The Real Cost of Riders

December 16, 2010

By Michael J. Prestwich

Before annuity producers discuss the features of a particular GLIR, they should ask their prospective customer about their future income goals, whether or not future income is desired for a surviving spouse, and calculate their customer’s potential life expectancy.  The cost and benefits of a particular GLIR should only be discussed after it has been determined to be a suitable option for the customer by the producer.

Since not all insurers provide their producers with software that discloses the cost of the GLIR, I developed an Excel spreadsheet that annuity producers can use to help their customers decide whether they should add the GLIR to their annuity contract. Important:  This, and any other software used to explain annuity products to consumers, is subject to state advertising laws.  Producers should have this spreadsheet reviewed by the compliance department of the insurance companies they represent before using it in front of clients.

In a sample illustration for a 70-year-old prospect, the spreadsheet uncovers an interesting fact:  the lower the average future interest rate that is earned on the indexed account — the more advantageous the GLIR is for the customer. For this hypothetical product, the guaranteed cost of the GLIR is 1.00% of the prior year’s Guaranteed Minimum Value and the current cost of the GLIR is .60 percent of the prior year’s indexed account value. After 10 years the illustrated cost of the GLIR for a hypothetical fixed indexed annuity product is as follows:

•         Guaranteed Minimum Value:                                                                     $10,185

•         Illustrated Hypothetical Average 3% Interest Rate:                                       $7,360

The annual Guaranteed Lifetime Income Benefit at the end of 10 years for this hypothetical 70-year-old annuitant is $16,624.  Let us assume this customer begins taking income at age 80 and lives until age 87, which is four years beyond the average male life expectancy. Withdrawing $16,624 each year from the indexed value of the annuity would produce the following illustrated results:

If the policy returns only the Guaranteed Minimum Value, the account value would run out of money at age 86 if the GLIR is elected; however, the GLIR annual payment of $16,624 would be paid each year no matter how long the annuitant lives.  Most customers whose primary concern is the fear that their income may run out before they die will probably conclude that the $10,185 cost to include the GLIR is a worthwhile expense.  This is especially true if they are currently in good health, are non-smokers, and have a family history of longevity.  In this situation they need only live one more year for the cost of the GLIR to pay off.

The 3 percent hypothetical interest rate assumption tells a similar story.  The indexed value would run out of cash at age 88 whether or not the GLIR is elected.  Since this is six years beyond the normal life expectancy, and two years beyond the assumed age at death, some annuity prospects may decide that spending $7,360 for “insurance” is not worth the cost and may decide to risk outliving their money. This choice is best left to the prospective annuity buyer after weighing the costs and benefits. This choice should not be made on behalf of the buyer by the annuity producer.

The spreadsheet can be modified to show a hypothetical interest rate higher than 3 percent but I highly discourage doing this for several reasons:

·         Guaranteed Lifetime Income.  The primary purpose of adding a GLIR to an annuity contract is to provide a guaranteed lifetime income.  I recommend that producers spend most of their time discussing the Guaranteed Minimum Value and the Total Income Received From Policy to Date columns on the ledger. The “Worst Case Scenario” is that they are guaranteed to receive a high, guaranteed, lifetime income!

·         Safety. Fixed indexed annuities were designed primarily as a safety vehicle, not as a way to achieve high rates of return. The account value of these products can go up, sideways, but never down.

·         Legal Liability. It is foolish to discuss potential high rates of return with fixed indexed annuities. This may set an unrealistic high expectation in the mind of the consumer, and this may come back to haunt the producer and the insurer.

·         History. Exhibit 2 shows the hypothetical historical results of purchasing an indexed annuity on April 1, 2000, using an annual point-to-point strategy assuming a constant 6 percent interest rate cap.  In this instance the interest rate would have been zero for the first three years, near the 6% cap in years four, five, six and seven, followed by two more years of zero. Based on these assumptions, the average interest rate for this 10-year time period would have been only 2.72 percent. Any historical example during the past 15 years will show three to five zero interest years in any 10-year period.

·         Interest Rates Do Not Matter. Again, when the producer recommends adding a GLIR to an annuity contract it becomes an income vehicle, not a growth vehicle. The example in Exhibit 1 shows a guaranteed lifetime income of $16,624 starting in year 11. This extraordinarily high income completely depletes the indexed account of the policy at age 86 based on the guaranteed minimum values, and depletes it at age 88 based on a hypothetical 3 percent interest rate. An illustration based on a hypothetical 6 percent interest rate would deplete the indexed account at age 90. If the annuitant where to live until age 90, he / she would receive exactly the same income whether the policy achieved the guaranteed minimum value, a 3 percent average interest rate, or a 6 percent average interest rate.

A Guaranteed Lifetime Income Rider is not for everyone. However, for those who enjoy excellent health, have family members who have lived into their 90s, and are concerned about the risk of running out of money before they die, adding a Guaranteed Lifetime Income Rider may be part of a solid income plan for those who want a worry-free income that is guaranteed to last as long as they do.

Michael J. Prestwich sold his first annuity in 1975. After seven years he started ImagiSOFT, Inc. which develops life insurance and annuity illustration, marketing, and compliance software.

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