The world of guaranteed minimum withdrawal benefits (GMWBs) has changed, and while these products are still useful, clients need to know that GMWBs are not what they used to be.
"For the most part, they were not a robust option to begin with," says Asher Tward, vice president, estate planning, with TriDelta Financial Partners Inc. in Toronto, who adds that GMWBs now are more diluted.
When the product category was launched, Tward says, GMWBs had lots of bells and whistles that increased their cost to produce and maintain - which eventually became unsustainable in the current climate of low interest rates and uncertain equities markets.
On the other hand, GMWBs still have their defenders. Michelle Ostermann, assistant vice president, guaranteed investment products, with Manulife Investments, a division of Toronto-based Manulife Financial Corp., argues, "The product was brought back in line with other income-producing vehicles," and while "its scope of applicability has narrowed," it remains an attractive option for retirement.
Since the financial crisis of 2008-09, GMWBs have undergone a series of changes designed to make them more feasible to offer while maintaining some advantages for clients. The results have been mixed. Many clients are no longer interested in GMWBs, especially given their costs. But for those clients who are primarily seeking protection against longevity, inflation and market risks, GMWBs are still potentially attractive.
First introduced in 2006 by Manulife, which remains the largest provider, GMWBs have since been issued by several other insurance companies, including Toronto-based Sun Life Financial Inc., Desjardins Financial Security Investments Inc. of Lévis, Que., Industrial Alliance Insurance and Financial Services Inc. of Quebec City, Toronto-based Transamerica Life Canada Inc., Empire Life Insurance Co. of Kingston, Ont., Montreal-based Standard Life Assurance Co. of Canada and Canada Life Assurance Corp. of Toronto.
However, earlier this year, all these issuers - except Manulife, Canada Life and Empire Life - either ceased issuing any new GMWB contracts or suspended sales for some or all of their products. Sun Life, however, has exited from only the independent advisor channel.
Both Manulife and Canada Life have dialed back on the features on certain products. Empire Life, a relative latecomer to the marketplace, has not made any changes because the timing of its entry was favourable.
The changes made to today's GMWBs also reflect growing uncertainty about the assumptions upon which they are built - the tendency of stock markets to recover from lows and correct for highs over time. Indeed, a March 2012 report from the Office of the Superintendent of Financial Institutions (OSFI) analyzed this idea by looking for evidence that equities' returns revert to the mean over the long term. The OSFI study found that there is as much evidence to refute this claim as there is to support it. Consequently, the report says: "It would not be prudent for OSFI to approve equity return models that are based on the assumption of mean reversion."
Meanwhile, the capital reserves of insurance companies have come under considerable strain as a result of the guarantees to investors provided by GMWBs; these guarantees must be met, regardless of equities market performance.
Indeed, the most significant changes made to GMWBs have been driven by continued weakness in equities markets, which has resulted in the reduction in the equities component of most GMWB products - in some cases, dropping from 100% to 60%. (Empire Life, however, continues to offer a 100% equities product.)
"This change [in the equities component] has certainly made GMWBs less attractive," says Faisal Habib, CEO and director of financial engineering at the QWeMA Group in Toronto. He contends that clients would prefer to take more risk to maximize growth than settle for the lower returns produced by today's GMWBs.
Another unfavourable change is the reduction in the principal guarantee upon death from 100% to 75% for some products.
But not all the changes have negative consequences. For instance, the annual guaranteed payout for some GMWBs is now for life rather than the 20 years previously offered. However, the rate of the guaranteed payout, which had been 5%, has fallen. For example, the payout for the Manulife GIF Select IncomePlus product has been reduced by 100 basis points at ages 55, 65 and 75. Manulife also has added two new ages at which withdrawals can begin: clients can elect to receive a guaranteed payout of 3.5% at age 60 and 4.25% at age 70.
Most GMWBs also offer a 5% bonus for each year that the client does not make a withdrawal. This bonus, which previously was paid for a maximum of 15 years, has now been changed to an indefinite period on some products - until withdrawals begin to be made.
Another benefit is that clients get the opportunity to lock in any gains every three years, which increases the value of bonuses they get before making withdrawals.
Added flexibility comes in the form of spousal benefits, which allow for a "two-life income stream" option. Under this option, the surviving spouse continues to receive income for the rest of his or her life at the same rate as the deceased client had.
One of the contentious issues about GMWBs is their high fees, which average 3.5%-4%. And the fees have climbed higher. For example, fees for all classes of the GMWB rider in Sun Life's SunWise Elite and the Elite Plus programs were increased in October by up to 15 basis points.
Tward contends that high fees erode the returns of GMWBs, which are, at best, balanced funds in his view. Consequently, he says, these products cannot experience any significant growth.
Habib adds that the cost of providing guarantees has gone up because of low interest rates and volatile equities markets, which have increased the cost of hedging.
Ostermann suggests that GMWBs "were seen as an 'everything to everybody' solution with a lot of flexibility." Although these products "are now different from what they've been before," they are still a viable income-producing option relative to the risk the client is taking to achieve the income they provide.
Lise Andreana, wealth and estate planner with Continuum II Inc. in Burlington, Ont., suggests that GMWBs "are still worth using to create an income stream." She says they are suitable for "clients who are risk-averse but yet need the potential upside that equities provide." IE
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