We have outlined many factors that impact deferred variable annuity performance: rollup rates and the frequency of their vesting, as well as how long they are applied, step-ups and their frequency, whether rollups stack on step-ups, guaranteed withdrawal rates, death benefits, investment choices, allowed asset allocation and the range of investment offerings, use of volatility-managed strategies, fees for the variable annuity and the optional riders and what they are applied to, and so on.
What approach can provide the most certainty to the retiree about guaranteed income while costing the least in terms of opportunity for upside growth? Companies tend to take a particular marketing approach toward framing their annuity products as the better option for retirees. They may focus on a few of these aspects and downplay others. With so many levers and possibilities, it is difficult to say which is best. Companies with better financial policies and strength could offer a better overall product, but at some level we should expect that among the best companies there may not be that much underlying difference, net of costs. There will be an associated cost for the risk accepted by the insurance company, and this will not vary too much among companies. In the end, the decision may ultimately center around choosing a strong company providing an approach and story that makes the retiree feel the most comfortable.
The most salient features for marketing variable annuities are the arms races that develop around which company is providing the highest rollup rates and/or guaranteed withdrawal rates. Companies may be strong on both, but without being the highest for either, can struggle to make their message heard. But they may also focus on what really matters: showing how their combination of rollup and withdrawal rates support more guaranteed income than the competitors along the lines of the discussion with Exhibit 5.1. Another position used here is to offer a higher initial guaranteed withdrawal rate on the condition that guaranteed income decreases if the contract value depletes, such as starting with allowed withdrawals equal to 7 percent of the benefit base but reducing withdrawals to 3 percent of the benefit base after contract depletion.
Along these lines, purchasers should remember to remain cautious and not necessarily pick the company offering the highest guarantees. Financial strength is important, and the company with the highest guarantee may have mismanaged its risk. Weaker companies may not have properly hedged their risks and the guarantees may not be sustainable.
Another marketing angle is to be the provider with more frequent step-up opportunities. The consumer receives value if step-ups can be locked in daily, rather than annually, as it increases the probability for step-ups to happen and for new high watermarks to be achieved. The contract anniversary is not always the date with the highest market level over the previous year. It is even better for owners if these step-ups can immediately vest and can have the rollup rate stacked on them.
Another approach is to be the provider offering the most investment freedom. While remaining competitive with the other means for reducing risk, a company may place emphasis on maintaining an open investment architecture with no limits on the stock allocation and no requirements that any sort of volatility-management approach be included for the underlying asset base. Arguably, this allows a retiree to choose an asset allocation appropriate to their situation rather than to the risk management needs of the insurance company.
Finally, companies could focus on providing the lowest costs for their guarantees, though this is not necessarily a key focus for any company. Offering a low cost alone is not the point, as the strength of the guarantees will also probably be less. The issue is more about what variable annuity offers the most value for its cost. Supporting a stronger guarantee is more costly, and paying a higher cost is not necessarily bad for a guarantee that provides greater value to the retiree.
Join us next Wednesday, Sept. 2nd for our webinar entitled, “Mutual Funds and ETFs – Which Vehicle is Better to Help You Achieve Your Financial Goals?” featuring special guest – Eduardo Repetto, Ph.D. Chief Investment Officer, Avantis Investors. CLICK HERE to register!
This is an excerpt from Wade Pfau’s book, Safety-First Retirement Planning: An Integrated Approach for a Worry-Free Retirement. (The Retirement Researcher’s Guide Series), available now on Amazon