Living Benefit Riders

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)

The great majority of variable annuity contracts only permit the purchase of the living benefit (a rider with an annual fee) when the contract is first established—and usually only one benefit can be purchased or used. A few insurance companies let the investor add a living benefit later. Some companies allow the contract owner to turn on or turn off the benefit for any given year (e.g., take a 5% annual withdrawal one year but opt for a 5% increase in the living benefit value the next year).

One of the easiest ways to explain a living benefit to a client is to point out the investment has two ongoing values: cash value (current market value of the subaccounts) and living benefit value (what may be a completely different number). In the great majority of situations, the living benefit is never available as a lump sum or as a surrender value; most living benefit values are used to compute an annual income or accumulation amount.

The investor should keep in mind: [1] he/she decides if the rider is to used; [2] often times, the rider may only be opted for 30 days before or after the contract anniversary date each year; and [3] the entire contract (growth and principal) must be used—there is no such thing as a “partial rider.” Some contracts have a living benefit that can be opted for at anytime, regardless of the anniversary date.

For example, Bill, age 51, invested $100,000 on October 3, 2012 in a variable annuity with a living benefit rider. Yesterday, the contract’s market value was $103,000 and its living benefit value was $111,000. Bill, now age 53, has decided to use his GMIB rider and wants to start receiving 5% of $111,000 for the rest of his life. Bill can only “turn on” this rider by making his request within 30 days before or within 30 days after October 3rd. If he misses this year, he must wait until next year, again 30 days +/- October 3rd.

In short, most living benefit values are used to determine an annual dollar distribution to the investor. A number of living benefit riders require contract annuitization before the benefit can be utilized. The idea of annuitization may not sit well with a client; if this is a requirement, it should be clearly explained to the client that he/she no longer owns the investment but instead is likely receiving a lifetime income > what they could get elsewhere (hopefully). There are also a large number of living benefit riders that can be used (now or in the future) that do not require annuitization.

GMIB

A guaranteed minimum income benefit usually requires contract annuitization. The period is frequently guaranteed for lifetime (and possibly the lifetime of the surviving spouse). Some companies use an age “setback” (a negative for the investor) when determining the lifetime income. This means the annuitization age setback for the annuitant is typically 3-7 years younger than the annuitant’s actual age. The result of this is periodic payments are lower and may result in a cumulative amount that may be modestly or moderately lower, depending upon the annuitant’s actual date of death.

For example, Mary’s living benefit provides lifetime income that can be started at anytime. Mary is thinking about using this benefit and Mary is age 63. If Mary decides upon the GMIB, the contract may base its lifetime payments as if Mary were 53 or 58 (not 63). The greater the remaining life expectancy, the smaller the annual lifetime payment.

GMIB Annuitization

If annuitization is required for the GMIB, insurers who offer these products often use “special annuity payout factors” that can significantly lower the dollar amount of each payment. This could be in addition to any annuitization age setback.

Annuitization is based on certain assumptions by the insurer: how they invest the client’s money, the direction (or future) of interest rates, life expectancy, overhead costs, etc. By using very conservative assumptions, the insurer can end up with a payment for the investor that is lower than assumptions made by the same insurer for a non-GMIB product.

For example, a GMIB based on a living benefit of $200,000 may result in lifetime monthly benefits similar to, or even less than, a $170,000 fixed-rate annuity offered by another (or same) insurance company. As a side note, if the actual account balance were, say $234,000, this higher amount would be used to compute the monthly lifetime benefit.