Guaranteed Minimum Withdrawal Benefit Products

September 11th, 2012

Guaranteed Minimum Withdrawal Benefit products (or GMWB’s) are financial products which have been developed by life insurance companies in the last ten years to respond to 3 important developments: a large number of “baby boomers”, estimated at a third of the total population, will be retiring in the next 10 to 15 years; these “boomers” have accumulated a large amount of savings. Investor Economics, consultants to the financial services industry, estimates that their savings are in excess of one trillion dollars; people are extremely reluctant to forfeit control over their savings by purchasing single premium individual annuities.

Although GMWB’s are complex, they offer guaranteed rates of return in the accumulation phase, guaranteed income for your lifetime in the payout phase and potential increases in value depending on the investment performance of the underlying funds. They offer the potential for market upside with no downside and a fixed income for life.

When we analyze GMWB’s in terms of the risks of retirement discussed in previous Newsletters, we get the following:

Longevity

The insurance company will pay the guaranteed income for the lifetime of the client. Joint and last survivor options are available to couples that guarantee income as long as one of them is alive.

Inflation

The underlying funds are invested in mutual funds. To the extent that the market value of the funds exceeds the client’s total deposits, there is a reset function that increases the guaranteed income every three years. This offers the potential to offset the effects of inflation under some (but not all) circumstances.

Sequence of Returns

The insurance company takes all of the risk for sequence of returns and the client is completely protected.

Liquidity in the Event of Health Issues

These products offer options for the level of death benefits and cash surrender benefits. These benefits diminish once the payouts commence. The client has an element of control over the funds.

Product Allocation

This risk is eliminated by GMWB’s. The insurance company manages the investment process and takes all the investment risks.

Withdrawal Rate

The payout is a percentage of the value accumulated at the start of payout phase. The percentage is determined by the age at which payments commence. This payout is fixed for the lifetime of the client.

GMWB’s have been very well received by the general public but are not without detractors.

Investment professionals point out that the various fees built into the product are excessive. One has gone so far as to accuse the products of being fraudulent, arguing that the fees are too high and that the payout guarantees too low.

The market for GMWB’s is also changing rapidly. When they were first introduced in the middle of the last decade, investment returns were very attractive and insurance companies had to offer generous payouts in order to compete.

Today’s low interest rate environment is limiting the returns on the investments which insurance companies use to fund GMWB’s, which is leading some companies to suspend sales of new GMWB’s while others are offering lower payouts on new sales. As-long term interest rates move back to historic levels, I expect that the insurance companies will ease these restrictions on GMWB’s.

In summary: GMWB’s offer interesting guarantees that should be considered when allocating retirement assets but they are also very complex.  I strongly recommend that you contact me to assess the suitability of these products for your needs before purchasing them through a licensed, knowledgeable life insurance agent.