Numbers falling over pale eyes (Credit: Shutterstock)

This is a follow-up to an earlier article that describes a free analytical tool I have developed for analyzing annuities.

My objective here is not to recommend any specific products or insurers, but instead, to show what a detailed analysis can reveal.

A deferred annuity often makes up a sizable chunk of a client’s portfolio. Advisors should, at a minimum, invest the time and effort to get each client the best available deal, while remembering that a product is not a contract.

A contract is a customized instance of a product, and it must be evaluated as such. It might be a bad fit for a male aged 45 but an excellent fit for a female aged 56. An advisor must always crunch the numbers for the client’s own customized contract.

(Related: Best Interest for Conservative Investors)

Advisors then must justify any ongoing compensation by showing how they’ll earn the compensation, not only by getting a client the best deal, by monitoring the contract as long as the contract is in force.

Deferred annuities can be quite complicated. Evaluating one properly can’t be done by simply comparing contract features, or projecting a few cherry-picked accumulation fund projections. This ignores a large number of possible cash-flow paths, all of which can change on the fly, due to changes in the markets, the contract, or to your client’s key attributes, such as the client’s health, goals, tax bracket, risk appetite and marital status.

Most of these paths are ignored in an evaluation, mainly due to shortcomings in the software or analytical method used. That’s a big mistake, as some of these paths, if elected, could have a major positive impact on the client’s retirement income.

Many insurers have offered variable annuities with rich income benefits over the years. This is especially true for ones issued from the mid-1990s to the mid-2000s, when the stock market was rising, and interest rates were higher. If a client has one of the annuities issued during that period, the advisor should crunch the numbers before making any recommendations. An income gold mine might still be in there somewhere.

What to Look For

The best deals are seldom the best due to major contract features. Instead, they occur in rarely examined areas, and, less often, when the insurer errs in the policyholder’s favor. That’s why it’s imperative to check all plausible income paths and to look for any outliers, even for much older ages. For example, suppose a contract has a rich living benefit starting at age 73, which is outside the client’s targeted retirement age range. For a client with some flexibility, the best strategy might be to cover living expenses with Social Security or investments until age 73, then exercise the rich living benefit at age 73.

Therefore, we’re looking for contracts with the richest living benefits, even when the products are ostensibly used as a tax-deferral vehicle only. However, this is not always obvious. We know the payout rates but often not the size of the future base the payout rates are applied to. That’s why it’s important to crunch the numbers over a broad range of both target ages and contracts.

Common drivers of the best deals fall into several categories. In each category, conditions may be present that are beneficial but not obvious.

Here are some of the conditions that diligent calculation may reveal.

  1. Guaranteed Income Benefits (GIB)

Here, take note of:

  • Payout rates based on a shadow fund with overly generous crediting rates.
  • Generous single-life payout rates for one or more target ages.
  • Generous joint-life payout rates (more likely to occur than generous single-life payout rates).
  • Generous payout rates at seldom-tested older ages, outside the targeted range.
  • Step-ups to the greater of account value and shadow fund balance.
  • Few or no restrictions when income elections can start.
  • No restriction on electing high-volatility subaccounts (variable) that would allow aggressive subaccount investments, and that are hedged by the GIB.
  1. Guaranteed Withdrawal Benefits (GWB)

All of the conditions for GIB may apply here.  In addition, the contract may have a guaranteed living withdrawal benefit (GLWB) option where payouts continue even after the account value goes to zero, and when the client has a high longevity estimate.

  1. Death Benefits

Here look for minimum guaranteed death benefits (MGDB) greater than the account value.

  1. Bonuses

These may increase future account values and related benefits.

  1. Subaccounts

Some contracts may allow for unrestricted selections, even when a guaranteed income benefit or guaranteed withdrawal benefit is elected.

  1. Cash Surrenders

This might be the greatest benefit but is rarely an outlier for a client. However, it’s the most important benefit when the client’s goal is for tax-deferral only.

Analysis in Action

Start by selecting and constructing contracts for testing and comparison.

I picked a typical variable contract with aggressive subaccounts, a fixed indexed contract with a 10% cap (and a 4% cap floor), 100% par, in an aggressive index, and a fixed contract with 3% guaranteed for 15 years, for a male age 55, all with the same guaranteed living withdrawal benefit, except that the variable contract had a more generous joint living benefit for ages male 70 and female 68. I looked only at contracts for purchase. However, the same approach could be used post-sale to meet on-going Best Interest due diligence requirements, to determine if a contract needs to be replaced or requires some other action.

I ran my BI-SEM analytical tool on each candidate contract. The tool automatically simulates thousands of stochastic scenarios, that anticipate optimum paths, under various client parameters, for the future calibrated random ebbs and flows of the markets.  In other words, choose the contract that, on average, performs best under a range of numerous economic scenarios.

Discounts here are based on the policyholder’s risk-appetite, and estimated evaluations are equal to a ‘solved-for’ amount that’s invested, at the start, in a parallel theoretical no-load mutual fund. For a more detailed explanation, look here. For analyses of the above 12 evaluations, look here.

In this mutual fund, for each scenario, these discount rates accumulate the ‘solved-for’ amount, so that the amount exactly funds the contract’s estimated projected future cash payments to the client, net of taxes.


Client Attributes
Premium Sex Target Retirement Age Estimated Longevity Issue Ages Tax Qualified
$100,000 M 65 M-81, F-87 M-55/ F-53 No


Conservative Risk-Appetite Evaluations
Reference Number Plan Type Target Age Range 0th Percentile 25th Percentile 50th Percentile/ Median 75th Percentile 100th Percentile
1 Variable 65-69 79,863 130,119 195,976 353,045 2,740,872
2 Variable 65-70 101,404 156,506 204,841 370,649 2,740,872
3 Fixed 65-69 88,904 129,127 140,963 151,799 201,316
4 Indexed 65-69 80,848 101,192 108,600 116,518 148,092


Moderate Risk-Appetite Evaluations
Reference Number Plan Type Target Age Range 0th Percentile 25th Percentile 50th Percentile/ Median 75th Percentile 100th Percentile
5 Variable 65-69 38,104 91,236 131,582 212,492 1,138,482
6 Variable 65-70 48,771 100,204 142,642 225,319 1,228,790
7 Fixed 65-69 33,272 67,793 81,513 99,847 265,185
8 Indexed 65-69 38,472 70,523 81,605 95,152 197,845


Aggressive Risk-Appetite Evaluations
Reference Number Plan Type Target Age Range 0th Percentile 25th Percentile 50th Percentile Median 75th Percentile 100th Percentile
9 Variable 65-69 29,374 69,461 93,198 131,603 427,364
10 Variable 65-70 31,004 74,567 98,536 138,987 421,355
11 Fixed 65-69 14,537 44,568 58,139 78,007 268,363
12 Indexed 65-69 16,847 48,293 61,676 80,377 244,725


In this example, the winner, by far, is the variable contract, especially for non-aggressive investors. This is mainly due to full participation in subaccount growth, which is not the case with the other two contracts.

Upsides to the fixed-indexed are limited by the cap.

Upsides to the fixed are limited by the guaranteed 3% credited rate.

Extending the target retirement age to 70 increased the median value of the variable contract. The lesson here is to tell BI-SEM to evaluate the maximum number of paths that a client can elect.

In general, variable annuities don’t deserve the bad press proffered by some pundits. For well-designed ones, crunching the numbers with BI-SEM, shows why they can be quite an attractive investment.

Annuities are not the ideal investments for non-conservative investors.

There are no shortcuts! Invest the time and effort to learn how to use an annuity evaluation app that supports an acceptable evaluation method, such as BI-SEM. In the long run, it will pay off handsomely.

For Best Interest requirements, before recommending a purchase, compare as many contracts as is reasonably possible.

Don’t just rely on the high-level product features, always use the evaluation app to crunch the numbers at the individual contract level.

Make use of the client’s personal knowledge to optimize the results, specifically use a simulation method to take advantage of the client’s attributes, which are known only to the client.

Next to estimated longevity, the attribute with the biggest impact, is the client’s risk appetite. This is because a proper evaluation must consider how a client would otherwise invest their money, based on it.

It’s also important to note that due to the recent pandemic, risk tolerance is trending more conservative so, as observed above, more clients should steer towards variable contracts with guaranteed income benefit riders.

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James KavanaghJames Kavanagh is the organizer of BI-SEM, a nonprofit group that’s trying to develop a method that advisors can use to update deferred annuity valuations.