The guaranteed for life withdrawal benefit (GLWB) in variable annuities is being hailed as the answer to income needs in the retirement market. However, its limitations and suitability for satisfying consumer income needs (particularly when compared to life contingent payout annuities), need to be more fully understood, differentiated and disclosed. Otherwise, consumer, regulatory, and legal backlash are a real possibility.
Without question, GLWBs can be useful for the right client situation. Clearly, the benefit’s main perceived value sounds pretty good: It guarantees to provide a VA policyholder with an amount of money for life, via withdrawals, while the owner continues to invest in the policy’s subaccounts–and the owner does not have to give up access to the nest egg, nor do the beneficiaries have to wait to receive its value at death.
But a closer look points up some potential shortcomings that need scrutiny, as follows.
Is the guaranteed withdrawal amount all that good?
The guaranteed amount has commonly been 5% of principal at issue ages to 65, with higher percentages guaranteed at older ages for subsequent increases in account value. In at least one case, the percentage is increased for inflation, but starts at a lower rate. To consumers, that guaranteed amount may sound better than the 4%-4.5% withdrawal rate recommended as safe by economists.
However, the “recommended as safe” withdrawal rate anticipates increases for inflation. Though ratcheting for account value increases may appear to handle this, account values during the payout phase will most likely decrease, even with reasonable returns.
So again, the question: Are the guaranteed withdrawal rates all that good? Even a female age 65 could receive 6% a year, fully adjusted for inflation and guaranteed for life, from a fixed inflation-adjusted single premium immediate annuity. A 65-year-old male could get 6.7%; a 70-year-old male 8.3%, etc. Innovation could improve these percentages by another 20%. Now, that’s the way to beat the rule–guaranteed. Such a SPIA would have no value on death, but if the primary objective is income, not legacy, this is a moot point.
In addition, after-tax income on non-qualified SPIAs benefits from exclusion ratio treatment, whereas VA withdrawals are taxed on growth first.
Will GLWBs keep up with the retiree’s inflation?
In the February 6, 2006, issue of National Underwriter, an article by Moshe Milevsky used that question as the headline. It presented valuable analysis of GLWBs relative to inflation-adjusted income, concluding that for the product to work best, it should have a ratchet feature and be aggressively invested.
But even on that basis, the GLWB does not keep up with inflation in almost 50% of the projections. It doesn’t even come close 25% of the time.
The failure rate in life contingent income annuities is much lower, by definition. That is “by definition” because life contingent annuities not only guarantee income for life, they also provide a leveraging effect from their survivorship element.
This leveraging effect can be seen in the unbundled illustration shown in the accompanying table. The table shows a life-only payout annuity for a male, issue age 70, assuming 5% interest and 2000 annuity mortality. It results in an annual payout of $9,925 per $100,000 purchase payment (9.9%). (Note: The unbundling is analogous to the way universal life insurance “unbundles” whole life insurance, except that UL’s negative cost-of-insurance is embodied in the annuity’s positive survivorship credit for payouts.)
Under this unbundled retrospective bank account-like view:
o The beginning account value comes from 1.) the purchase payment in year one; and 2.) ending values in subsequent years.
o Interest is credited at 5% on beginning account values.
o Survivorship credits are applied to the account, because funds related to people dying during the year according to the mortality tables are “released” proportionately to those who live to the end of the year.
o The income payment that can be paid based on the lifetime assumptions is debited from the account.
o The year-ending account value is the result of these basic bank account-like transactions.
o The “banking” continues until the funds are all actuarially paid out (the for-life guarantee is not part of this solution, even in traditional SPIAs).
Note the extent the survivorship credit contributes to the higher income payment that can be made to all purchasers of life-contingent payout annuities–perhaps 30% or more! Variations of the unbundled approach can make it even more attractive as a product feature.
This whole survivorship benefit is under-discussed, under-appreciated, and under-utilized in the market. Yes, the survivorship element involves trading access to account and legacy values. However, if income is the need, then the survivorship element is at least as valuable and probably more appealing (given our culture’s focus on gain and in the short term) than the “for a lifetime” guarantee.
Utilizing both in a SPIA seems even better, as revealed by the unbundled approach.
How valuable is the access to the nest egg provided by the GLWB?
Skipping the survivorship element does allow access to cash values. But the access is at the expense of the income guarantee. This isn’t much of a problem if performance obviates the likelihood of the guarantees coming into play (though the GLWB fees would then be a drag on the values). However, if performance is such that the guarantees are apt to be relied upon, access would be problematical. Improved access to lifetime annuities also weakens this GLWB “advantage.”
Is the legacy value worth what the policyowner gets for the GLWB?
In those instances where the GLWB actually kicks in, there won’t be any legacy value remaining. Many other VAs with a GLWB will have only small legacy values; and, in all cases, the legacy value will be lower because of the GLWB fees. To the extent legacy values are desired, a more direct approach would be superior.
Those who live longer on lifetime annuities will also receive more income over their lifetimes and, all else being equal, they’ll end up with higher legacy amounts.
How suitable is the GLWB benefit for most clients?
It is the annuity industry’s responsibility to provide products appropriate to the needs of its customers.
So, then, what is the profile of a person for whom the GLWB is the right choice? Certainly people who are deficient in meeting their income needs should be focused more on life contingent annuities. In fact, studies show that well-crafted combinations of investments, including life contingent annuities but excluding GLWBs, are highly likely to provide income, access, and legacy benefits significantly superior to those offered by VAs with GLWBs.
In sum, distributors should carefully examine the suitability of GLWBs. Furthermore, insurers and distributors alike should remember that life contingent annuities can and do provide unique and unmatchable value, and they should put a priority on framing them to deliver their benefits more clearly and desirably.