GLWBs
GLWBs were first offered on fixed rate and fixed index annuities two years ago and I compared the entire world of fixed annuity and top VA carrier GLWBs in a report initially issued 13 months ago. The report has been revised five times as carrier after carrier either entered the GLWB arena or redrew their offerings, and a complete overhaul of the report is underway as carrier GLWBs got both more creative and convoluted as competition grew in the annuity benefits race. This issue attempts to show some of the changes I am finding in the index annuity GLWB field. It also tries to compare the different products to see what guaranteed life payouts are produced given certain assumptions.

I placed $100,000 in each annuity using an issue date of age 50. I then calculated the income benefit account value based on the product guarantees and multiplied the values by the respective payout factors at ages 65, 70, 75 and 80 to produce the annual lifetime payout. The result is a list of the initial lifetime payouts that would be received if each annuity only earned the guaranteed minimum.

There is a little fudging. The guaranteed growth in some cases was the annuity contract minimum guarantee and many of these used floating rates; I used a 1.75% rate. Premium bonuses were ignored unless the bonus was built into the GLWB. And in cases where the rider cost could increase if the growth period was extended, I used the maximum permitted rider cost after the first 10 years. All numbers are believed to be accurate, but due to the fluid nature of the marketplace I will reserve space in the August issue to publish corrections.

Two Points: The Living Benefit Balance Is Not A Cash Value
Neither the 15% “bonus” on the Allianz Endurance, nor the 4%, 7.2% or 8% “guaranteed income account growth” on other assorted annuities with GLWB benefits are what the consumer first thinks they are which is cash in hand. These bonuses and growth guarantees really only come into play if and when the consumer’s money is exhausted.

To illustrate, if no interest is earned and you withdraw 5% a year on $100,000, or $5,000, the money is gone in 20 years. If by means of a bonus or growth guarantee the carrier says you may withdraw 5% on $120,000 or $6,000 a year you are still spending your own money until some time in the 16th year. If you die before 16 and two-third years you receive zero financial benefit from the bonus or guarantee. Indeed, due to the explicit or implicit costs of that GLWB you are worse off financially if you die while spending your own money. However, if you live a long life the actual benefit could be much greater than the bonus or guaranteed rate you were told.

And The Payout Is Not A Return
You receive a 5% income for life, what is your return? To figure out the return you need to know what you will receive and what your heirs receive. If you start with $100,000, receive $5,000 a year for 10 years, and your heirs receive $100,000, your real return is 5%.

But what if you receive $5,000 for 10 years and your heirs get $80,000? Then the real return is 3.3%. 

And what if you receive $5,000 for 10 years and your heirs get $50,000? Then the real return is 0%.

My Comments On SEC Release Nos. 33-8933, 34-58022; File No. S7-14-08
“We are proposing that an annuity issued by an insurance company would not be an “annuity contract” or an “optional annuity contract” under Section 3(a)(8) of the Securities Act if the annuity has the following two characteristics.
First, amounts payable by the insurance company under the contract are calculated, in whole or in part, by reference to the performance of a security, including a group or index of securities.
Second, amounts payable by the insurance company under the contract are more likely than not to exceed the amounts guaranteed under the contract.”

The SEC proposed rule would make all currently marketed index annuities securities. Why should index annuities be made securities?

“We have determined that providing greater clarity with regard to the status of indexed annuities under the federal securities laws would enhance investor protection”

What about Safe Harbor Guideline 151 saying when an annuity is not a security?

“Indexed annuities are not entitled to rely on the safe harbor of rule 151 because they fail to satisfy the requirement that the insurer guarantee that the rate of any interest to be credited in excess of the guaranteed minimum rate will not be modified more frequently than once per year” 

According to annuity producers the overriding reason given for the purchase of index annuities is safety and avoidance of market risk – what is your exact opposite logic?

“these purchasers obtain indexed annuity contracts for many of the same reasons that individuals purchase mutual funds...and open brokerage accounts.”

 Section 3.A
“When the amounts payable...are more likely than not to exceed the amounts guaranteed under the contract, the purchaser assumes...the risk of an uncertain and fluctuating financial instrument, in exchange for exposure to future, securities-linked returns. The value of such an indexed annuity reflects the benefits and risks inherent in the securities market, and the contract’s value depends upon the trajectory of that same market. Thus, the purchaser obtains an instrument that, by its very terms, depends on market volatility and risk.”

Essentially the proposal says the future return of an index annuity is unknown therefore it is a security. The reality is the future is always unknown. A bank money market account rate floats from day to day, universal life insurance rates float from year to year, an I Savings Bond return varies based on the inflation rate, and even SEC registration prices are not locked in forever. And yet none of these are viewed as securities. 

The proposal attempts to minimize the index annuity benefit that protects principal and credited interest from market loss by saying the benefit does not eliminate all risk. I submit that because of an unknown future it is impossible to eliminate all risk in any aspect of life and is therefore an invalid criterion to use. The criteria should be “can the consumer lose principal without taking any action of their own”. 

“Should the proposed definition apply to forms of insurance other than annuities, such as life insurance or health?”

Altho the proposal only applies to index annuities there is nothing to stop the final rule to cover any other type of insurance that bases pricing or returns on an external index. If index life carriers are remaining quiet about the proposal in the hope they will be ignored, I believe this ostrich strategy will fail.

 How would “small entities” be adversely affected? 

Adding together the most conservative estimate of additional expenses to insurance agents combined with lost revenues to marketing organizations, the proposal could result in a loss of $852 million to insurance industry distribution channels. Most of this loss would be incurred by small entities, it would have a significant effect on the economy, and it would result in a major increase in costs for insurance agents.

Nobody Circled The Wagons 
Back in March 2005 I wrote an article titled “Circle The Wagons” that commented on a couple high profile lawsuits against index annuity carriers. I said “So far any negativity in the index annuity story has been confined to the trade journals, but the general press will pick up the story and write some sensational articles about alleged consumer abuses. Next up will be a regulator or politician asking for an investigation. And the SEC will reopen the question as to whether index annuities are securities.” I mentioned the industry needed to clean up products, police producers and help insurance regulators fight to protect their turf. 

I closed by saying “If index annuity carriers do not change the way they do business they could face a world wherein most, if not all, index annuities will be classified as securities, and require registered producers to sell index annuities through their broker/dealers.”

So far, my early crystal ball visions have been on target. I hope my final one is wrong. 

Copyright 2008 Jack Marrion, Advantage Compendium Ltd., St. Louis, MO (314) 434-6030. webmaster at indexannuity.org. All information is for illustrative purposes only,  does not provide investment or tax advice.  No index sponsors, promotes, or makes any representation regarding any index product. Information is from sources believed accurate but is not warranted. Advantage Compendium neither markets nor endorses any financial product.