In today’s market, variable annuities offer a wide range of both living and death benefits in the form of optional riders.  These riders can allow clients to guarantee an annuity’s contract value and/or a minimum income stream. However, they come at an additional cost and can be complex. As such, it is important that you understand how these riders work and are able to assist clients in evaluating and selecting variable annuity contracts and riders.

This section provides an overview of variable annuity riders, including characteristics and features of common riders and important considerations associated with these riders.

Retirement Planning Needs

Today, Americans have a greater responsibility for preparing for and funding their own retirement than they have ever had before. For this reason, it has become increasingly important for clients to manage the potential risks associated with their retirement strategy. Many variable annuity contracts now offer a wide range of optional riders that are designed to directly address these concerns. However, these riders come at an additional cost and have unique features and risks. In order to determine how and when these riders can best be used, it is essential for both you and your clients to understand how they work and the relevant risks involved.

Life Expectancy

Will I and/or my spouse outlive our assets?

Purchasing Power

Will rising prices diminish what I can afford later in life or how much income I will require?

Market Downturns

What will happen to my plan if the market declines as I near or enter retirement?

Cash Flow

Will my portfolio be able to provide enough income to sustain my lifestyle throughout retirement?

Living and Death Benefits

Many variable annuities now offer both living and death benefits in the form of optional riders at an additional cost. These benefits typically guarantee some minimum contract value and/or minimum income stream, regardless of the performance of the underlying investments. It is important to note that the name for these benefits, as well as the specific provisions of these benefits, can vary between insurance carriers and annuity products. These riders are distinguished by a variety of factors, such as cost, flexibility of allowable underlying subaccount investments, access to principal, and the extent of protection and guarantees provided.

Guaranteed Minimum Death Benefit

A GMDB guarantees a future death benefit, regardless of subaccount performance. While variable annuities typically include a standard death benefit as part of the core contract, many carriers offer optional enhanced death benefit riders for an additional cost.

Guaranteed Minimum Accumulation Benefit

A GMAB guarantees return of purchase payments at the end of a specified holding period, regardless of subaccount performance. Some GMABs also allow annuitants to periodically lock in gains above the amount invested during the accumulation period.

Guaranteed Minimum Withdrawal Benefit

A GMWB guarantees minimum periodic withdrawals for a specified period of time, or for life, regardless of subaccount performance.

Guaranteed Minimum Income Benefit

A GMIB guarantees a future annual lifetime income stream after a specified holding period, regardless of subaccount performance, provided the contract is annuitized.

Common Features

When discussing and evaluating variable annuity riders, it is important that both you and the client understand certain common terminology used to describe the benefits these riders provide.

Benefit Base

The benefit base is the value under a rider on which benefits are determined. For example, in the case of a GMWB, the benefit base is the value used to determine the lifetime withdrawal amount. In a GMIB, the benefit base is the value used to determine the guaranteed income floor. The benefit base is different from the contract value and is not available as cash or as a lump-sum distribution. The benefit base may be reduced depending on how and when withdrawals are taken, and can increase through automatic step-up and roll-up features as well as additional premium payments.

Step-Up

A step-up feature increases a benefit base, by offering “steps-up” to the current contract value, if higher, at specified intervals. For example, a rider may allow a step-up annually on the contract anniversary. Step-ups may restart holding periods for receiving guaranteed benefits.

Maximum Anniversary Value

The maximum anniversary value is the highest contract value as calculated on a specified anniversary date. Certain riders offer the ability to use this value to determine benefits when the rider is exercised.

Roll-Up

A roll-up is a specified rate at which a benefit base will accumulate. For example, a 5% roll-up is equal to the premiums accumulated at 5% interest. The roll-up can be credited as simple interest or compound interest as specified in the contract. Withdrawals may affect or eliminate any future roll-up.

Features and Characteristics

Variable annuities generally guarantee that, if the owner dies during the accumulation phase, his or her chosen beneficiary will receive a minimum amount upon the owner’s death even if the contract value at the time of death is below this amount. This guaranteed minimum death benefit generally guarantees that upon the death of the owner, his or her beneficiary will receive the greater of 100% of premium payments, less withdrawals, or the contract value on the date of death.

Many annuities now also offer enhanced death benefits that:

• Allow the owner to step up the death benefit base on contract anniversary dates;
  
• Allow the maximum anniversary value to be used for determining the death benefit; and/or
  
• Guarantee a minimum amount of interest on principal payments compounded annually.
  

The enhanced death benefit options offered by insurance companies come at an additional expense typically ranging from 0.05% to 0.50% on top of regular annual expenses.

Enhanced GMDB

In this example, a client makes an initial investment of $100,000 and elects an optional death benefit rider that guarantees the contract value will not be less than the greater of 4% compounded annually, the maximum anniversary value, or the contract value on the date of death. This example assumes the owner dies immediately following the twelfth anniversary of the contract purchase date.

Guaranteed Minimum Accumulation Benefit (GMAB)

Features and Characteristics

A Guaranteed Minimum Accumulation Benefit (GMAB) rider is an optional rider that guarantees that the contract value will not fall below the principal investment amount, following a specified holding period, regardless of the performance of the underlying investments. As such, a GMAB can help protect retirement assets from market fluctuations that could negatively impact the contract value.

• At the minimum, GMABs generally guarantee the return of all premiums paid into the contract after the specified holding period.
  
• Many GMABs also allow the owner to periodically step up the contract value to its current level. In most cases, electing to step up the value will restart the holding period.
  
• Although holding periods can vary among contracts, GMABs often have holding periods of 7-10 years from issue or last step-up.
  
• Withdrawals from the contract will reduce the benefit base.
  
• GMAB with Step-Up
  
• In this example, a client makes an initial investment of $100,000 and elects a GMAB rider that guarantees the contract value will not be less than the principal amount at the end of a 7-year holding period. Following several years of positive market returns, the owner elects to step up the contract value in year 3 of the contract. As a result of this step-up, the holding period is reset to seven years from the date of the step-up.
  

Guaranteed Minimum Withdrawal Benefit

Features and Characteristics

A Guaranteed Minimum Withdrawal Benefit (GMWB) rider guarantees an income stream in the form of annual withdrawals of a specified percentage for a specified period of time, or for life, regardless of subaccount performance. At a minimum, the total withdrawals will not be less than the premiums invested, regardless of subaccount performance. However, total aggregate withdrawals may be more than this amount depending on the performance of the underlying subaccounts.

• GMWBs typically offer upside adjustments to the guaranteed annual withdrawal amount through step-ups in the benefit base if the underlying investments increase in value, but protect the guaranteed annual withdrawal amount from falling should the investments perform poorly.
  
• The owner can typically begin taking guaranteed withdrawals without a holding period.
  
• Some GMWBs may also offer a roll-up provision that guarantees a minimum interest rate on premiums if withdrawals are delayed for a specified period.
  
• GMWBs often guarantee an annual income stream of 4% and 7% of the benefit base depending on the age when withdrawals begin.
  
• The GMWB benefit base will only be reduced for withdrawals in excess of the lifetime withdrawal amount. An excess withdrawal will result in reduced future lifetime withdrawal amounts.
  

Lifetime Withdrawal Amount
The amount determined under a GMWB rider that is guaranteed to be available for withdrawal each year, regardless of the contract account value.

Lifetime GMWB with Step-Up and Roll-Up

In this example, a couple (both age 62) makes an initial investment of $250,000 and elects an optional lifetime GMWB rider which offers automatic annual step-ups and a 5% compounding roll-up rate until the earlier of 10 years or the first withdrawal. Assuming they do not begin taking withdrawals until age 67, the rider guarantees minimum withdrawals for life equal to 5% of the benefit base. Any increase in the value of the benefit base through step-ups or the roll-up will also increase the lifetime withdrawal amount and the amount of annual withdrawals.

Guaranteed Minimum Income Benefit

Features and Characteristics

A Guaranteed Minimum Income Benefit (GMIB) rider guarantees a minimum rate of return on invested premiums regardless of the performance of underlying investments. Based on this return, the owner is guaranteed minimum annuity payment amounts upon annuitization of the contract for a specified period or for life. If the underlying investments increase in value above the guaranteed account value upon annuitization, the guaranteed minimum annuity payments will increase. As such, a GMIB can provide a safety net for retirement assets in the form of a guaranteed minimum income stream—no matter how the underlying annuity investments perform.

• The contract must be annuitized in order to receive the guaranteed minimum income stream.
  
• GMIBs typically have holding periods of 7 to 10 years before the contract can be annuitized and the owner can begin receiving guaranteed minimum annuity payments.
  
• During the holding period, the benefit base is guaranteed to earn a minimum rate of return (e.g., 5%) through a roll-up feature.
  
• Most GMIBs also offer the ability to periodically step up the benefit base if the contract value exceeds the roll-up base.
  
• GMIBs can generally be used to guarantee minimum income payments for either an individual or a couple.
  

GMIB with Step-Up and Roll-Up

In this example, a client makes an initial investment of $300,000 and elects an optional GMIB rider with a 10-year holding period and a 5% roll-up rate (Roll-Up Base). The GMIB also provides the ability to step up the benefit base to current contract value on the contract anniversary date. If elected, these optional step-ups increase the benefit base and restart the 10-year holding period.

All of these riders often offer the ability to periodically step up the benefit base to the current contract value. Some benefits also may offer a roll-up provision that guarantees that the benefit base will accumulate at a specified rate, regardless of the performance of underlying investments, provided certain conditions are met.

A GMIB rider can provide a safety net for retirement assets in the form of a guaranteed minimum income stream—regardless of how the underlying annuity investments perform. However, the contract must be annuitized in order to receive the guaranteed minimum income stream.

A GMWB rider guarantees an income stream in the form of annual withdrawals of a specified percentage for a specified period of time, or for life, regardless of market performance. A GMIB rider guarantees a minimum rate of return on invested premiums, regardless of the market performance of underlying investments. Based on this return, the annuitant is guaranteed minimum annuity payment amounts upon annuitization of the contract for a specified period or for life.

Both GMABs and GMIBs typically require holding periods before benefits can be exercised. GMWBs typically allow the owner to begin taking guaranteed withdrawals without a holding period. However, GMWBs may offer step-up or roll-up provisions that only apply if withdrawals are delayed for a specified period of time. Enhanced GMDBs guarantee a minimum contract value upon the death of the owner, regardless of holding period; however, any roll-up provisions offered by an enhanced GMDB may only increase the guaranteed benefit base after a specified holding period.

GMWBs can generally be used to guarantee withdrawals for an individual or a couple. Similarly, GMIBs can generally be used to guarantee minimum income payments for either an individual or a couple.

Risks and Considerations

Important Considerations

Although variable annuity riders can allow clients to guarantee an income stream, obtain downside protection on the value of invested assets, or assure a minimum death benefit, there are important considerations and limitations with respect to these riders that must be recognized.

Holding Periods

Many riders require a minimum holding period in order for certain guarantees to take effect. For example, GMABs typically require a 10-year holding period before the guaranteed minimum value becomes available. Similarly, GMIBs typically require a minimum holding period prior to starting the guaranteed lifetime income stream. Holding periods may also restart when certain features are exercised, such as a step-up. These holding periods must be carefully considered in light of the client’s age, overall goals, and his or her income and liquidity needs.

Costs

In return for the guarantees offered by an optional rider, the owner must pay additional fees on top of those associated with the base annuity contract. These additional charges are deducted from the annuity's contract value and these costs must be carefully considered. When considering the charges associated with these benefits, it is also important to be aware of how these charges are assessed. Depending on the product and benefit selected, these charges may be assessed on the current contract value, the current benefit base, or the greater of the current contract value or benefit base.

Cost Increases

Carriers typically reserve the right to increase the charges associated with a rider, subject to a defined maximum rider charge that is stated at the time of purchase. Clients need to be aware of this possibility and how such an increase could impact investment returns. For example, a carrier may reserve the right to increase the rider charge on a step-up. A client can often choose to opt out of a step-up to avoid the higher charge. However, if he or she chooses to take advantage of a step-up in the future, higher charges may apply.

Limitations on Subsequent Premiums

Carriers typically reserve the right to reject or limit additional premiums after contract issue. In such cases, a client who wished to continue to invest premiums would be required to purchase a new contract that might at that time offer less attractive benefits and/or involve greater costs. For this reason, clients who plan to fund a contract with multiple premiums over time should carefully consider this risk.

Loss of Certain Benefits upon Annuitization

Death benefits and GMABs can be attractive features for clients who are concerned with protecting the value of their assets. However, it is essential that clients understand that any death benefit or GMAB ceases to apply once the contract is annuitized. Similarly, if a contract with a GMWB rider were to be annuitized, the withdrawal benefits would cease and annuity payments would be determined based on the current contract value rather than the GMWB benefit base.

Insurer Risk

The guarantees offered by a variable annuity contract, including those provided by optional riders, are only as good as the claims-paying ability of the issuing insurance company. If the insurance company were to become insolvent, it might not be able to meet its obligations under its annuity contracts. As such, clients should carefully consider the creditworthiness of carriers, including the ratings issued by independent rating companies.

Allocation Restrictions

The protections and guarantees offered by variable annuity riders involve risk for the issuing insurance carrier as it is obligated to meet these guarantees, regardless of the performance of the underlying investments. For example, a GMWB gives the owner of the contract the ability to continue withdrawing guaranteed amounts for a specified period, regardless of the value remaining in an annuity contract. If the value of the contract were to decrease to zero during this period, the carrier would be responsible for continuing to fund these payments. To minimize such risks, carriers will often place allocation restrictions on how annuity premiums are invested.

Permitted Subaccounts

When a rider is added to a contract, the carrier may limit the authorized allocations to a subset of all of the contract’s available investment options, so that the client can only invest in certain specified subaccounts or asset allocation models.

Allocation Limitations

In some cases, carriers may also place restrictions on how investments can be allocated among these subaccounts, such as requiring a certain percentage to be allocated to fixed income subaccounts.

Automatic Reallocations

As a means of managing risk associated with certain riders, some carriers have begun using predetermined mathematical formulas that will automatically transfer assets between permitted equity and fixed income subaccounts. Generally, these risk management programs will transfer assets from equity subaccounts to fixed income subaccounts during market downturns and then transfer assets back to equity subaccounts as the market recovers. The client is not advised of the transfer prior to its occurrence (but is notified of any transfer by confirmation), nor can the client undo the transfer without forfeiting the rider.

Impact of Excess Withdrawals

Some variable riders allow owners to withdraw an annual amount from the contract’s value without negatively affecting the rider guarantee. This annual withdrawal amount may be specified as a percentage of the benefit base. Withdrawals that exceed this amount will have a negative impact on the value of the benefit base. Depending on the terms of the rider, the adjustment to the benefit base resulting from excess withdrawals may be determined on a “dollar-for-dollar” or “pro-rata” basis.

Dollar-for-dollar

In a dollar-for-dollar adjustment, the amount of excess withdrawal reduces the benefit base on a dollar-for-dollar basis.

Pro-rata

When the pro-rata, or proportional, method is used, the reduction in the benefit base is made on a proportional basis. In this case, the benefit base is reduced by the same percentage the excess withdrawal amount reduces the contract value. In cases where the benefit base is higher than the contract value, a pro-rata adjustment will reduce the benefit base by a dollar amount greater than the excess withdrawal amount. Conversely, if the contract value is higher than the benefit base, it will reduce the benefit base by a dollar amount less than the excess withdrawal amount.

Impact of Excess Withdrawals

Clients must also be aware that even if an annuity allows for a specific amount that can be withdrawn annually without incurring a contingent deferred sales charge, that “free withdrawal” amount may still be an excess withdrawal under the terms of the rider.

Depending on the amount withdrawn and the adjustment used, excess withdrawals can lead to significant reductions in the benefit base. For this reason, clients should avoid taking excess withdrawals and should have sufficient liquidity outside of the annuity to avoid having to take excess withdrawals. To help keep clients from inadvertently making an excess withdrawal, some carriers offer automated withdrawal programs to distribute income without exceeding withdrawal limits.

Impact of Excess Withdrawals – Example

A client has a variable annuity with a GMWB rider. She has already taken the annual GMWB withdrawal amount and decides to take an excess withdrawal of $10,000. At the time of the excess withdrawal, the GMWB benefit base is $100,000 and the contract value is $50,000.

Dollar-for-Dollar

In the case of a dollar-for-dollar adjustment, the GMWB benefit base would be reduced by $10,000. As such, the adjusted GMWB benefit base after accounting for the excess withdrawal would be $90,000 ($100,000–$10,000=$90,000).

Pro-Rata

In the case of a pro-rata adjustment, the $10,000 excess withdrawal would be equal to 20% of the current contract value ($10,000/$50,000=20%). As such, the GMWB base would be reduced by 20% (or $20,000), from $100,000 to $80,000.

Responsibilities

When recommending a variable annuity contract and/or a benefit rider, you must ensure that applicable best interest, fiduciary, and suitability obligations are met. This includes:

Understanding the Product

It is your responsibility to thoroughly investigate and evaluate the features and risks associated with any variable annuity contract or rider that may be recommend to clients. This understanding is essential to your ability to determine whether a recommendation involving a variable annuity rider is in the best interest of a particular client in light of his or her investment profile. For these reasons, you should carefully review the annuity prospectus for information regarding available riders, before discussing the product with or recommending it to clients.

Gathering and Evaluating Client Information

You must obtain and consider all relevant investment profile information necessary to determining whether a recommended variable annuity contract or rider is in the best interest of the client. Given the unique features and costs of variable annuities and benefit riders, additional or more detailed information may need to be obtained and considered to make a reasonable determination of best interest.

For example, prior to recommending the purchase of a living benefit rider, further investigation into the client’s retirement goals, liquidity needs, and other investments and retirement savings may be necessary. All additional information related to the recommendation should be documented in accordance with your firm’s policies and procedures.

Determining Best Interest

Before recommending a variable annuity contract or rider, you must determine that there is a reasonable basis for believing that the recommendation is in the best interest of the client. In doing so, you must carefully consider the features, costs, potential rewards, and risks of any living or death benefit offered under the contract in light of the client’s investment profile. In addition, you must ensure that the client has been made aware of relevant features of the variable annuity, would benefit from certain features of the annuity, and that the variable annuity as a whole, the underlying subaccounts, and any riders or other enhancements are in the best interest of the client.

Providing Disclosure

As with the recommendation of any investment product or other securities transaction, you must ensure that the client has been provided with full and fair disclosure of all material facts regarding the recommendation. In connection with the recommendation of a variable annuity contract that includes or offers living or death benefit riders, you must ensure that the client possesses sufficient information regarding these benefits to be able to make an informed decision. As part of this obligation, the client should be directed to review the prospectus and any related information regarding a living or death benefit. If applicable, the client should also be provided with any additional written or oral disclosures as required under your firm’s policies and procedures.