Guaranteed Lifetime Withdrawal Benefits


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What are the primary issues related to the GLWB or income riders currently available on annuities?

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Guaranteed Lifetime Withdrawal Benefits

  1. 1. POINT OF VIEW - GUARANTEED LIFETIME WITHDRAWAL BENEFITS (GLWB) Part of a thought leadership series presented by … Garth A. Bernard, President & CEO THE SHARPER FINANCIAL GROUP LLC May 11, 2008 (updated as of October 2010)©2010 The Sharper Financial Group, LLC Page 1 of 5
  2. 2. POINT OF VIEW - GUARANTEED LIFETIME WITHDRAWAL BENEFITS (GLWB)SFG acknowledges the value of and need for guarantees against downside market risk, but we questionthe value and use of popular GLWB approaches due to various concerns: We acknowledge the value proposition: It is not surprising that consumers are very concerned about protecting their retirement investments from downside market risk; there is a perfect storm brewing right now – the tidal wave of baby boomers are beginning to retire at the same time that there are major stresses in the investment markets and in the broader economy – that underscores the need for vehicles that can address these real consumer concerns. Poor investment performance can devastate a retirement portfolio, derailing well laid retirement plans and destroying the confidence of retirees in having a secure future. Retirees can’t afford to make any mistakes with their portfolio – so we see the need to address this risk. There are questions about the value of these popular approaches: GLWBs in variable annuities or unbundled and placed on mutual funds and on 401ks are clearly only one approach to addressing the problem of protecting investors from downside market risk, providing guaranteed lifetime income, and providing access and control of assets while allowing some participation in upside potential. However, investors and their advisors should be clear on whether these vehicles provide the best value for the money involved. We have some concerns about the lack of transparency in these vehicles: o Complexity:- The designs of the popular GLWBs are extraordinarily complex primarily due to the existence of a “benefit-base” mechanism whose sole purpose is to define the amount of the guarantee. However, this mechanism leads to major confusion because there are many moving parts, calculations and contingencies involved in the changes to the benefit base. This complexity can lead to gross over-simplifications and misplaced expectations on the part of consumers and advisors, with serious compliance and suitability implications. For example, the roll-up rates typical on GLWBs are often misinterpreted as a guaranteed minimum on the performance of the underlying funds when it is anything but that. o Nomenclature:- The name of the feature – guaranteed lifetime withdrawal benefit – is somewhat of a misnomer. It is not the withdrawals themselves that are guaranteed since the investor is making withdrawals of their own annuity account values for as long as possible. The insurance benefits are the amounts paid, if and only if, the funds are depleted by withdrawals. This benefit is better described as a contingent deferred income annuity. o Fees:- the total fees for variable annuities including these protection features are quite high (about 3% to 3.5% per year) and makes one wonder if this protection cannot be provided at a lower cost – in fact, many insurers reserve the right to double the rider fees if the guarantees are reset higher so you could be talking 4% to 4.5% per year. In addition, fees on the GLWB may be based on the “benefit base” and not on the account balances – this leads to actual fees that may be significantly higher than the nominal fee percentage for the GLWB. When it comes to retirement income, every dollar of fees that goes to the insurers©2010 The Sharper Financial Group, LLC Page 2 of 5
  3. 3. POINT OF VIEW - GUARANTEED LIFETIME WITHDRAWAL BENEFITS (GLWB) and fund managers that could otherwise be saved represents another dollar that could otherwise have gone to the investor. o Value of the downside protection:- we believe that following the identical withdrawal and investment constraints prescribed by a GLWB but on withdrawals outside of a variable annuity without the incremental fees may in fact not involve a significant risk of depletion; since the GLWB benefit is not the variable annuity withdrawals themselves, but rather is the series of insurance payments made only if the variable annuity account is depleted, it would seem that the rider fees that may be paid for many years may provide a relatively small benefit. Of course we understand that withdrawals outside the variable annuity would not be guaranteed, but we have concerns about how much insurance value is being provided in relation to the insurance fees paid. o Misplaced upside expectations:- the reset provision in these features is often touted as enabling the guaranteed withdrawals to “keep up with inflation”, however we are quite sure that this is highly unlikely given the withdrawals taken (5%), total variable annuity fees (3%) assessed plus inflation (3%) that the fund performance consistently needs to cover if the reset is actually going to keep up with inflation - that’s 11% per year which would be phenomenal even in the best scenarios; this could lead to very disappointed retirees if they have this expectation going in that the withdrawal stream will keep up with inflation. There are alternatives which may provide substantially better consumer value: o The simplest and cheapest approach to providing downside protection against market performance is a put option, and in the variable annuity world this is a GMAB. Not only is this feature simple and uncomplicated, this benefit can protect future cash values and provide investors with more control of their future options including the purchase of an immediate annuity for guaranteed lifetime income, and it gives them the very choice of which financial provider they will use at the time they wish to exercise those options. o It is easily possible to design a next-generation GLWB which offers substantially better consumer value. In particular, current GLWB designs make a critical unstated assumption and force a particular choice or trade-off on the investor seeking this form of guarantee: there is an assumption that the investor values a lifetime income guarantee at the same level as the current income (withdrawal limit) offered in the current designs. However, by dropping this assumption, it is possible to create designs which produce more current income, with an attractive guarantee and ultimately higher guarantees, at substantially lower fees. In addition, such designs can provide higher asset accumulations with greater upside participation (because of the substantially reduced fees.) Such new designs can also completely eliminate the “benefit base” and the excessive complexity associated with it. Finally, next-generation designs of this nature may reduce or eliminate the strict constraints on the asset allocations that are available for investment when the GLWB is selected (which could potentially provide even more upside opportunities to the investor.)©2010 The Sharper Financial Group, LLC Page 3 of 5
  4. 4. POINT OF VIEW - GUARANTEED LIFETIME WITHDRAWAL BENEFITS (GLWB) o It is a well known fact that immediate annuities provide the highest amount of lifetime income for a given amount of assets. They do require that the consumer trade-off liquidity for the portion of the portfolio that is allocated to the immediate annuity. Many advisors make a big deal about this, but this is only an issue if you try to solve the problem from a product-centric stand-point. Instead we believe that consumers’ needs are nuanced and that guaranteed lifetime income sources should be used to offset the consumer’s basic lifetime expenses such as food, shelter and clothing that is not being met by social security and defined benefit plans. We do not believe they necessarily need lifetime income for all their expenses since some expenses are discretionary. But that is what you get with a single product approach such as GLWB – an “income hammer” looking for “expense nails”. o Our point of view is that efficient lifetime immediate annuities should be used to secure a minimum floor of lifetime income before other less efficient lifetime income approaches are used. This way, not only can consumers’ needs-based concerns about downside risk be addressed, but they will have more of their investments available to address other concerns which may be high in their list of priorities such as chronic and acute health care needs. Ultimately, combinations of immediate annuities with other retirement income products, such as more effective GLWB designs, retirement income mutual funds, systematic withdrawals, etc, may provide more robust income, guarantees, inflation protection and asset growth, as well as greater flexibility and control for investors than any single retirement income product.©2010 The Sharper Financial Group, LLC Page 4 of 5
  5. 5. POINT OF VIEW - GUARANTEED LIFETIME WITHDRAWAL BENEFITS (GLWB)GARTH A. BERNARD, MAAA Mr. Bernard is Founder and CEO of the Sharper Financial Group, a consulting practice specializing in design and marketing of retirement income solutions. He is also CEO of Thrive®, a firm that markets and distributes a retirement income selling system that is supported by a web-based platform for delivering solutions. He is also a Principal of Retirement Income Solutions Enterprise. RISE® helps advisors profitably educate, win and satisfy more clients with compelling retirement solutions delivered via a process called Mature SimplicityTM.Mr. Bernard has over 25 years of experience in the US and Canadian financial services industriesand is widely recognized as an expert in retail and in-plan retirement income solutions andannuities. He has written several articles on both subjects and is often quoted in national andindustry media. He has been a frequent speaker and participant at retirement industryconferences and serves on numerous retirement industry committees.Prior to launching his own company, Mr. Bernard was a senior executive at MetLife where hewas responsible for developing innovative retirement solutions including a broad suite ofinvestment and insurance products and for product management of several annuity productlines across MetLife’s retail distribution channels. He also held executive level roles at KeyportLife, ReliaStar Northern Life, Providian Capital Management, Transamerica and National Life ofVermont where he had responsibility for various functions including marketing and productmanagement, asset-liability management, reinsurance pricing and customer relationshipmarketing for life and annuity lines.Mr. Bernard is Past President of the International Association of Black Actuaries. He is amember of the Advisory Board for the American College’s Retirement Income Center. He alsoserves as the contributor for “Ask an Expert” at the Center for Due Diligence. He has been aMember of the American Academy of Actuaries for over 20 years, and holds a Masters degreein Mathematics from the University of Waterloo, Canada.©2010 The Sharper Financial Group, LLC Page 5 of 5