Understanding the Value of Living Benefit Guarantees

Advisor Perspectives just published the first in a series of articles from Wade Pfau. These pieces are important and should be read by anyone considering guaranteed lifetime withdrawal benefits or any of the other optional guaranteed living benefit features that accompany variable annuities.

While Pfau’s focus is on standalone living benefits (SALB), the analysis covers the closely related guaranteed lifetime withdrawal benefits (GLWB). Pfau’s analysis shines the light of day on living benefits and helps readers better understand not only how these things work but also--most importantly--how to think about the value proposition they present on a relative basis.

Pfau begins by looking at how SALBs, GLWBs and an unguaranteed mutual fund portfolio perform during the deferral phase. Results are simulated for a hypothetical 55 year old couple and a 10 year deferral period leading-up to their retirement. The simulation looks at rolling 10 year periods for retirement dates between 1936 and 2011.

Readers are encouraged to visit Advisor Perspectives to read the full article (link provided at the beginning of this post). At the highest level, Pfau concludes that investors seeking sequence of returns protection through living benefit guarantees will most likely find themselves worse-off in real (inflation-adjusted) terms than if they had remained invested in the unguaranteed mutual portfolio. Much of the drag or relative underperformance of the living benefits is attributable to the cost of the guarantees.

This is presumably a big blow to providers of living benefits as much of the purported value is in having sequence of returns protection during the deferral phase.

Preserving and enhancing purchasing power during the 10-15 years leading to retirement is critically important because of the need to be able to turn on the income spigot--through annuitization, systematic withdrawals or otherwise--at the highest possible level upon retirement.

My hunch is that Pfau’s subsequent piece will find the value proposition of living benefits during the income phase to be underwhelming as well. Similar analysis focusing on the embedded investment return of living benefits has surfaced some of the frictions around GLB income generation.


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