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Upgrading a Policy: Protect Your Client’s Cash

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Annuities have come a long way from their inception, and today there are numerous riders and benefits to consider when you assess the product’s suitability for your client. To give your client the optimum return on their investment, you must become knowledgeable about which benefits are available.

If your client has an older annuity policy, they might consider switching to a newer contract with better benefits. During this transition, it is critical to know which living and death benefits your client has in place. To demonstrate the difference, imagine your client has a $1 million policy with a value currently at $500,000, and he would like to move from his original policy to a newer contract.

Death Benefit

When considering death benefit options, your client should be encouraged to choose dollar-for-dollar on their contract, rather than selecting pro rata. Assume the client has made a $1 million contribution to his annuity. Further assume that the account hit a market high of $1.5 million. Now the value has fallen to $1 million from the $1.5 million. Now the client withdraws $900,000 from the contract. This will leave a $600,000 death benefit with only a $100,000 policy value. The $900,000 can be rolled over to a new variable annuity (assuming this makes sense) with no loss of death benefit. You must pay attention to any remaining surrender charges as well.

With a pro rata death benefit, if your client leaves a small sum of money in the original contract, the company will likely only pay out the difference. For instance, if the client keeps $1,500 in the old policy, the company may say, “You’ve stripped 98 percent of the benefit; therefore, we will pay 2 percent of the original $1 million investment.” Your client stands to lose a substantial amount of money in the transition.

Living Benefit

Conversely, in regard to a living benefit, a client will be better served by a pro rata calculation than a policy value reduction in living benefit. When dealing with a policy value reduction calculation, the client has a greater chance of seeing a larger reduction in his yearly distributions. Since the client starts with $1 million, the company would guarantee him 5 percent of the original investment, or $50,000 a year for the rest of his lifespan. If after 10 years, the market is flat and the client has pulled $500,000 out of the contract but needs to withdraw an additional $100,000, he has essentially broken the guarantee by leaving only $400,000 in the policy. He has now taken a non-complaint withdrawal. The company then can reduce the payout to 5 percent of that amount, or $20,000 per year. For the most part, this type of calculation no longer exists. 

In the same scenario, if the client has a pro rata living benefit, the policy-issuing company will assess what percent the $100,000 was of that $400,000 when he withdrew the money. The $100,000 reduction translates to a 25 percent reduction in the value. Since the company promised the client $50,000 per year, they will only take 25 percent of that sum away, resulting in a $37,500 per year distribution. Another way to look at this is that the insurance company will reduce the guaranteed value from $1 million to $750,000. Five percent of the $750,000 will result in $37,500 per year in payments for life.

By looking at these hypothetical situations, it becomes clear which benefits will provide the largest amount of money to your client. Though every situation is unique and client suitability is critical, you will likely want to suggest a dollar-for-dollar death benefit and a pro rata living benefit when adding an annuity to a client’s portfolio.

Important disclosures regarding riders:

  • Living benefit riders and guarantees are subject to additional costs and restrictions above and beyond the basic annuity contract. Living benefit riders may not be suitable for all investors.
  • Guarantees are based on the claims-paying abilities of the issuing insurance company.

This article is for advisor use only.  It is not intended for use with clients or the public.


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