Living Benefit VA's

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Feb 9, 2008 11:27 pm
I am taking a closer look at VA's with GMIB's, and need some help.
It seems to me, that the guarantee's being offered are income for life, with a benefit base that is guaranteed to increase annually at a specified rate, and/or a guarantee that you will be able to withdraw a specified % of your benefit base, or portfolio value each year, whichever is higher. Also a step up in the floor of the benefit base. It also seems to me that the negatives, are higher expenses, and some giveup in liquidity, along with, in non qualified accounts, conversion of cap gains into ordinary income.

So questions:
1. What, if anything am I missing
2. For guaranteed income for life, whats the best product out there, among the highly rated Ins co's, and why? Investments, guarantee rate, tax treatment?
3. Does this make sense for a client say, in their mid 50's, 10 years to retirement, needs to be aggressive? Any reason NOT to put a substantial piece of a retirement pie in these products?
4. how do you position it as a piece of a bigger picture plan?
5. Are there situations in which you wouldnt use it?

Feb 10, 2008 12:05 pm

Pratoman - you've got the gist of it. When you do this for a client compare the expected income from these VA's to the payouts you'll receive from their fixed siblings(or conversely, how much you have put in to the product to get the same income).

I've found the insurance company charges the client a substantial amount in the form of income they're willing to guarantee with VA's. Also, the average VA has M&E fees of 1.25% & the rider costs .6 - .7%. If you're taking out 5 - 6% / yr I don't see these contracts substantially increasing or keeping up w/ inflation.

I think VA's are better for people who want to guarantee income & also guarantee a certain amount of death benefit(return of premium in most cases). Also, if you want to guarantee future income, you can't do it any other way than a VA(take a look at Pac Life's 10% increase in income for 10 yrs) Another VA that I like is the Allstate's(Pru's in the wirehouse/Indy channel) w/ the daily step-up. It has a reasonable M&E of 1.15% total & the rider costs .6%(.75% if you're making the spouse joint on the rider). It also has unique investment choices, and their cost is also very reasonable. Daily step-ups lead to more step-ups & the income roll-up is on top of the growth & not just a fixed amount of the initial premium.

Fixed immediate annuities will have fewer tax issues than their variable counterparts in non-taxable accounts(most people use the GMWB). Many fixed immediate annuities can guarantee an increase in income per year. Some will allow you some flexibility with the principal or future income payments, but this flexibility leads to lower payments.

The primary cons with the fixed immediate annuity is that you lose control of the principal, and the rate is fixed to the current interest rate environment(I wouldn't be surprised to see a t-link immediate annuity coming out soon).

Feb 10, 2008 12:28 pm

Thanks Ashland. You hit the two related concerns i have. One is that its hard with a 3-5% exp ratio to plan on increases in your income that result from an increase in portfolio value. Also you need to build something in for  inflation, almost like you need to start with a higher number. Other than those, I dont see a lot of downside.

I've done a few of these, mostly with American Legacy from Lincoln Life. Their expenses are reasonab le, and especially for non qual money, they are great tax wise, because they allow you to take about 75% of your distributions as return on principal as long as the principal lasts (IRS Private Letter Ruling). The one thing I dont like aobu them is that I hate being locked into one fund family, even American Funds, which is what American Legacy does.
Have you looked at Equitable, Nationwide and Hartford?
Feb 10, 2008 6:00 pm

American Legacy has a great product that mixes the tax efficiency of annuitization w/ the guarantees of a VA. Like you, I don't like being stuck w/ one fund family & I've shied away from American Funds these past couple of years.

AXA's(I think Equitable's got the same product - same company at least)has a strong menu of riders in their product. I've used them for a couple of clients who aren't insurable. Their 6% roll-up product allows us to take out their RMD(at least until age 82 when they have to take out more than the 6%) & will 'give' their bene's back their purchase payment if they die before 85. This is a VERY expensive product w/ fees in the 2.50% range just for M&E & riders. A 71 yr old diabetic client found this to be the perfect solution. Nationwide's product is very good. Most products protection features(at 10 yrs) is much too long to be useful. If a client is looking for protection of principal w/ the upside of the market in the 5 or 7 yr time frame this VA has a good story, but I can't see the client getting much more than 5% w/ the 50/50 portfolio and 7% w/ the 70/30 portfolio after expenses. I'd do my darndest to convince clients I can do that w/ a very conservative fund portfolio. I haven't used Hartford, sorry.

American Legacy has a great idea for funding estate plans. I've not completed my research on it, but ask your American Legacy wholesaler what would happen if you use a grandchild as annuitant, grandparent retains ownership & the middle generation is put as beneficiary. Essentially you're creating an income stream that will last grandma, their child's & the grandchild's lifetime. After grandchild passes, the death benefit will payout whatever principal is left.

I think overpromising w/ these products is the big downside. Also, it's very likely that something will come out w/o that M&E fee in the next 5 yrs & we'll be able to do this in non-deferred accounts. So, products that allow to add, drop & change riders added at a later date may be a good thing. Finally, the rider costs are not guaranteed. If the cost for these riders become greater for the insurance companies they can pass those costs on to policyholders. Moshe Milevsky suggests this is the greatest risk w/ these investments.

Feb 10, 2008 6:49 pm

Thanks Ashland, great information again.

One other VA that I am looking at is the Met Life Marquis. This is a former Travelers product that at the time was available only in the Smith Barney channel. However, I think its been opened up since Met Life Bought Travelers.
Its an expensive product, at about 3 1/4% all in, but its fully liquid from day one. Thats a big plus.
Also pays well, 1 1/4 % trail, I believe the upfront is 1%
Feb 10, 2008 7:47 pm

I believe that Lincoln Choice Plus offers the same cost and riders as AM Legacy, but gives the option to choose among 10-15 fund families.

Feb 10, 2008 8:06 pm

pratoman, you start putting clients into products that cost over 3% and you crush their upside potential and greatly increase the probably that they'll be stuck with the guaranteed values. 

100K at 10% for 20 years grows to $670K
100K at 6.75% for 20 years grows to $370K
Feb 10, 2008 8:43 pm


I'm very aware of the effect of high expenses on a portfolio, and I always invest with an eye on controlling overall costs. So your point is well taken. I'm not advocating putting a clients entire portfolio into a VA because of the living guarantees.
But it might not be a bad idea to put enough in a guaranteed product to provide for a clients necessary expenses in retirement (assuming the client has enough to do so, with enough left over), and invest the rest prudently in an asset allocation with lower expenses and no guarantees. Maybe even, the riskier portion of the portfolio, I.E. small cap, emerging markets, etc, in the VA. Those asset classes tend to have higher expense ratios anyway, (i.e., in MF;s) and the more stable stuff, like large cap, in a non guaranteed product, so you end up with an overall cost of investing of say, 1.5%?
Feb 11, 2008 12:18 am

You may want to do the exact opposite, prato - have the more aggressive stuff have the guarantees on it because the whole point of the contract is to grow those guarantees. If you put more stable(less growth potential) stuff into the VA that might defeat the purpose.

I agree with anon - if you're going to go w/ these products go for the lowest cost(7 yr product) & only the riders they really need.

Feb 11, 2008 11:11 am

Ashland, I agree with using the 7yr surrender on annuities which have the GMWB.  IMO, If the client is anticipating guaranteed income for life, then they should have no problem with a long surrender period, as it should mean lower fees over time.

Feb 11, 2008 12:29 pm

I believe that Lincoln Choice Plus offers the same cost and riders as AM Legacy, but gives the option to choose among 10-15 fund families.

That is correct...and there are some excellent subaccounts in this product.  I had a review last June that was 26% YOY in this product.  Obviously, things have changed a lot since last June, but for subaccount choice and performance, Lincoln and Jackson National have been hard to beat in my experience.  Also, Jackson has recently improved their living benefit in an attempt to mirror AXA's.
Feb 11, 2008 10:32 pm

You may want to do the exact opposite, prato - have the more aggressive stuff have the guarantees on it because the whole point of the contract is to grow those guarantees. If you put more stable(less growth potential) stuff into the VA that might defeat the purpose.

I agree with anon - if you're going to go w/ these products go for the lowest cost(7 yr product) & only the riders they really need.

Thats what I said, have the stuff like emerging markets, small cap in the guaranteed product, with Large Cap, etc in non guaranteed.
Feb 12, 2008 12:50 am

Pratoman - so you did. Sorry... I misread.

Feb 16, 2008 9:33 am

One thing to think about when looking at expenses.  With the VAs you can invest 100% in equities (or maybe 80% as many products require) and pay an additional 2% in M&E/riders and have a guaranteed income for life.  For a conservative client, compare this to the cost of putting 50% of the portfolio in bonds and still not have any guarantee.  I'd make the case that from a total return standpoint the "cost" is no more with the VA.

From a tax standpoint, consider that for many clients the other option is CDs or other fixed income.  They are going to be more comfortable in the guaranteed VA than "playing in the market".   Their taxes are no worse than what they have with CDs or other fixed income. 
With the AXA GMIB, a 60 year old can get 6% for life.  Monte Carlo won't give you very good odds on a 50/50 portfolio at this withdrawal rate.  If the client and/or beneficiaries are able to withdraw 6% for 30 years, even if there is no principal left they will have acheived a 4.3% rate of return.  Better than CDs.  Potential to do much better.
Feb 16, 2008 10:16 am

Vag - you are absolutely correct. My only thesis is depending on the client's age and their health we may be able to get them more payout in a guaranteed fixed immediate annuity. If one assumes the market will get below trend returns this decade - say 9% & then we take off 3% in total for expenses & portfolio costs we get to that 6%(if you add 20% bonds, it's worse).

You and I both know the market doesn't move in 9% moves every year - it's more like +big%, +avg%, -big%. We better hope that we're getting that +big% first. Because if we're not the client may not get back to even & will only get the 6% w/d over their lifetime(given they're taking w/d in the 13 month w/ the Axa product. If they're deferring w/d's the VA looks better because of the guaranteed roll-up of income).

If we can, even in these horrible interest markets, give the insurance company the risk & get the client a 7 - 8 - 9% payout on a guaranteed basis, why not structure SOME of the money that way.

Feb 16, 2008 10:47 am

Even though the GMIB is an income rider, I strongly believe that the true benefit is for accumulation and not for income.

Here's why I don't think that it's not very good for income.   Let's go back to Vagabond's post where he says that Monte Carlo shows that at 6% there is a good chance that someone will run out of money.  (I don't know what assumptions are used, but I'll take his word on this.)  If the money is in a VA, I'm willing to bet that the expenses are in the neighborhood of being 2% higher in the VA than what was used in the MC simulation.  If the MC sim is run with 2% higher expenses, there is probably a very high probability that the person will run out of money.
With the VA, this means that the contract value will hit $0.  In turn, this means that all that the person will get is the 6% which means that they would have been better off in most cases with a SPIA.
It's very important to understand that it is much harder to stop a downward trend with investments that have a living benefit inside of a VA than it is in other investments.  This is because the expenses of the VA go up when the account value goes down.  
Ex. GMIB costs .8%.   If the contract value is $100,000 and the GMIB value is $100,000, this will be .8% or $800.  Look what happens when 6% withdrawals are made and the contract loses money.  Let's say that the GMIB value is still $100,000, but the contract value is $50,000.  The cost will still be $800, but this is now 1.6% of the contract value!
In short, if the GMIB is used for income, there is a very strong chance that the client will only get the guarantee. 
Feb 16, 2008 10:56 am

Ding, anon!

Feb 16, 2008 12:30 pm

Ashland & Anon,

I agree there is a decent possibility they will only get the guarantee.  However, the last time I got a quote on a SPIA for a 60 year old, the payout was in the 6-6.5% range.  I'd rather take a slightly lower payout on GMIB and not give up control.  Now, if I could get 8 or 9% then I would do some in the SPIA.
All the 'experts' that I have read lately on taking withdrawals from balanced portfolios have been recommending 4 - 5% withdrawals to avoid the possibility of running out of money.  So if I'm telling someone I can give you $4K/yr from your $100K or I can give you $6K from the VA, a lot of folks are going to like the VA.
Feb 16, 2008 12:52 pm

So if I'm telling someone I can give you $4K/yr from your $100K or I can give you $6K from the VA, a lot of folks are going to like the VA.

If you tell them that and then shut your mouth, you will sell lots of VA's.  The problem is that you are not coming close to giving them a complete picture.
1) The 6% from the annuity doesn't change with inflation.
2) The 5% from mutual funds includes increasing the withdrawal by 3% a year.
Let's look at what happens with a 60 year old who lives 25 years. 
Withdrawals of VA:
Year 1: $6,000
Year 10: $6000
Year 15: $6000
Year 20: $6000
Year 25: $6000
Withdrawals from Mutual Fund starting at 5%:
Year 1: $5,000
Year 5: $5796
Year 10:$6720
Year 15: $7790
Year 20: $9031
Year 25: $10,469
The MF will probably allow them to take out significantly more money AND because of significantly lower expenses, they will be able to leave a much higher amount of money behind at death.
Please don't read my post and conclude that I'm against these riders.  That is very far from the truth.  I just don't think that they are good for income.
Feb 16, 2008 1:17 pm

I have a slightly different take than Anon as I'm concerned that mutual funds don't take into account longevity or market(sequence of returns) risk & if we're stuck w/ the guarantees from the VA, I'd be OK with that - but I'd also want to disclose to the client that they should be happy w/ that, too!

In the 90's we could have a 9 - 10% rate of w/d and have no problems. In the late 60's & the first half of the 70's if we took out 3.5% we were in a trouble.

My eventual point is that I don't have a crystal ball. I'd prefer to spread the risk between fixed & variable products. I may look at a VA more closely when someone is 4 - 6 yrs from retirement because of the roll-up provisions & a SPIA may be something I give a great deal of thought to when they need to take the income the next day/week/month. I can add inflation protection(making the income lower today) to a SPIA in the range of 3%, 4%, 5%. This gives the client a known whereas the VA remains a possibility of... I also like for non-IRA money the SPIA because of the tax preferenced treatment of payments. The SPIA may also be a better option when considering RMD's because we can work in the likely path of the RMD payments & make sure we've accounted for that w/o having to worry about investment loss & higher charges against the cash value as Anon pointed out.

Two final things: 1 - Why do we always tell the client to take out the maximum in a VA? Why not take out the max the 1st yr & if there's growth the max + inflation factor. 2 - It's a good idea to structure money outside of guaranteed income products because in good years you don't want to take the money out of the guaranteed income product - you want to take it out of the other stuff.

My last word: Compare fixed, variable, and non-guaranteed products & create a sophisticated, complete income plan over time. Give the choice to the client. It'll make you look smarter because truthfully we don't know whether we're closer to the early 70's or the late 90's.