We have written in the past about concerns with the proliferation of benefits provided to variable annuities through the various riders that have come to market in recent years. In particular, we are concerned that 1) many consumers will not truly understand the impact of these riders on the pricing of their VAs, and 2) insurers may not always have correctly priced the features.
Moreover, some of these rider features have been difficult for consumers to understand, even when they receive statements of contract value. The benefits often require complex computations in order to determine their actual value.
Many of these riders are now finding their way into index annuities and even into traditional fixed annuities.
With the expansion of these features, a clear understanding of how they work is essential–an understanding that is not always available to contract owners.
Case in point: A friend of ours, a senior executive of a mainstream insurer, recently pointed out that the guaranteed minimum withdrawal benefit (GMWB) enables contract owners to determine correctly the benefit value merely by looking at the account statements most insurers provide, but this often is not the case with the guaranteed minimum income benefit (GMIB).
When contemplating a GMIB, the average consumer arrives at the simple conclusion that the benefits received will always be at least the percentage of the original premium specified in the rider. Thus, a 6% GMIB on a $100,000 investment would yield the greater of $6,000 per year or the annuity payment determined by the standard method for VAs.
Unfortunately, in many instances, GMIBs are not that simple and can be confusing and capable of misinterpretation. In fact, some of the ways GMIBs are sold sound almost too good to be true, at least for the price charged for the rider.
As our friend noted, an annuity contract owner with a GMWB can look at the periodic statement and easily determine how much the guarantee will yield in monthly distributions. Such a determination is generally not possible with a GMIB.
Yet, a GMIB, particularly with a variable annuity or an index annuity, is a valuable feature, one that can eliminate a great deal of the risk that is inherent in such types of investment. Anyone who survived the adverse stock market conditions of 2000 to 2002 can testify to the problems facing taking annuity payments from a VA that did not have a GMIB feature–particularly if the annuity payment was the sole source of income. The purchasing power of the monthly annuity payments would have been seriously eroded by the decline in value of the portfolios underlying most such VAs. That is the problem GMIBs were designed to solve.
We continue to believe that annuity payments, as opposed to mere withdrawals from an annuity, afford a superior form of retirement planning.
The “pooling” inherent with annuitization provides a guarantee against outliving funds available for retirement–something not available for mere withdrawals. Annuity payments, coupled with a GMIB, should be the perfect retirement package. It is the solution to the old notion that “being of sound mind, I spent it all.” It affords the opportunity for retirees to have themselves and their money terminate at the same time while affording a hedge against inflation combined with protection against adverse market fluctuations.
However, for a GMIB to be truly effective, purchasers need to understand exactly what they are getting for the extra premiums they have paid. Moreover, they should be able to monitor their contract as the years progress to determine exactly what the benefit will be.
A recent call to us from a consumer puts the issue in focus. The caller was considering buying a VA with a very generous GMIB. In fact, the GMIB was central to his consideration of the product. But the man had 3 concerns: 1) Was the benefit too good to be true? 2) Was the insurer financially strong enough to make the benefit viable? 3) How to reconcile the feature with articles in the mainstream financial press that trash VAs?
The product he described did seem almost too good to be true. The contractual language certainly supported the consumer’s understanding of what the rider promised, but without illustrations, it was impossible to determine the truth–and, remember, illustrations are not permitted with deferred VAs.
The insurer is one of the strongest in the industry, so solvency is not a concern. However, we certainly hope the insurer has adequate reinsurance to assist with the provision of such a generous benefit.
Concerning the bad press on VAs, we told the consumer that the mainstream financial press has always misunderstood VAs. The media seems to be unable to understand the role of a VA in longevity planning. The writers never consider that over half of all retirees will outlive the funds available for retirement and that the only solution is a life contingency annuity.
The consumer seemed to take our statements at face value (since we did not charge for such advice, it was probably worth what he paid for it).
However, he was still wondering how he could be sure what the benefit was that he was buying. This represents the major challenge that insurers face with respect to GMIBs: How to inform purchasers what they are buying and how to keep them informed in regular statements about how much they stand to receive when the benefit kicks in.
Illustrations are the answer, but illustrations can be as dangerous as they are useful, unless they are based on random market fluctuations. In any event, the industry needs to strive to clarify these questions if it is to provide the valuable benefit encompassed in a GMIB.