Monday, January 16, 2012

On the Pros and Cons of GLWBs

Guaranteed Lifetime Withdrawal Benefit (GLWB) riders, also known as Guaranteed Minimum Withdrawal Benefit (GMWB) riders, provide a seemingly attractive offer for retirees: they protect on the downside with a guaranteed income for life, they include upside potential with step-up features for growing markets, and they are contracts which can be ended with remaining assets returned.
I recently explored the performance of GLWBs compared to systematic withdrawals from one’s savings using US historical data in the column, “GLWBs: Retiree Protection or Money Illusion?” at Advisor Perspectives. Subsequently, Bob Powell included an interview with me in a column he wrote for MarketWatch, “Variable-annuity guarantees disappoint over time.” After reading some harsh criticism in the comments there and at SmartMoney, I do still stand by all the points I made in the interview.
Variable annuities and GLWBs are controversial. Some observers are set dead against them, while others think much more highly about their potential. In my initial column, my conclusions tended a little bit toward the anti-GLWB side.
I am not pushing any agenda and am only trying to determine what potential role GLWBs may have helping retirees to meet their goals. We do need to be careful, because in these trying and volatile financial markets, we might be too eager to grasp onto something offering assurances that might really be too good to be true. Skepticism is warranted.
Some of the feedback about my column and the interview suggest that my somewhat negative conclusions were unfair, and that GLWBs really are more useful than I gave credit. Today I’d like to further explore four of the pro-GLWB arguments I’ve been reading.
1. I only considered the rather plain GLWB rider offered by Vanguard. Other GLWB riders offer all sorts of interesting features such as guarantees to double one’s wealth and so on. These alternatives are much better.
This issue is the main reason for writing today. My initial response to this is that while other products may offer more attractive guarantees than Vanguard, they must also certainly be accompanied by much higher fees as well. But this gets to heart of a rather confusing issue for GLWBs.
If two different GLWBs offer the same initial guaranteed withdrawal amounts, it seemingly doesn’t matter what their fees are. Or at least, the role of fees may not be clear for someone who is just starting to learn about GLWBs. But the fees do matter.
Joseph Tomlinson* has written his inaugural monthly column at Advisor Perspectives on this issue. His column is, “Income Annuities versus GLWBs: A Product Comparison.” He argues that the way to assess the impact of fees from a GLWB is to look at the remaining account contract value as time passes. One of the features of GLWBs is that they can be terminated with assets returned. But higher fees will mean less is available to be returned. Fees on the variable annuity and GLWB rider reduce the contract value of the remaining assets, which also reduces the likelihood of the step up features for the upside potential kicking in. Market returns have to be so strong that the account value can still increase despite of the fees eating away at the account value.
To repeat, two GLWBs may offer the same guaranteed initial withdrawals, but if one has higher fees, then the contract value of the remaining assets will be depleted more quickly, which also has the implication that there will be fewer opportunities for upside gains should markets perform well.
Joseph Tomlinson’s new column explores this. He compares systematic withdrawals, Vanguard’s GLWB offering, a cash-refund annuity, and a more typical GLWB product with much higher fees than Vanguard. He estimates the average remaining bequest value in order to make a comparison about the impact of fees for different strategies offering approximately the same payouts. It’s a way to show the cost of the fees in more understandable dollar terms.
What he finds, naturally, is that one can’t really expect to enjoy downside protection along with upside potential. Risk is commensurate with reward. After fees for the guarantee, GLWBs end up behaving more like fixed income than like stocks. The potential for upside growth is constrained by the degree of downside protection. You can’t have your cake and eat it to. There’s no free lunch. You get the point.
2. By guaranteeing income, GLWBs will help their owners to maintain a higher stock allocation and to avoid the mistake of panicking and selling stocks after a market decline.
This is a popular argument from pro-GLWB sources. Essentially, the argument is that people who would otherwise be terrible investors prone to buying high and selling low or who might be permanently scared away from stocks will be suddenly transformed into proper stay-the-course buy-and-hold investors with a healthy dose of stock holdings on account of the GLWB guarantee.  Examples of this point can be seen in letters to the editor about my column at Advisor Perspectives here and here
I’m not sure about this. Especially, GLWBs still have an account balance, and assets can be returned, so people might still be prone to worrying about the account value and making the same mistakes.
What’s more, I’m not sure how one would even go about determining whether this point is true. Even if GLWB users make fewer behavioral mistakes with their asset allocations, we cannot know if that is due to the guarantee, or due to the different psychological make-up of GLWB users. This is called the sample selection problem. We would need a randomized experiment in which some people are randomly required to buy GLWBs and some are not, in order to properly demonstrate whether this point is true. Relying on anecdotal evidence and memories about client behavior is not enough.
This is a question which really requires further data exploration. It may or may not be true, and I would like to know! If anyone reading this does have such data, I’d be quite interested to hear about it and to potentially work with you on some data exploration.
3. Perhaps because future returns may be more gloomy than what we’ve observed in the past, GLWB providers may have been too generous and are now starting to leave the business.
This is certainly an interesting and important point. I do want to explore GLWBs further with simulations that may be more realistic. As I’ve argued many times, US financial market returns in the 20th century were quite high by international standards, and perhaps higher than we can reasonably expect to see in the future. With more realistic (i.e. lower) return assumptions, GLWBs may come out looking much more attractive from a buyer’s perspective (which is bad news from the seller’s perspective). Of course, if a GLWB is so great that it ends up driving the seller out of business, this is bad news in terms of still getting one’s guaranteed income. But this is an interesting point that I want to explore further in the future.
4. GLWBs can provide their users with comfort and peace of mind, knowing that they have a guaranteed income source no matter how bad things get.
I don’t dispute this (subject to the insurance provider remaining viable). In my interview, this is what I meant which I mentioned that retirees must decide on a personal level whether they value the guarantees more than the fees. This really is a personal decision and I can’t give an answer for anyone. Only you can decide.
One commenter about the interviewer said that this point is stupidly obvious. Yes, it is chapter 1 of principals of economics that you only buy something if you value it more than the price. But the problem with GLWBs is that it is so hard to determine the real world meaning of the price. The benefit of the GLWB is also rather abstract as well.
In that regard, I do think the analysis provided in Joseph Tomlinson’s new column can be very helpful in quantifying the real world impact of the GLWB fees, and so help retirees to decide whether the guarantees are “worth it” for them.
Again, I am not condemning GLWBs. I suppose I am just saying that I would like to see greater transparency about the meaning of the fees so that people can make better decisions about them.
If you are thinking about purchasing a GLWB, make sure to do your homework and understand all of the features and fees.
 
*I have been getting to know Joseph Tomlinson as we share common interests both in comparing retirement income strategies, as well as in applying utility analysis to retirement income, which looks to find a balance between the safety of lower withdrawal rates and the added life enjoyment of being able to spend more with a higher withdrawal rate. You can find more of his writings at his webpage, and he will also have a research article I recommend checking in the upcoming February issue of the Journal of Financial Planning called, “"A Utility-Based Approach to Evaluating Investment Strategies."

18 comments:

  1. I was disappointed you did not mention certain Fixed Index Annuities (FIA) with GLWB riders (like those offered by Security Benefits Insurance, rated A-) that cost less than 1% annual GLWB rider fee, add 5% to 10% sign up bonus depending on your state location, guarantee 8% annual GLWB base roll up that will more than double the initial premium in 10 years, then pay 6% or more of that GLWB base for life. No matter what the stock market may do, an annuitant will deplete that entire FIA cash value within 15 to 20 years, but the GLWB keeps paying for life, and if the annuitant dies early before the FIA cash value is fully depleted, any balance goes to the death benefit for heirs. The stock market is no place for retirees aged 60 and over to be risking their hard earned IRA nest eggs. FIA with GLWB rider is not only the safest, but best return lifetime investment a retiree can make with their IRA funds since IRA CD rates have plummeted recently. If you can't realize that, I question your financial skills.

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  2. There is no such thing as a free lunch.

    So what is the catch?

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    1. Okay, Wade, I don't think you ought to be asking, "So what is the catch?" before you respond to the product as described by 'Unknown'. I am looking at this product, too, and so far, I don't see any 'catch'. How about helping all of us less-knowledgeable folks out and telling us if you think the SB FIA with GLWB rider is a good deal AS DESCRIBED, and then we can go from there to discuss it further? Thanks.

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    2. As described, it does indeed sound like a pretty good deal. That's what makes me suspicious. You've got my interest now. I'll put on my to-do list to try and look more deeply at this product and figure out why it offers such seemingly wonderful terms.

      Just as a starting point... that 6% payout is for what gender and what age range?

      And how exactly is that company able to hedge the risks to offer those guaranteed terms with a rider fee of less than 1%?

      Were the terms set by actuaries, or the marketing team?

      If the product terms really are to good to be true, then there's a risk that the company will go bankrupt, and the issue of whether a state guarantee association would cover it is much murkier.

      I admit that I do need to learn more about how indexed annuities work. It isn't something that I've explored or written about before.

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  3. Thanks for replying. You ask some good questions. Let me provide some further information and suggestions.

    1) Go to this website: https://www.siaincome.com/SB website, and plug in some ages/figures and take a look at the GLWB amounts. They look quite attractive.

    2) The current 'roll up' rate is 7% (no longer 8%) guaranteed for 10 years; you can then lock in another 10 years, but the company has the right to up the rider fee from .95% to 1.50%. It still seems like a good deal.

    3) I don't think this matters, however, as I would plan to begin taking income likely within 5-7 years.

    4) The person who is offering to sell it to me says he looks for the best fixed (fixed only, he doesn't do variable) annuities out there, and this is currently his favorite. He owns five contracts himself.

    5) The rep says that the state guarantee associations cover you up to $250k. He also said that this company's assets to liabilities ratio of greater than 1:1, unlike a lot of banks. Very solid. And, finally, he said that even if it were to start having trouble--which, again he believes is highly unlikely--it is almost certain that another company would step in and buy it, because insurance companies don't like to see another company go under, and the existing contracts are still profitable.

    The sales rep I am dealing with seems like a very solid, non-pushy, genuine good guy. He is in his mid-sixties, and wealthy. He is doing this to make some money, of course, but he genuinely seems to like helping folks like me develop a guaranteed income stream in retirement. He believes in this product.

    Looking forward to engaging in more dialogue, as I would like to know what to do with whatever lump sum we have been able to accumulate before I retire in, say, 5-8 years. i.e., continue to manage it myself, or perhaps purchase some annuity contracts. With this product, the sooner I buy it the better, as the payout increases every year you wait to start it.

    Thanks.

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  4. Oh, also, two other points:

    1) Regarding the '6% payout': the first poster, 'Unknown', was not entirely accurate on that point. Security Benefit uses a sliding scale, starting at around 3.9% and going up every year you delay taking income. It will eventually reach 6%, but not for a couple of decades! Still, the payout amounts seem like a good deal.

    2) "Were the terms set by the actuaries or the marketing team?" I realize what you're asking, but the answer is, as in most cases, almost certainly to be 'a combination of both'.

    3) If you play around with the calculator on the SB website, you will be able to answer most of your questions.

    I am very much looking forward to your assessment, as it is very difficult finding some truly independent counsel on these complicated issues.

    Thanks again.

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  5. And...

    - the SB product has another feature: the annual payout can double for up to five years if you need/qualify for long-term care insurance.

    - if there is a better place to have this dialogue (i.e., another of your blog sites) and generate more public commentary, just let me know.

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    1. Hi, thanks for all the details about this project. It will take a while before I can get to it, but I will aim to do a detailed analysis about these using Monte Carlo simulations. I'll look at how likely it is for someone to run out of money trying to replicate the income that this product will provide when using withdrawals from their own unguaranteed mutual funds. That will make it more systematic, rather than just being based on an opinion.

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    2. Great, that's exactly the calculation I'm trying to make. If I purchase the SB annuity, I won't run out of money; the payout is guaranteed for life. However, am I sacrificing a potentially higher standard of living by not managing the money myself, and taking my own distributions? I suppose it all comes down to how active an investor I want to be, and how much risk I am willing to assume. i.e., what returns do I need to achieve to match or exceed the payout from the SB product; and is that return level reasonable in today's environment?

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  6. Hi anonymous,

    I'm starting to take a closer look at this. I think I can simulate it, except I can't do a proper job to incorporate the probabilities of getting that 5-year increase for long-term care events. That is an issue I will just need to leave out.

    But there is one other hang-up as well. It may take a while for me to figure out how things work if the market is up more than the guaranteed 7% in a given year. Based upon an initial glance, it seems that the "market" in this case is the S&P 500 index without dividends. Is that your understanding? Also, what about cumulative issues such as these returns:

    year 1: 0%
    year 2: 20%

    In year one, you get your 7% return, but in year 2, will you get the full 20%, or only the portion of that to get you up to a cumulative 7% return for each of the two years? I need to study that more. This might be an issue where the "catch" happens. They are guaranteeing that you will double your hypothetical benefit base over 10 years in nominal terms, but it might be hard to expect any more upside since they don't count dividends for the market returns, and doubling in nominal terms isn't necessarily all that difficult (though of course there is downside risk with this if you don't have a guarantee).

    About the website, does it bother you as a client that you are unable to see the commission schedule that the advisor receives? That bothers me a bit. This information should be transparent.

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    1. Hello, Wade.

      - Okay, let's leave out the doubling health benefit for now (although it IS a benefit, and possibly an important one if needed).

      - On the commission issue: I actually called Security Benefit directly. They were nice on the phone, and said this product is sold through representatives, and that these reps received a commission. They didn't tell me what it was, but I didn't ask. Everyone deserves to get paid. Does it really matter what it is? Not to me: I am buying a product, and if I get the return advertised/guaranteed, then I shouldn't care; and I don't. (Remember the parable of Jesus when he hired men throughout the day, and the ones hired early complained that the ones hired late in the day got the same pay? Jesus replied (paraphrasing): 'What's it to you? You got what I promised, you shouldn't care what I pay to someone else.') If I like the return on this product, it really doesn't matter to me what Security Benefit pays its sales force.

      - Market performance for this product is irrelevant. Returns do not matter. I buy the product, with the GLWB rider, and I get the annual payments listed on the chart, in whichever year I choose to start taking payments. They can earn 0%, or -12%, or +25%, it doesn't matter: once I buy this product, my returns are set. There will be no additional upside, no matter what the market does; but there will be no downside, either. That is what they are selling: an assured income.

      - To wit, using the secure website I sent you to set up a hypothetical example, if I choose the joint payout option, buy a product for $100k, and input an age (57) and another age for the co-payee (54), and take it immediately, I/we would received $4212 per year for life; if we wait 1 year, $4622; 2 yrs, 5070; 3 yrs, 5557; 4 yrs, 6665; 5 yrs, 7294; 6 yrs, 6087; etc., as the chart on the website I gave you shows. The benefit base and the withdrawal rate increases at a set guaranteed rate, year by year. The company assumes all the risk--and yes, all of the benefits--of market performance. This is a FIXED product.

      - Yes, you see the crux: doubling my 'benefit base' in 10 years is not perhaps all that difficult, "though of course there is downside risk with this if you don't have a guarantee." Exactly. This product IS a guarantee. The stock market earned 0% between 2002 and 2010. What would happen to my personal 'benefit base' if that happened again? I am not 33, can I afford that risk now?

      - There are online 'retirement payout' calculators that can potentially show me that I can earn more if I keep my money, manage it, and take my own payouts. But they all presuppose a steady average return, and usually it's around 6%, with a life expectancy to age 87. Will I live longer? Will my wife? Can I achieve a steady 6%, or at least an average, with no heavy losses in the early years? All vexing questions. I'm looking to lock in some income, and would just like to know if, after analyzing it, you think it is a reasonable return. The company seems solid. If you do think it is a decent deal, I'll probably take some of our lump sum savings and buy a certain amount of these products, in perhaps $100k increments, and keep a certain amount to manage myself, to have the flexibility to use a lump sum if needed/desired for something else in life.

      - Thanks for your continued engagement on this, it is quite important to me (and I imagine to a lot of others as well.)

      'Anonymous'

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    2. Hi,

      That's an interesting take on fee transparency. I understand your point.

      About the long-term care benefits, yes that is potentially important, but I don't have the capacity to properly model the probabilities of receiving it.

      I still have to study more carefully about how the returns work during the deferral period. If you are right that you simply get a 7% return, then modeling it becomes very simple and I can proceed. But I was under the impression that the return had some characteristics of "7% or more" based on market performance, and in that case I still need to figure out how that would work. Again, if you are right, it makes this aspect _MUCH_ easier to program into my computer.

      This is still on my to-do list.

      Best wishes, Wade

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    3. Wade,

      Thanks for continuing to engage/study this. As I said, I would like to be in a position to make a decision by mid-summer, so thee is no rush, and I appreciate you taking the time to look this over.

      As far as modeling, I'm not sure it's even necessary. This is a fixed product the moment I buy it. I think the simplest way to understand this product is just to plug in figures on the following website: https://www.siaincome.com, and see what you think.

      Regarding how the returns work during the deferral period, they are absolutely fixed: the benefit base is immediately plussed-up by an 8% bonus; the benefit base increases by a fixed 7% a year for every year you defer exercising the GLWB rider; the withdrawal rate also increases year by year, by .1%. This results in an increased annual income stream, for every year you defer starting to take income.

      To wit: if you plug in an initial investment of $100k, for a joint payout, current age 57, spouse age 54, you would receive $4212 per year for life if you exercised the GLWB rider immediately; if you wait 1 year, it becomes $4622, which is an increase in income of 9.75%; 2 yrs, $5070, another 9.75% increase; 3 yrs, $5557, an increase of 9.5%; 4 yrs, $6087, an increase of 9.5%; 5 yrs, $6665, an increase of 9.5%; 6 yrs, $7294, an increase of 9.4%; etc.

      Now, of course, these terms can change, i.e., the company can change the bonus amount, the interest roll-up amount, the withdrawal rates, etc, any time it wants to, but NOT on contracts already sold. Once purchased, the terms are locked in.

      Here's another potential advantage to this product: the benefit base is not the same as the amount left in the principal. That amount will only increase by the prevailing interest rate, maybe 1% if we're lucky at the moment, so, over time, once payouts are elected, this principal amount will decrease, eventually to zero. But that will not affect your income as long as you live. So, when the actual principal amount gets down to about $10k, the rep advises 'Rothing' it at that point, thus changing all future income payouts, which again are fixed and guaranteed, to tax free. And if I buy the product with money I currently have in a Roth, all the income, from the moment I elect to start taking it, will of course be tax free.

      So, bottom-line, can I do better managing my money myself and taking my own distributions? Yes, maybe, if certain future market performance assumptions are made. But this product seems like a good deal by giving a solid return while taking a lot of the worry away.

      I, too, am skeptical of a 'free lunch', but it is a competitive market out there, and this company has a product it believes it can offer and sustain, and carve out a niche with. The rep I am dealing with says he represents several companies (other I've heard mentioned are ING and Aviva), and he says this is the best product he can find at the moment. He says he has five of these contracts himself.

      The company seems sound, there are state guarantee associations, etc. Unless you find something to be very concerned about, I'm leaning toward buying a few of these with our to-date accumulated savings/investments, to lock in some future income against possible future market declines or roller coaster rides.

      I am very interested to hear your conclusions after you've had some time to study and consider this product.

      Thanks again,
      Anonymous

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  7. Wade,

    Any further thoughts on this product? If you're still looking into it, I'll probably be deciding on a course of action (i.e., buy some of these products or continue to self-manage our savings) by late-June/the first week of July.

    Thanks,
    Anonymous

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    1. Hi,

      No, I haven't gotten to this yet. It may still take a while, though it's on my to-do list.

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  8. Ok, I just got back from a business trip. I'm still hoping to make a decision over the summer on this. I really need some independent, informed advice. I don't want to make this decision alone, as I'm not a financial analyst, but nor do I want to rely on the salesperson for this product. Of course he likes it, and thinks it's the best thing I can do with my money!!! If you think it is going to be a long time before you can look this specific product over, could you let me know what kind of person I could look for in the DC/Northern Virginia area who could provide me this advice? I am NOT looking for a financial planner/advisor who wants me to put assets under their control. Thanks again.

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    1. Hi, I'm afraid that a number of projects are coming up with higher priority and my efforts to dig into these types of indexed annuities is going to take longer than I hoped. You shouldn't count on me to finish any analysis this summer, though I hope it can happen.

      About your request for who to talk to, that is a tough question. There are various planners who charge an hourly fee and who may have some knowledge about indexed annuities, but I honestly don't know of anyone I can suggest. The planners I know tend to be more comprehensive in nature.

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  9. Not a big fan of the variable annuity; prefer equity indexed or immediate, but the mutual fund folks have really pulled a fast one with its propaganda. The losses in retirement income for folks due to the last 10 YEARS of a bear market were predictable. The truth is the 18 year bull market [1982-2000] was an anomaly. Bear markets happen about every 7 years on average. And they do real damage to folks retirement income who are dependent on equity performance. The sequence of returns problem is the single most difficult issue to deal with for retirement planners and annuities are one way to deal with it. Now if you are an experienced and active investor when you approach retirement you can find strategies [dividend paying stocks, asset mixes] that can help you deal with this problem. But the bottom line is that the vast majority of folks aren't experienced nor active investors as they approach retirement. And the truth is most financial planners are not either.

    Bottom line those guarantees are well worth the price for many folks approaching retirement. And despite several companies being bailed out, so far those annuity payments are still being made, even by AIG!

    - Tom from Life Ant

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