The annuity industry gets into trouble occasionally by not discouraging the overselling of potential returns; now some in the business are doing the same thing with guaranteed lifetime withdrawal benefits in annuities.
E-mails are coming into my office from consumers saying they were told their variable annuity was “guaranteed to double in value in 10 years. “
Meanwhile, some index annuity ads are talking about guaranteeing 6%, 7%, 8% annual growth or an upfront income account bonus. These ads do state that this growth is on the value of the guaranteed income account, but the disclosure is inadequate and does little to build consumer understanding of what GLWB guarantees really mean.
These problems may well result in another round of class action lawsuits against industry providers, plus unwelcome regulatory attention in the future.
So, what do the GLWB guarantees really mean? These growth guarantees are designed to generate a higher level of guaranteed lifetime withdrawals.
Suppose a 60-year-old puts $100,000 into an index annuity and earns a net 4% forever. By age 70, the annuity would have an actual account value of $148,024. The guaranteed lifetime withdrawal benefit payout rate for a 70-year-old under many GLWB riders is 6%, so the person could withdraw $8,881 until death.
Let’s say a new annuity comes along that guarantees 10% annual GLWB “income account growth” for 10 years. This policy would produce an “income account value” of $259,374 after 10 years. At a 6% payout rate, this $259,374 would generate a lifetime income flow of $15,562 a year–a big difference from the $8,881/year payout the owner would receive if 6% payouts are based on actual account value.
But if the owner believes he/she could receive the full $259,374 by cashing in the annuity after 10 years, when at age 70, the client is bound to be unhappy. That’s because, for cash-outs, owners only receive the actual account value (in this case, $148,024 minus any surrender charges). The guaranteed income account growth value (i.e., 10% growth over the first 10 years) is only for the income guarantee; it has no relationship with growth of the policy’s actual account value.
Now, say the owner has an actual account value of $148,024, earns 4%, and withdraws $15,262 a year–based on the 10% income account factor–beginning at age 70. In such a case, the annuity’s cash will be gone by age 83. The “guaranteed” part of the GLWB does not come into play until age 84. If death occurs before then, the owner has simply spent down his own money and the heirs receive what’s left.
This leads to the positive aspect of the income account guarantees: simply put, if the owner withdraws $15,262 on a balance of $148,024, the owner could easily run out of money by his/her mid-80s; but if the policy has a lifetime benefit account growth guarantee, this income will continue for life, providing the owner with a true and honest value proposition.
What was the actual return to the owner of the 10% guaranteed growth? If the owner dies before age 83, the value is zero. Remember, if the annuity earns 4% and pays out $15,262, the money would last to age 83 anyway, and the heirs always receive the balance of the actual account value (not the income account value). But if the owner dies at age 90, the value of the initial 10% income growth guarantee is 7.57%–since earning 7.57% for the first 10 years would have meant the owner could have received $15,262 until age 90.
How long would the owner have to live until the 10% income growth guarantee truly becomes a 10% yield? Age 99.
So, a carrier touting “10% growth for 10 years” should follow on by saying “if you live to be 100.” Also, since owners do not receive financial value from growth guarantees until their money is used up, the carrier should state this in the annuity materials.
It’s not essential for the disclosure to say something like “you will receive this benefit if you live long enough.” But policy materials do need to emphasize that any guarantees increase the future benefit of the GLWB and should not be considered a current yield or return.
But remember, most customers do not differentiate between yield and payout in the first place. So, hyping income account growth guarantees can lead to confusion. A possible solution is to ban the mention of growth rate guarantees entirely and only cite examples of “enhanced” payouts that would be received at different ages.
GLWBs are attractive since they preserve freedom and flexibility. They represent a true value that should make consumers more rational in their overall retirement planning. But the insurance industry must ensure that consumers know what they are getting with a GLWB and not oversell the benefit.