One variable annuity rider that drew little attention during the boom years seems to be gaining more notice among today’s skittish investors: the guaranteed minimum accumulation benefit.
“Based on the dramatic losses in asset value in 2008, the investing public is starting to learn just how significant a rider like this can be to the overall portfolio,” says Timothy Gahler, a senior annuity product specialist at Thrivent Financial for Lutherans, Minneapolis, Minn.
“Consumers who purchased a guaranteed minimum withdrawal benefit are now wishing they had a guarantee on their assets, rather than a withdrawal guarantee.”
Adds Ethan Young, a manager of Annuity Research at Commonwealth Financial Network, Waltham, Mass.: “For clients who want piece of mind, need to be in equities and otherwise would be too risk-averse to be invested in the stock market, the GMAB can help them stay the course. And with fees ranging from 35 to 65 basis points, the rider is relatively inexpensive compared to other guaranteed living benefits offered on VAs.”
The GMAB rider allows investors to protect principal by either locking in growth or accepting the annuity company’s guaranteed return during a set term, such as 10 years. At the end of the term, the account value will be the greater of the contract value or the GMAB value. Upshot: no matter what happens in the markets, the client’s investment is protected for at least the GMAB’s term.
The GMAB’s key attraction–the ability to walk away at the end of contract period with a guaranteed lump sum–is making the rider increasingly attractive to market-wary investors. If the economy contracts further, observers say, interest in the rider among prospects will likely grow.
Enthusiasm for the benefit isn’t shared by all product manufacturers. Paradoxically, fewer insurers are offering the rider than in years past–or else jacking up its fee–because of the heightened risk of making good on the guarantee during a downturn, points out John Olsen, John L. Olsen, a chartered financial consultant and principal of Olsen Financial Group, Kirkwood, Mo.
“The guaranteed amount has to be paid in one lump sum, rather than over time, which would be easier on the carrier’s cash flow,” says Olsen. “My impression is that many insurers have crunched the numbers and determined that in an environment of extreme volatility, [offering the rider] is simply too big a risk to take for what they’re charging.”
Sources say the GMAB is most appropriate for the conservative to moderate investor who has a long-term investment horizon, typically 7 to 10 years. The key motivators for buying the rider are its guarantee of principal protection and, secondarily, the potential it offers for growth.
When attached to a VA, the rider is often compared to a fixed indexed annuity, which also offers upside potential with no downside risk. But unlike FIAs (the value of which will vary according to a complicated interplay of the vehicle’s gain formula, participation rate and market value adjustment), a VA with GMAB enjoys unlimited upside potential.
True, the client pays a fee for the rider. But one can argue that the FIA’s cap on market gains is itself a hidden, and potentially larger, cost.
There is no overt cost associated with FIAs, notes Young of Annuity Research. “But that doesn’t mean you’re not paying for it. If the first year participation rate EIA is 80%, then it drops to 30% next year, I would argue the decline represents a hefty cost.”
What needs to be weighed when recommending one or another GMAB option to a client? In addition to the fee, experts say, advisors need to consider the hold period: a contract term, typically 7 to 10 years, that must pass before the rider kicks in.
Long hold periods, observes Young, aren’t necessarily a bad thing. He says that if the rider is coupled with a B-share annuity that comes with a declining surrender charge schedule, the client might actually pay less in fees than if he or she were to own a more liquid C-share annuity that carries no surrender charge.
Also to consider is what the rider actually stipulates. Some GMABs, says Gahler, guarantee only a return of premium after a given waiting period. Others tie the guarantee to the performance of an asset allocation subaccount selected by the client based on risk tolerance. For a moderately conservative portfolio allocation, for example, the client might enjoy a guaranteed 1% annualized return; for a more aggressive investor, the return might rise to 2%.
Advisors also need to read the fine-print on such subaccounts. Some insurers, notes Olsen, place asset allocation restrictions on the rider, limiting the client’s choices to a fixed ratio of conservative to aggressive investments. The carrier may also reserve the right to move assets from the subaccounts to a fixed account to reduce the risk, thereby limiting the product’s performance potential. The insurer may additionally stipulate conditions that, if invoked, would invalidate the rider.
These provisions often are not fully understood by agents, he adds. And many among them don’t realize that the guarantee is only as good as the guarantor. Advisors thus need to factor in the company’s financial strength and, especially, the hedging strategies it uses to mitigate market risk associated with the guarantee.
Olsen notes also that the GMAB is inappropriate for clients who purchase an annuity to pass on a lump sum to heirs or to secure the product’s principal benefit (a guaranteed source of income).
“If you want to leave money to the kids, buy life insurance,” he says. “An annuity, with or without a GMAB option is probably the worst mechanism for transferring wealth inter-generationally because of the tax treatment. Also, an annuity is designed to produce income. So why treat it as an accumulation device?”
Herb Daroff, a partner at Baystate Financial Planning, Boston, Mass., agrees, noting also that GMAB option, even in the current economic climate, remains the least attractive of riders available on annuity contracts, and is only appropriate for the “transactional investor” who is looking to invest without risk.
Generally, Daroff says, clients with income needs will be better served by annuities offering the guaranteed minimum income or withdrawal riders.
“If you’re an advisor and are recommending a GMAB rider, then you better make sure you cover for the client why the GMIB and GMWB riders aren’t better options,” says Daroff. “These last two are superior to the GMAB for most every situation we run into.”