 years. The left side shows that, if the market declines in the first few years of retirement, the investor runs out of money by year 18 (as denoted in the blue highlighting). But, if the order of returns is reversed, with positive returns at the beginning of retirement and negative returns near the end (see the right side), the investor still has substantial assets after 30 years.

In short, the “sequence of performance” makes a difference.

The Bad

The rap against living benefits is that they add to annuity costs. But, guaranteed protection is not free, and, as is the case with living benefits, not cheap. Fees for living benefits vary by company and type of benefit purchased, but they typically cost anywhere from 0.25% to 0.60% of a clients account value each year. That fee may be a charge against account value on a daily basis, or it may be a single annual charge. In any case, the extra cost of the optional benefit can dampen growth of account value.

Another potential drawback of living benefits is that the cost absorbed can be more than just the fee. For instance, some living benefits require election of certain asset allocation programs or use of specific funds. Depending on the funds available with a living benefit, that ultimately can limit an investors investment choices, which can compromise the full range and flexibility otherwise enjoyed. Also, this could dampen an investors participation in a period of aggressive market growth.

Finally, investors and, in some cases, even their investment professionals may not fully understand the available living benefits, including limitations and time horizons required for benefits to work.

The Truth

The first truth relates back to the point about “bad” fees for living benefits. With living benefits, clients are buying the “insurance” that protects the money invested in an annuity. Like any insurance protection, however, there is cost and risk assumed by the insurance company. This is not a new idea in risk management. It is the cost for transferring risk from the individual to the insurance company. This occurs every day with homeowners insurance, auto insurance and life insurance. The fee is paid to protect your clients against a loss they do not want or cannot afford.

A second truth is that living benefits are popular, dynamic and continually changing. One kind of benefit does not fit all clients, and investment professionals need to develop and maintain education and training on whats available and understand how these protective guarantees work.

Finally, heres a truth the annuity industry knows well: One thing you cannot put a price on is the clients self-security. When they are suitable, optional living benefits can protect clients against unnerving market fluctuations and provide a paycheck for life.

is president of Prudential Annuities, the domestic annuity business for Prudential Financial Inc., Newark, N.J. He can be reached at david.odenath@prudential.com.


Reproduced from National Underwriter Edition, February 25, 2005. Copyright 2005 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.