HOPING AGAINST HOPE
Rod Halvorson

Rod Halvorson serves on the Advisory Board of the Bank Insurance and Securities Association and is Senior Vice President of Financial Institutions Distribution for Symetra® Financial. Symetra Financial Corporation and its subsidiaries provide life insurance, annuities, employee benefits and retirement plans through a national network of independent advisors and agents.
 
 

IT WAS NOT LONG AGO that carrier hype abounded over variable annuity (VA) contracts with guaranteed withdrawal benefits. They were purported to be an all-in-one solution that could enable bank investment programs to easily capture more of their customers' retirement assets. Positioned as a way to take advantage of market growth while protecting against downside risk, these rider-laden VAs were bought up by retirees at a rampant pace.

Then something unexpected happened. The subprime crisis led to a severe credit crunch that has subsequently driven one of the most dramatic recessions in American history. In its wake, demand for simpler, more reliable retirement income solutions such as fixed interest-rate annuities has emerged stronger than ever. In contrast, VA sales have slowed and, within the industry, the luster is wearing off of many popular VA living benefit guarantees.

At the same time, customers who hoped that their VA's minimum withdrawal guarantee would help backstop the effects of declining market conditions are finding that this sense of security is misplaced. In reality, some unpleasant realities await customers who opt for their VA's living benefit guarantee in the current environment. Worse yet, taking withdrawal benefits now may prevent them from ever recovering their contract value.

A closer look at one of the more prominent living benefit riders, the guaranteed lifetime withdrawal benefit (GLWB), reveals why.

A GLWB is an annuity rider that guarantees a stream of income, without annuitization, that cannot be outlived. When a GLWB is attached to an annuity, two separate values come into play-a contract value and an income value. On the income side, the GLWB seems to offer considerable value in that customers who chose such a rider would have a future income stream locked in at a specific withdrawal rate. With a prolonged downturn however, important GLWB features such as income step-ups may not materialize.

Step-ups only take effect when the contract value rises a certain percentage above the original contract value. When the contract value is in decline, as is the case when the markets drop some 40 percent in 2008 for example, the client continues to pay fees for a benefit feature that may not kick in. Meanwhile, the rider's considerable fees continue to erode proportionately more of the contract value, making it even more difficult to recover. Additionally, what some clients fail to realize is that, when withdrawals exceed the guaranteed amount, their rider benefit base resets from the original amount to a new value reflecting the impact of market declines to their contract value.

Customers often believe they can ride out the decline with their guaranteed withdrawal amount until their portfolio recovers. Unfortunately, it may be a long time before annuity values recover sufficiently. In fact, even under the most optimistic market scenarios, a customer who opted to take a withdrawal under the GLWB following last year's dramatic market decline may never get back to his/her original contract value.

Moreover, VA carriers frequently limit their own risk by requiring customers who opt for the withdrawal guarantees to select from a prescribed list of relatively conservative investments. This diminished control over asset allocation can restrict upside potential when markets finally recover and may affect a client's wealth accumulation. Carriers are also becoming increasingly restrictive to guard against the kind of pricing miscalculations and risk taking that has impacted their financial condition. Indeed, many life insurance companies are wrestling with how they will continue meeting liabilities for existing withdrawal guarantees as more customers exercise riders.

An alternative

So what can be done to help customers with these pitfalls?

Instead of purchasing a GLWB rider in a VA, one strategy that may appeal to increasingly risk-averse customers-and may actually provide greater overall retirement income-is to purchase a single premium immediate annuity (SPIA) alongside a streamlined, rider-free VA. After buying the SPIA, customers could put remaining savings in a lower-cost VA that features a wide array of investment options. This way, customers can still get the benefits of tax-deferral, achieve diversification, and take advantage when portfolio values increase.

Income annuities are, after all, designed for securing steady retirement income that is not susceptible to market volatility. The SPIA can even be structured to deliver similar payouts as a GLWB might. Plus, by coupling the SPIA with a rider-free VA, the customer is likely to have fewer asset allocation restrictions and less costly fees than one with a living benefit attached to it.

History shows us that markets do not stay down forever, and when VA demand does return, we may see a very different type of VA product than our industry has grown accustomed to. As this plays out, the quality of the carrier that stands behind the customer's VA will matter more than any "next big thing" rider attached to such products.