Ask advisors what their top challenge is when dealing with risk-averse clients and they are likely to point to the chasm that separates the client’s financial objectives and the requisite risk exposure needed to attain those objectives.
How to bridge that chasm? Sources interviewed say that one time-tested strategy is to recommend a variable annuity backed by one or more guaranteed living benefits.
“As a general rule, these guarantees enable clients to be more aggressive with equity investments,” says David Morales, a registered rep and registered investment advisor with MetLife, New York. “So, a client who otherwise might have a 60-40 ratio of equities to fixed income might go with a 70-30 or 80-20 ratio when the investments are guaranteed.”
Mitchell Kauffman, an independent financial planner affiliated with St. Petersburg, Fla.-based Raymond James Financial Services, agrees, adding: “The VA’s guaranteed living benefit riders allow [clients] to be more concentrated in mutual funds than would otherwise be the case. [The GLBs] offer them peace of mind.”
GLBs come in three forms: a guaranteed minimum accumulation benefit (GMAB); a guaranteed minimum income benefit (GMIB) and a guaranteed minimum withdrawal benefit (GMWB).
Generally, the GMAB guarantees the client’s initial investment. At the end of the vesting period (typically 10 years), if the contract value is below that of the client’s initial investment, then the VA issuer will make a one-time adjustment, adding the difference between the current contract value and the initial premium (minus withdrawals), back to the contract.
The GMIB generally guarantees an income level when the client annuitizes based on the contract’s highest anniversary value (less withdrawals) and/or the premium payments accumulated at a guaranteed minimum annual compounding rate. This rate, which typically ranges from 4%-6% (less withdrawals), is guaranteed until annuitization, regardless of market conditions.
The GMWB guarantees a return of principal over time through systematic withdrawals. The amount of the withdrawal is typically about 7% of the principal annually for a period of 14 years. The annual withdrawals are guaranteed even if the contract value declines to zero.
Many insurers now offer such riders. In a November 2005 survey from Diversified Services Group, Wayne, Pa., 27 of 43 insurance companies, or 63% of those polled, said they offer one or more GLBs. Nineteen companies, or 44% of respondents, offer the GMWB. This compares with 40% and 37%, respectively, for the GMIB and GMAB riders. Additionally, 81% of the GLB products surveyed have a “step-up” feature that locks in market gains.
Clients who purchase these guarantees are not always without risk, experts point out. Many VA contracts require the client to hold the product for a period of years before the guarantee kicks in. But even when the guarantees are in force, there are limits to how aggressively the client can and should invest.
Steve Scanlon, a managing director for sub-advisory services at AllianceBernstein Investments, New York, observes that insurers generally require clients to subscribe to an asset allocation model to enjoy contract guarantees. Guided by the investor’s risk tolerance level and financial objectives, the company will apportion investment dollars among asset classes, each class being assigned a fixed percentage.