An increasing number of fixed indexed annuities (FIAs) are now sold with guaranteed lifetime withdrawal benefits (GLWBs). Though common historically on variable annuities, GLWBs on FIAs are something of a new phenomenon as is policyholder behavior in regards to the utilization of those riders.
With that in mind, Ruark Consulting, LLC recently undertook its first-ever study of partial withdrawals on FIAs.
Under a partial withdrawal provision, a policyholder can take cash out of the contract before the lifetime income benefit commences, although they will pay a penalty. However, as Peter Gourley, vice president at Ruark, points out, most contracts allow the policyholder to take a “free” withdrawal amount (typically 10 percent of the contract) in any given year without paying a surrender charge.
To gauge policyholder behavior in regards to partial withdrawals, Ruark reviewed more than 8 million contract years of exposure between January 2006 and September 2012 submitted by 11 companies, including most of the major FIA writers. Highlighted was the partial withdrawal experience under those contracts, even those without a GLWB. (Ruark declines to reveal exact statistics, characterizing the results only in generalities.)
Overall, Gourley admits the results diverged a bit from conventional wisdom. For instance, the company found that having a free withdrawal option had “a significant effect” on withdrawal behavior, including those with a lifetime withdrawal feature.
In other words, taking those free withdrawals becomes ingrained in the contract owner’s behavior. Even though they know taking those free withdrawals ultimately cuts into the guarantee, they continue to taking them. “It might be the guarantee is not the foremost reason they are buying the contract as much as the immediate cash need of the free withdrawal amount,” Gourley speculates.
Although policies with the GLWB rider take withdrawals less frequently than those without that clause and less by amount prior to turning on the lifetime income, the withdrawals “are still at levels that are detrimental to the guarantee,” notes Ruark in its summary of the study. Both the firm and its clients were “surprised” by that finding.
Since policyholders pay extra for the GLWB rider, having that guarantee would, in theory, dampen the taking of early or excess withdrawals. For example, in a typical GLWB rider, a policyholder waits until 65 to take 5 percent of the contract’s guaranteed value out every year for life. If they withdraw more than 5 percent, the guarantee is reduced proportionately. Taking withdrawals before age 65 further diminishes the guarantee.
However, the study indicated that the guarantee had a negligible impact on withdrawal behavior. “Although there was a little bit of a depressive effect compared to contracts that don’t have this guarantee rider, it wasn’t nearly as much as we would have thought,” Gourley explains. “We saw quite a few contracts taking withdrawals before they were eligible to start lifetime withdrawals and in doing so, that hurts the guarantee and degrades the benefit.”
Nevertheless, FIA owners with the GLWB have shown a reluctance to turn on the lifetime income benefit, doing so in the “low single digits,” Gourley says, even lower than what is charted on variable annuities (VAs) with similar guarantees.
That could be because the guaranteed income rider on a FIA is somewhat less valuable than the same benefit on a variable annuity, Gourley theorizes. In a VA contract, the account value can plunge to zero, something that is not going to happen in a FIA contract. “You might not get an interest credit, but the account value won’t go down,” he says. “So a guarantee that protects that [account value is] therefore a little less valuable on a FIA than on a variable annuity.”
Impact of interest rates
Will a rise in interest rates have much influence on FIA policyholder behavior? Possibly, but Gourley doesn’t think it will have a significant impact. While higher interest rates are good for interest crediting, Gourley is not sure withdrawal behavior is predicated on interest rates. More likely, an owner has either started taking the income in retirement or they have an immediate cash need, like a tuition payment (if they are in their 50s). “Those are still going to happen regardless of where interest rates are,” Gourley says.
Gourley says these initial results are favorable to carriers. “The most damaging way a guarantee can be used versus a company would be someone who takes the withdrawal amount when they are supposed to and at the amount that is guaranteed and that’s not really the behavior we’ve seen so far,” Gourley says. “Maybe ultimately that will be true, but to the extent that it is not true so far, that is certainly good for the carriers’ risk profile.
Yet Gourley cautions that it’s too early to make any definitive statement on FIAs with GLWBs and carriers need to continue to monitor policyholder behavior. “They don’t want to get caught unawares if people start using them a lot more to the detriment of the company’s risk profile.”