Variable annuities Primer

Document Sample
Variable annuities Primer Powered By Docstoc
					www.advisor.ca	                                                                                                                                       		Advisor’s	EdgE	rEport		may 2007 11




Variable annuities Primer
                                                                                                                                  by more than 5% in that year.             Boomer Products
                                                                                                                                      The bonus is not added to             Continued from page 1
                                                                                                                                  the contract balance, just to
gMWBs	are	making	inroads	into	Canada,	but	how		                                                                                   the guaranteed withdrawal bal-
                                                                                                                                  ance. In other words, the bo-
                                                                                                                                                                            client first signs a contract or tagged
                                                                                                                                                                            on later, depending on client needs,
do	they	stand	up	to	market	history?	                                                                                              nus cannot be cashed out, but             says Peter W. Glaab, Sun Life’s vice-
By Jim OtaR                                                                                                                       it increases the annual income            president of individual wealth man-
                                                                                                                                  for the entire guarantee peri-            agement. Glaab believes this flexibil-
                                                                                                                                  od. For example, if you sell a            ity will not only attract new buyers
Variable annuities with guaranteed               The day you buy the VAG, both                                                    $100,000 VAG to a 55-year-                to its seg funds but will also allow
minimum withdrawal benefits are               the contract value and the guar-          if	the	portfolio	does	well	               old client and he is planning to          pre-existing consumers to continue
very popular in the USA. They                 anteed withdrawal balance are the                                                   start withdrawing at age 65, his          with Sun Life funds that they used
                                                                                        and	the	contract	value	
were first introduced by Hart-                same, i.e. your initial premium.                                                    guaranteed withdrawal balance             for wealth accumulation without
ford in 2002. In 2004, sales of all           Even if the contract value might          exceeds	the	guaranteed	                   is increased to $150,000 by age           transferring into a different product
variable annuities (with or with-             go down to zero in adverse mar-           withdrawal	balance,	then	                 65, even if the investments stay          when their investment needs change.
out GMWB) in the U.S. reached                 kets, annual payments continue            it	is	reset	higher,	equal	to	             flat or go down. There is usually            Moshe Milevsky, a professor of
$128 billion, of which 69% of all             for the life of the contract based        the	contract	value.                       a 10-year time limit on bonus             finance at York University’s Schulich
sales had the GMWB rider. The                 on the guaranteed withdrawal bal-                                                   accumulation.                             School of Business and the direc-
total assets in variable annuities            ance. If a client buys a VAG with           antee is for 20 years, each time     • Death Benefit, Creditor-proof-             tor of the Individual Finance and
were about $1.1 trillion at the end           $100,000 at age 65, he is guaran-           there is a reset, the clock on          ing: Usually, the same death              Insurance Centre, says the Cana-
of 2004. In this five-part series of          teed to receive $5,000 each year            the portfolio life restarts for         benefit and creditor-proofing that        dian GMWBs are just the begin-
articles, I will refer to a variable          throughout the contract period              another 20 years.                       apply to a segregated fund apply          ning of innovation in this field. The
annuity with guaranteed with-                 regardless of how his investments         • Guarantee Period: The guar-             to variable annuities as well.            appeal of these products reflects the
drawal benefits as VAG.                       perform.                                    antee period is the length of              Example: Bob, 65, is just              changing needs of boomer investors
   Last year, Manulife introduced                There are several important fea-         the guarantee after withdraw-           retiring. He buys a VAG for               as they enter what Milevsky terms
VAG to Canada. Other insurance                tures and benefits of VAG:                  als start. The basic VAGs had           $300,000. His contract allows             the “retirement risk zone,” which is
companies are following Manu-                 • Step-up: If the portfolio does            originally a 20-year guarantee          him to reset once every three             the seven- to 12-year period before
life’s lead. I will try to demonstrate           well and the contract value              period. Currently, almost all           years until age 95. The guar-             investors start to draw on their
the benefits, pitfalls, the hype and             exceeds the guaranteed with-             contracts in the U.S. have a            antee period is 20 years. The             retirement income.
the truth about VAG before you                   drawal balance, then it is reset         guarantee period for life, with a       asset mix is 80% S&P/TSX                     As Milevsky explains, over the
put your client’s money and your                 higher, equal to the contract            joint last-to-die option available      index and 20% fixed income.               long term, investments tend to grow,
practice at risk.                                value. These resets are allowed          to clients.                             The chart (see The Difference a           but as the time frame is shortened,
   What is this product? The name                at certain intervals. In Canada             In Canada – at the time of           Guarantee Makes, below) shows             risk increases. Even moderate losses
variable annuity is a misnomer;                  – at the time of writing – insur-        writing – insurance companies           the contract value, guaranteed            or slow growth in retirement savings
it has little to do with an annuity.             ance companies offer resets              offer only a 20-year guarantee          withdrawal balance and the                during this “risk zone” can signifi-
Think of it as a segregated fund.                once every three years.                  period. If you sell a $100,000          resets over time, if he were              cantly reduce the length of a person’s
Your client’s investment in a seg-                  In the U.S., most contracts           VAG to a 65-year-old female             to buy this contract in 1949.             retirement income (see A Tale of Two
regated fund is the “premium.”                   allow annual reset. That means           client, she is guaranteed to            The green dots indicate where             Portfolios on page 12). “During the
Add to it the basic GMWB rider                   in the U.S., clients can take            receive $5,000 each year until          step-up resets occurred. The              accumulation phase, wealth is going
and you have a living benefit and a              advantage of cyclical markets            age 85. According to mortal-            last step-up was in year 9,               to bounce back,” Milevsky explains.
guarantee of return of your entire               to reset. In Canada, they usu-           ity tables, at age 85, she has a        therefore it resets the guaran-           “As you get closer to retirement, you
premium by means of annual with-                 ally have to wait for long-term          50% chance of being alive. Yet,         tee period by 20 years. Even              can’t hold on for the long run and
drawals spread over 20 years. This is            secular trends. In some cases            that is when the guarantee ends.        if the contract value goes to             just wait it out.”
the worst-case situation. If markets             this can make a big difference           You might think that resets             zero anytime after year 9, the               There is tremendous opportu-
do well, you may be able to have                 to the outcome. There is also a          might help extend the guarantee         GMWB rider ensures that 5%                nity for Canadian GMWBs. Inves-
income for a longer period of time.              time limit or age limit for resets:      period. Don’t count on it, they         of the last guaranteed balance            tor Economics foresees the total
   The segregated funds have a                   Some companies allow resets              don’t occur often.                      is paid each and every year               Canadian marketplace above the
market value, which fluctuates just              for 30 years from the initial          • Bonus: If your client buys a            until year 29.                            $40 billion mark within five years.
like a mutual fund. This is called               contract date; other companies           VAG prior to needing the                This is an introduction to VAG.              Clients don’t necessarily have to
the “contract value.” In addition,               allow resets until age 80. Read          income, then the insurance           At this point, you need to be clear          buy an insured product to derive the
there is another balance to track                the fine print.                          company may pay an annual            about one thing: In a mutual fund,           same benefit of a GMWB, Milevsky
– the “guaranteed withdrawal bal-             • Reset of Guarantee Period:                bonus until withdrawals start.       we focus on the market value. In a           adds. He notes that insurers excel
ance.” Its value does not fluctuate              When the guaranteed with-                The bonus increases the guar-        VAG, we focus on two balances:               at offering these products because
with market conditions, but it is                drawal balance is reset through          anteed withdrawal balance by         the contract value (market value,            they are much more sophisticated
the base amount used to calculate                a step-up, this also resets the          5% each year, unless there is a      including all deposits and with-             at mitigating long-term risk.
the income that is paid out.                     guarantee period. If the guar-           reset that increases the balance     drawals) and the guaranteed with-               Products like the joint BMO
                                                 0%    10%   20%    30%    40%    50%   60%    70%   80%                       drawal balance, which determines             Dynamic Funds RetirementEdge
thE	diffErEnCE	A	guArAntEE	MAkEs                                                                                               the guaranteed withdrawal amount.            are an example of a non-insured
                                                                                                                               In Part 2, we’ll go into more                product that essentially derives the
                                                                                                                               details.                          aER        same fundamental results. Retire-
          $500,000
                                                                                                                                                                            mentEdge, for instance, consists of
                                                                                                                               Jim Otar, CMT, CFP, is a financial           income portfolio notes sold in 15,
          $400,000                                                                                                             planner, a professional engineer, a market   20 or 25-year maturities.
                                                                                                                               technician and a financial writer and the       While the principal is not guar-
                                                                   20-year	guarantee	period
          $300,000
                                                                                                                               founder of retirementoptimizer.com. His      anteed, the product targets the
                                                                                                                               past articles on retirement planning won     same demographic as the insured
                                                                                                                               the CFP Board Article Awards in 2001         GMWB by offering fixed income
          $200,000                                                                                                             and 2002. He is the author of High           and moderate growth. This prod-
                                                                                                                               Expectation and False Dreams                 uct will not appeal to risk-averse
          $100,000                           Contract	(Market)	value                                                           – One Hundred Years of Stock                 investors since there is no princi-
                                             guaranteed	Withdrawal	Balance                                                     Market History Applied to Retire-            pal or creditor protection, or death
                                                                                                                               ment Planning. This article is excerpted     benefits, but it does offer tax defer-
                  $0
                        0                5             10           15            20            25          30                 from his upcoming book Mathematics           ral opportunities, which gives it a
                                                                                                                               of Retirement. Your comments are             greater growth potential than an
                                                                 Year
                                                                                                                               welcome: jimotar@rogers.com                  insured product.                   aER