Variable annuities (VAs) have risen in popularity since their development in 1952. This increased attention is due to the products’ annuity benefits being coupled with the potential for market-based gains. Yet, it is this same potential for unlimited gain that has caused volatility in sales for companies issuing these products. Why? In exchange for the variable annuity’s unlimited potential for gains, this type of annuity also has unlimited potential for loss.
As a result of this risk/reward annuity feature, VA sales have historically fluctuated in tandem with the market. When the market goes up, VA sales typically increase. However, when the market declines, we usually see a corresponding decline in VA sales. Interestingly, when VA sales decline, there is generally an analogous increase in sales of fixed variety annuities (including traditional fixed, fixed indexed and multi-year guarantee fixed).
Before the turn of the century, companies selling VAs developed product features to combat these cyclical declines in sales. These features were intended to provide their variable annuity purchasers some type of guarantee against the risk of market losses. The annual fees charged for these optional riders/endorsements provide the following benefits in exchange:
- Guaranteed Lifetime Withdrawal Benefit (a.k.a. GLWB) guarantees annual withdrawals at a specified level (based on the annuitant’s age), regardless if the annuity’s Account Value falls to zero or less.
- Guaranteed Minimum Accumulation Benefit (a.k.a. GMAB) guarantees that the Account Value of the annuity will grow by a minimum specified percentage, over a stated period of time.
- Guaranteed Minimum Death Benefit (a.k.a. GMDB) guarantees that the annuity Death Benefit payable will be no less than a specified amount.
- Guaranteed Minimum Income Benefit (a.k.a. GMIB) guarantees that the income amount withdrawn from the annuity will never drop below a minimum specified amount, as long as the contract is annuitized over a specific number of years.
While each of these features provides some sort of guarantee, none of them guarantee a minimum Cash Surrender Value should the VA purchaser decide to terminate their annuity. Fixed annuity types are famous for such guarantees. However, the above guarantees that are offered on VAs establish a secondary “shadow” value to the annuity, which is only utilized in the event of withdrawals, death, annuitization, etc. It is also important to understand that there is a very good possibility that this “shadow” value will always be greater than the annuity’s Account Value.
That being said, what is one to do if the insurance company decides that they no longer want to be obligated to these “shadow” value guarantees?
In reality, three insurance companies have already made public announcements, communicating that they would like for their policyholders to cash surrender these optional riders on their variable annuity contracts. These insurers are essentially proposing a cash buyout if their policyholders will voluntarily surrender these riders. Regardless of how long or short a time the annuitant has paid for the benefit, they will receive an increase in the Account Value of the contract.
Undoubtedly, the professionals that sold these variable annuities in the first place have more questions than I do. In subsequent columns, I’ll explore these issues in more depth. Until then, CYA (Cover Your Annuities).
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