A few weeks ago I was preparing an indexed annuity illustration for one of our agents who had a client that wanted guaranteed lifetime income. So, I was running one of my favorite indexed annuities with the GLWB rider. As I looked at the printout, I came across something that I hadn’t seen in years. It was a “step up!” It had been such a long time since I’ve seen one of these, at least on this type of a GLWB rider, that I was confused until I realized what was happening and why it was happening: The 11.5 percent S&P 500 “cap” was outpacing the GLWB rollup rate. Now that is not something you saw when caps were at five percent!
Over the last few weeks I have also had a few questions from agents asking me, “Can you explain what is happening in this illustration?” So, I felt the topic to be worthy of a column along with a few other random thoughts on GLWBs.
A couple decades ago I was with a very large company that was a leader in the variable annuity space. At the time, the hot item with variable annuities was “guaranteed lifetime withdrawal benefits”(GLWBs), and its predecessor, “guaranteed minimum income benefits” (GMIBs). These were very popular because, on the back end of the dotcom crash, consumers were looking for guarantees to protect them from the turmoil they had just experienced. The GLWBs separated themselves from the GMIBs in that the GLWBs did not require annuitization, just “withdrawals.” Hence, with the GLWBs, the company did not require the client to lose control of their account value by locking it into a perpetual income stream.
At that time our hot VA product story was that the client had a “benefit base” that was guaranteed to grow by seven percent every year, regardless of what the actual account value did on that variable annuity. Even if the account value lost 50 percent, again, the client had that baseline guarantee that they can eventually take income based off of. Furthermore, the variable annuity world marketed an additional benefit, and that benefit was “step-ups.” The notion of a step-up was that if, at the end of the year, the actual account value is higher than the benefit base—meaning that the account value increased by more than what the seven percent rollup percentages had done—the client’s new benefit base would “step up” to what that account value was in that year. And then the ongoing seven percent roll up percentages would generally apply to that higher value. Later on came quarterly step-ups, monthly step-ups, and then daily step-ups. Then the economy crashed in 2009, interest rates plummeted, and these robust variable annuity benefits “stepped down”…but I digress.
We all know that GLWBs on indexed annuities came from the variable annuity world. The first GLWB was put on an indexed annuity chassis around the year 2006, after the variable annuity business had been running with the concept of GLWBs and GMIBs for years. This made sense to the indexed annuity market because the VA business had used these riders with huge success. The VA business was a good business to copy because the VA business at the time was about six times the size of the indexed annuity business. 2006 VA sales were $160 billion and indexed annuity sales were around $25 billion.
Over the last two decades these riders have evolved like everything else. I now discuss that there are two different categories of GLWBs in general: a) Performance-Based (the newer breed); and, b) Guaranteed Rollup Riders (the traditional breed).
The performance-based riders generally have minimal (sometimes none) “rollup rates.” These riders largely rely on the account value to increase in order to have the benefit base (and eventual income) increase. An example of one of these GLWBs may be, your benefit base will increase by two times what the amount of credit/performance was in your account value.
The performance-based riders are a good option for the clients/agents that believe that the performance of the underlying index may enable the benefit base to grow faster than what a guaranteed rollup rider may be able to do. These riders effectively rely on “step-ups” like what I discussed with the variable annuities.
The other category—at least how I categorize them—is “Guaranteed Rollup Riders.” These are the traditional seven percent, 10 percent, etc., benefit base rollup rates. These GLWBs are for the clients/agents that want straight guaranteed income without any reliance on the account value. These are the riders that have been on indexed annuities since the beginning.
Generally, the “performance-based” riders will show “non-guaranteed” income that is higher than the guaranteed-rollup riders, at least based on the illustration. However, from a guaranteed income standpoint, the guaranteed rollup riders will generally show the highest guaranteed income.
With the guaranteed rollup riders, something odd is starting to happen with interest rates having spiked the way they have, and that is the potential to receive a step-up on the benefit base… If the indexed annuities in the early years had much potential for “step-ups” back then, then I certainly don’t remember it. If there was ever much potential then it only lasted until the financial crisis, when interest rates really started to plummet.
Why no step-ups? Two primary reasons:
- Low interest rates: Because caps and par rates on these products were so low that the odds of having the accumulation value outpace the “benefit base” was almost nothing. (Caveat: There are some “volatility-controlled indexes” that show very high “backcasted rates” that have been able to show a step-up, but that has not been the norm.)
- Bifurcation of objectives: Another reason that you have not seen step-ups on this flavor of GLWB is because the GLWB focused annuities are “generally” watered down from an accumulation standpoint relative to the same company’s accumulation focused annuities. If you compare the cap rates, par rates, etc., on a product that provides very good guaranteed income, you will find that the tradeoff is “usually” the lack of accumulation performance. (Note: There are exceptions to this rule in that there are products that have the same cap as their “accumulation focused” counterpart. Hence, the product I used in the first paragraph.)
With interest rates having increased the way that they have, and by choosing a product that also has great accumulation potential, there may be opportunities to show the consumer the potential for an occasional step-up on their indexed annuity. But be cautious of rosy illustrations.
One last point on income focused products that also have great caps, par rates, etc. Even without a “step-up,” a great income focused annuity represents less of an “opportunity cost” to the client—versus a purely accumulation product—when that income focused annuity also has great accumulation potential.