In anticipation of the baby boomers' exodus from the work force, financial services companies have inundated the market with guaranteed lifetime with-drawal benefits--income riders available on variable annuities--and fixed indexed annuities. The proliferation of these products and associated GLWBs has left the typical advisor's head spinning as he attempts to stay on top of product innovation and change, as well as the hundreds of potential solutions for his clients.
VAs with GLWBs
In recent times, advisors have been very inclined to turn to VAs with GLWBs. According to a recent LIMRA survey, nearly 90 percent of all VA sales, a $150 billion a year market, include a living benefit feature. The popularity of VAs with a GLWB as the go-to guaranteed retirement income solution is directly linked to their perceived ability to deliver protection against the risks of longevity, sequence of returns and inflation.
VAs with GLWBs offer guaranteed income for life that provides security against the risk of running out of money if you live too long (longevity risk), or retire at the wrong time in a market cycle (sequence-of-returns risk). However, VAs do not provide a guarantee against running out of purchasing power (inflation risk).
Instead, investors are relegated to self-insure against inflation risk by leveraging the ability to allocate to the equity markets in their efforts to grow the underlying account value and, in turn, their income. While this may sound like a viable strategy in theory the cost of the underlying subaccounts, mortality and expense charges and rider fees make it unlikely to succeed in practice after withdrawals have begun.
Finally, VAs with GLWBs do not provide a guarantee against running out of assets during the distribution phase due to the sequence-of-returns risk. It is only the withdrawal stream that is insured. Thus, a VA with a GLWB provides lifetime income with access to underlying assets while they last but with limited ability to keep up with inflation.
FIAs with GLWBs
Like their VA counterparts, FIAs with GLWBs are also popular among independent agents. The FIA is a fixed annuity that differs from a VA by providing a guaranteed minimum rate of return on all or a portion of the principal, but like a VA, it offers potential upside. This is accomplished via the mechanism for crediting interest to the account values.
The index-crediting mechanism provides an annual interest credit that is based on the price change in a selected equity market index. While it typically credits part of the upside change in an index, it will not credit less than 0 percent, thus protecting principal and accrued interest.
The ability to provide potential upside without risk to principal is an important distinguishing characteristic of fixed index annuities. However, the implied cost of principal protection might suggest that the potential upside on a FIA could be significantly less than the potential upside on a VA.
Differences between FIAs and VAs with GLWBs
GLWBs on FIAs work in an identical fashion to GLWBs on VAs. They both exhibit the same potential benefits and the same shortcomings noted earlier. However, besides the principal protection, there is another key distinguishing characteristic between an FIA and a VA with a GLWB--the level of fees charged against the account. The fee for a GLWB on an FIA is typically a fraction of the cost of the rider on a VA. Furthermore, the total fees on a VA with a GLWB can be several multiples of the fees on an FIA with a GLWB.
There are two key implications to the principal protection and fee differences between a FIA and a VA:
- When the total fees in a VA with a GLWB are taken into account, the reduction in the expected performance of a VA may bring it closer to what would be expected of a fixed annuity. It becomes more "bond" than "equity."
- A GLWB with a feature set (i.e., annual increase on the income base and guaranteed withdrawal factor), costs substantially less to deliver on a FIA platform than on a VA platform.
In combination, these two differences suggest that an FIA with a given GLWB may deliver relatively the same amount of guaranteed income as a VA with the same GLWB but with principal protection. In fact, given differences in design, it is not difficult to imagine cases where some FIAs with a GLWB could deliver more guaranteed income, higher account values and principal protection than some VAs with GLWBs for a given client.
Which GLWB Is Better?
The natural question that then arises is "which GLWB is best for a given client situation?" This question might occur when comparing GLWBs between two FIAs, two VAs or even between an FIA and a VA. Many advisors have probably been confounded by this very conundrum in practice.
The answer is "it depends." Clearly, one cannot make a valid comparison simply by looking at the design features of the GLWBs and the underlying products to be compared--there are just too many moving parts. A financial technician can certainly develop comparative measures to make an assessment. With technology, it is certainly possible to build tools that can provide a convenient comparative analysis.
Furthermore, how do distribution gatekeepers select which products are best for their advisors to offer clients and which are not? It certainly raises the issue of due diligence and the methodologies used in making that selection.
GLWBs on VAs and FIAs offer valuable benefits for managing risks in retirement though there are some soft spots. There are also feature differences between riders and between the two product types. Gatekeepers are faced with a tremendous challenge in developing a clear and valid financial basis to determine which products and riders should be offered to their advisors. A comparative tool is sorely needed to help distributors and advisors exercise due diligence and ensure that what they offer is suitable for their clients.