My feature on contingent deferred annuities portrays a generally positive future for these newfangled insurance products, one that could yield a significant revenue stream for fee-based investment advisors. Financial professionals would be wise, however, to consider some caveats before investing much time and resources in this nascent market.
Let’s start with a big one. The CDA—a guaranteed minimum withdrawal benefit that offers principal protection and the assurance of a lifetime income stream—is, depending on the contract, potentially no match in bear markets for another popular rider that can only be offered with variable annuities: the guaranteed minimum income benefit.
Why might be a GMIB be superior to the GMWB? To use an example cited by Herb Daroff, a partner at Baystate Financial Partners in Boston, consider a hypothetical 54-year-old client with an initial investment of $100,000 in May 2001, when the Dow Jones Industrial Average reached the 14,000 mark, a high that it has not since attained. With a GMWB rider, the now retired client would be assured in 2013 of an income stream totaling $100,000, despite market troughs in the intervening years.
But if the same client were to pay an additional fee in 2001 for a GMIB rider offering a guaranteed 6% payout, compounded annually, then the accumulated value will be significantly greater. Given the rule of 72—the number of years required to double one’s money at a given interest rate—the investment would by 2013 have doubled to $200,000 (72/6 = 12 years).
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The client may thus decide that a GMIB rider on a VA is a better deal than a CDA, even if the VA comes at a higher expense. Only in bull markets, when both a CDA and the VA enjoy gains equally, would the lower-cost CDA be superior, notes Daroff.
Performance relative to the VA aside, there’s another reason to counsel caution in projecting CDAs’ growth potential: market-strangling regulation. As I note in my feature, the National Association of Insurance Commissioners ruled in March that CDAs qualify as hybrid insurance products, but has charged a subcommittee with determining the appropriate capital reserve requirements for the products.
Moshe Milevsky, a professor of finance for the Schulich School of Business at York University in Toronto, warns that if the NAIC imposes excessive reserve requirements, it could kill off CDAs.