Annuities

A 55-year-old male buying long-term care insurance can expect to pay ~ $2,000 a year for $165,000 in total benefits, including a 3% CPI adjustment rider (source: American Association for Long-Term Care Insurance). New underwriting has become more strict; applicants in their 40s now require blood work, urinalysis, weigh-ins and cognitive tests to look for signs of chronic illnesses or dementia. The result is higher rejection rates.

Using annuity ladders is very similar to bond laddering: different positions maturing at different times. Annuity and bond laddering can be particularly effective today because of the low interest rate environment. Most of your clients likely realize interest rates are going to increase at sometime in the future. Annuity laddering can be the answer to this concern.

Do Not Supersize Your Annuity

Fixed-rate and variable annuities provide a number of solutions for financial and estate planning. However, like any other investment vehicle, there are negative features to annuities, as shown in the table below. Each feature and consequence is detailed in the subheadings below the table.

Annuity Negatives

The vast majority of variable annuities include an optional rider known as a living benefit (a fair description since no one has to die for the benefit to kick in). There are four basic living benefit riders (sometimes referred to as “enhancements”):

[1] GMIB—guaranteed minimum income

[2] GMAB—guaranteed accumulated benefit

[3] GMWB—guaranteed withdrawal (percentage)

[4] GLWB—guaranteed lifetime withdrawal benefit (similar to GMWB)

There are four costs associated with variable annuities: [1] a possible upfront sales charge (similar to mutual fund A Shares), [2] sliding scale surrender charges (typically range from 0-8%), [3] insurance charges (i.e., mortality and expense, administrative, and possible distribution), [4] management fees (expense ratio, similar to mutual funds), and [5] an additional annual expense if a rider is chosen).

Moshe Milevsky is an associate professor of finance at University of Toronto’s business school; he is also a founder of QWeMA Group, a company that develops products for wealth management and insurance, with a focus on retirement income.

A number of issuers of variable annuities with living benefit riders—including Hartford, AEGON, AXA, and Transamerica—are making offers to buy back some contracts from contract owners. The possible short-term losses to the insurers are expected to be more than offset by their long-term savings. 

Variable annuity death benefits need to be compared against term life insurance. The standard death benefit pays the greater of principal or value upon death. Some death benefits can have an annual cost of 1.1% to 1.75% of the contract value (the M&E charge). 

It is difficult to measure the real value of a variable annuity death benefit. Conceptually, the value of any death benefit (except the “standard” death benefit that only pays contract value at death) is enormous if the investor has donative intent. The death benefit allows the contract owner to invest in one or more subaccounts he would not normally consider because of risk.