MDRT: Failing to offer GMWB could lead to liability

Advisors who fail to mention guaranteed minimum withdrawal products to clients could be leaving themselves open to legal liability, a U.S. lawyer and variable annuities expert says.

John Huggard, a U.S.-based lawyer and retired law professor who now consults on variable annuities, believes GMWBs are the most important financial innovation for personal finance since the introduction of the mutual fund in the 1940s. Speaking before the Million Dollar Roundtable Annual Meeting in Toronto, Huggard said advisors have a fiduciary responsibility to mention GMWBs just like they need to discuss other major asset classes like mutual funds, stocks, bonds and insurance.

Huggard believes GMWBs are the only product that addresses two important problems faced by investors in the drawdown phase of investing — longevity risk and sequence of returns.

Longevity risk is straightforward; it’s the risk that a retiree will outlive their money. While sequence of returns relates to the devastating impact drawing down a portfolio during a bear market can have on a retirement portfolio — particularly during the early stages of retirement if it’s a bear market. Sequence of returns greatly contributes to longevity risk, since a market downturn in the early stages of drawdown could take a decade off the retirement portfolio’s lifespan, leaving an investor financially ruined before they die.

Defined benefit pension plans solve this problem but most people don’t have them and those that do may see it phased out in the future. For those without a guaranteed pension income, GMWBs could be a worthwhile alternative.

This isn’t just Huggard’s opinion. U.S. regulators, such as the Financial Industry Regulatory Authority, are also taking notice. Huggard said he was asked by a financial entity to help on the case of an accredited advisor who didn’t mention the existence of GMWBs to a group of early retirees who had received lump-sum pension buy-outs from an oil company.

“He sat down and decided to tell these people they needed to put their money in stocks, mutual funds, a little bit of bonds and a little bit of managed money,” Huggard said. “The two concerns these people had were what? If they don’t raise it as an advisor you’ve got to raise it. These are blue-collar oil workers who have just left work at age 55, they are never going to work again and the cheque in their hand has got to last them the rest of their lives.”

Huggard noted that the advisor should have mentioned to clients the existence of these products which would replicate the protections of a pension, providing an income for life and protect a spouse if the retiree happened to die prematurely.

“These people put their money in these other products, the market went against them and all of a sudden longevity risk was a big issue for these clients. Not only that, there was the sequence of returns they got caught in. Along the way they realized around age 63, with no education, they would lose everything they own, their house, their car and most importantly their dignity,” he said. “The one that really bothered the regulators was the idea this advisor did not even bother to present variable annuities to these folks.

Huggard also noted that the advisor’s firm was fined for $3.5 million and the rep was personally fined for $19.5 million, $10 million of which was for punitive damages. The company had to pay it and the advisor doesn’t get his license back until he pays the company, virtually impossible. Other cases surrounding the same advisor have been subsequently filed that have cost his company, all company $40 million.

“The lawyer for the clients asked every one of them on the stand, “Had you been told that there was such thing as a living benefit that would have replicated your pension? Every one of them came back and said not only would they have considered it, they probably would have bought it,” he said. “I am 100% convinced in my heart every one of those people were telling the truth.”

He offered the following rule of thumb for advisors he works with to avoid similar situation.

“If someone comes in your office, and they are 45 years or older, and they have money that both you and them recognize has got to last into their retirement. It could be an IRA, RRSP, a pension buyout, sale of the family farm — it doesn’t matter — you’ve got to help them take time understand a suitable way for them to invest. That would certainly include a variable annuity with living benefit,” he said. “You’ve got to make them available to the clients. The minute they come in and say I don’t want them, you’re off the hook,” he said.

Huggard adamantly believes few clients nearing retirement who don’t have a guaranteed source of income, will not turn them down. Rather, he says it’s advisors who are stalling their sale. For instance, a lot of advisors are concerned about the solvency or credit risk of insurers to meet the guarantees, something he finds incredulous, because the same advisors have no problem selling life insurance.

“Look at insurance. If somebody sells me a million dollar life insurance policy and I pay $100,000 premium on it and die. Where is the guarantee that insurance company is going to be able to pay my wife?” he asked the audience. “The insurance company is taking the risk to pay a $1 million 㬆 times more to my wife in lump sum if I die. With a variable annuity, if I put a $100,000 dollars in and a couple years from now start pulling money out of it while the markets go against it, the insurance company may have to pay $200,000. However, they will have a 20 year window to do it.”

Huggard said risk in GWMB contracts is simply mitigated the same way as a life policy. Insurers find the break-even point, and then reinsure all of the excess liability. In turn, the reinsurer will go out and insure their risk, so multiple levels of risk are spread across the industry.

This level of reinsurance means all the variable annuities contracts in the U.S. have been honoured, Huggard said, despite the providers of some of early versions of variable annuities, like guaranteed minimum income benefit products (GMIB) or guaranteed minimum accumulation benefits (GMABs) have stopped selling them or gone out of business.

He chalked this up more to the fact the older versions of variable annuities had serious flaws. For example, with a GMIB a client has to opt to annuitize their investment otherwise it’s subject to market conditions.

He said the Canadian GMWB products, which offer automatic guaranteed income for life, represent the best in class features. However, in the U.S., the market is moving forward another step to include inflation protection and long-term care policy conversion.

Tomorrow: Are GMWBs worth the cost?