Let’s compare the projected performance of a typical variable deferred annuity with a no-load mutual fund for a conservative investor.
With the Best Interest sales standards in mind, and using proper analytical tools, here’s what I found: Traditionally, contracts have been compared one feature or facet at a time. However, different facets interact. You must consider each contract as a whole.
Here are just some of the tradeoffs that can complicate a simplistic comparison of the highlighted “product features”:
|The Highlighted Feature||The Related Tradeoff|
|Lower fees||Lower benefits|
|Guaranteed living withdrawal benefit fund with higher Crediting Rates||Lower payout rates or subaccount restrictions|
|Step-up options||Situations in which exercising these provisions leads to terminations of other benefits, or delays in a client’s ability to exercise certain benefits|
|Sign-up bonus||Recapture on surrender, higher fees, benefit deferrals|
|Lower surrender charges||Higher fees|
|Unrestricted subaccount selection||Higher fees for high-volatility subaccounts|
You’d get a skewed view of the proposed contract if you looked only at the kinds of highlighted product features listed above. What counts is what actually ends up in the policyholder’s pocketbook. You can determine that only by looking at both columns. In other words: The whole cash flow that the features and the related tradeoff provisions generate together.
Higher commissions generally lead to more tradeoffs. The commission challenge is for advisors to find the right product, where the advisors can earn a reasonable compensation for their due diligence and also act in their client’s best interest.
When I ran my comparison for this article, I deliberately picked a typical variable deferred annuity. In other words, one with relatively high fees and charges.
Because the client in this comparison a risk-averse client, the client’s no-load mutual fund subaccounts will be low-risk. Replace that fund with a variable deferred annuity with a guaranteed living withdrawal benefit and the variable deferred annuity subaccounts can be more aggressive. Why? Because variable deferred annuities are not solely investments. They’re also insurance products. The guaranteed living withdrawal will lessen the impact of any downsides.
The Plan: Fees were 1% for the conservative (low volatility/risk) subaccounts, 1.5% for the aggressive (high volatility/risk) ones with a mortality and expense charge of 1.05%. Surrender charges in first seven years of 7%, 6%, 5%, 4%, 3%, 2%, 1%. Charge-free withdrawals of 10% are allowed, starting in year two. The plan was single ownership, but with a joint option for income benefits. Commission was 5% of initial premium.
The Guaranteed Income Rider: The guaranteed living withdrawal benefit rider’s minimum base is a shadow fund with an annual 5% compounded growth. The cost was 1.5% of the account value, per annum. Payout rates for ages 65 through 67 were 5.1%, 5.29%, 5.5% for single life and 4.31%, 4.41%, 4.5% for joint lives. In all cases below, the conservative investor elects this rider.
A Diligent Set of Scenarios: Testing a few cherry-picked scenarios was simply inadequate for this task. With a large, representative sampling of scenarios, the only way to make the calculations tractable was to use a stochastic method. This automation provided a major facet of due diligence, with relatively little effort.
The Runs: To value the plan, I used the BI-SEM Evaluation Method to run stochastic simulations. All runs used the exact same 1,001 economic scenarios.
Here’s a summary of the results. (Go here for complete technical analyses.)