Insurers have been expecting a spike in in the annuitization rates of certain older variable annuities, but that hasn’t happened—at least not yet.
Advisors may have had some influence on this, but the impact appears to be indirect or even incidental. More on that later. First, the numbers.
In a recent study, Ruark Consulting uncovered an unexpected trend: Annuitization rates in variable annuities that include a guaranteed minimum income benefit (GMIB) rider have been less than 5 percent a year in the aggregate over the past five-plus years.
Annuitization rate is the rate at which consumers convert their contracts from the accumulation (or savings) phase to the income payout (or annuitization) phase. That latter phase is when the customer “takes income” from the policy for retirement, travel, or other reasons.
Most insurance company experts have been expecting that annuitization rates on variable annuities with GMIB features would be “very high, certainly above 5 percent,” says Richard Tucker, vice president at the actuarial and consulting firm.
The operative word here is GMIB. Available for an extra cost, this feature is a rider that guarantees the annuity will pay out a certain level of income for life, regardless of the variable annuity’s subaccount performance. Typically, owners can exercise the guarantee after a waiting period (10 years is common). Most GMIBs also sport “roll-up provisions.” The roll-ups increase the account value on which the income payouts are based by a fixed percentage (say, 6 percent a year) during the accumulation years. Some GMIB riders have other bells and whistles, too.
The GMIB products have their fans, but insurance company experts have been giving them a sober eye as of late. That’s due to a prevailing concern is that their annuitization rates will be “high” and that this may put upward pressure on reserves sometime down the road, says Tucker in a telephone interview .
The reason for the concern is that many variable annuity/GMIB contracts are (or have been) “in-the-money,” he says. “In-the-money” means the value of the guaranteed benefits, relative to account value, has increased to the point that many contract owners could see themselves as being better off financially by taking their rider benefits sooner rather than later.
The thought is, “why wouldn’t policyholders annuitize if their benefit was in the money, especially in view of the history of equities in the last five years?” Tucker says.
The question has legs. After all, many variable annuity subaccount values took a steep nosedive during and following the 2008-2009 recession. Meanwhile, the roll-up provisions in their GMIB riders kept pushing up the guaranteed income account value of their contracts. “That’s like a built-in economic motivator (for policyholders) to annuitize,” says Tucker.
To test the waters, the Ruark study looked at the annuitization experience of seven major insurers that sell variable annuities with GMIBs. The experience data covers January 2007 to June 2012, representing 600,000 contract years of exposure and 10,000 annuitizations. Only contracts that had passed their waiting periods, and were thus eligible to for annuitization under the GMIB, were included.
Not only did the researchers find that GMIB-related annuitization rates were less than 5 percent annually, they also found that the annuitization rates varied by age of annuitant, the peak being 65-69. They did find a spike in election rates following the end of the waiting period, but this was at a “muted level,” the study says.
How to account for the lower than expected annuitization rate?
Forgetfulness may be a factor, suggests Robert Klein, president of Retirement Income Center, a Newport Beach, Calif., registered investment advisory firm. “My gut feeling is, people get excited when they are first offered some of these riders. But unless you bring it up periodically, and point out when and how to use the benefits, clients just forget about it.”
That could easily happen if the client has been orphaned by the advisor who sold the contract, he says. “A disconnect can even happen if the client keeps the same advisor but the advisor does not regularly meet with the client and track the person’s money, products and needs.”
Confusion can play a role too, Klein says. “A lot of the time, the GMIB is not the only rider on the contract. There are a lot of moving parts to the policies, and that can be confusing to both client and advisor.” If they’re confused, they may not do anything with the rider.
Another factor could be the reason the person bought the annuity in the first place, Tucker adds, citing retirement planning, tax deferral, legacy purposes, and retirement income as examples.
The role of the advisor
Are advisors influencing this trend in any way? Richard W. Paul, principal of Richard W. Paul & Associates, a Novi, Mich. registered investment advisor, answers firmly that “advisors aren’t the gatekeepers on this.”
In other words, “it’s the client who decides.”
The advisor should be looking at the client’s whole picture, Paul continues, stressing that “retirement income is not just about the annuity.”
In fact, the first time a client mentions needing or wanting more cash flow—to balance out the pension and Social Security, for instance—Paul says he encourages the client to start the annuity income. “We do that whether the client wants to enhance lifestyle or to fulfill retirement dreams.”
“It’s incumbent on us as advisors to recommend they take income when they want or need it.”
As a result of this approach, he says, there is no utilization trend he can detect at his firm. “Some clients start income immediately, while others wait a long time. It’s across the board.”
The roll-up provision might be a factor that influences people to put off exercising the GMIB, he allows. Some clients may want to delay income so they can continue getting the annual increases on the monthly payout. “But that’s just like deciding when to take Social Security. Some people wait to take it at a later date to get a higher monthly benefit, and others don’t.”
As to whether some advisors might intentionally be dissuading clients from exercising their GMIBs, Paul thinks that is highly unlikely. “Someone out there might try to put a firewall over it,” he concedes, “but any financial benefit the person might get from that would be so small and so gradual that it would be inconsequential.”
Looking to the future, Tucker has a few words about the variable annuity policyholders who are already outside of their GMIB waiting period but who have not yet exercised the rider. “Those people still have the right to annuitize, and they could do so eventually, when it is best for them. So although annuitization rates are lower than expected now, they could go up in the future.”
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