Guaranteed withdrawal benefits

Since the onset of the financial crisis, the word ‘guaranteed’ in a product name has resonated more powerfully with advisors and clients than ever previously. Shell-shocked baby-boomers will likely continue reacting more positively to guaranteed products than before the crisis.

The Guaranteed Withdrawal Benefit (GWB) is a feature available through a segregated fund contract or guaranteed investment fund contract and comes in two variations. A Guaranteed Minimum Withdrawal Benefit (GMWB) offers a guaranteed payout – often but not necessarily 5% — of its capital base – sometimes called the GWB Benefit Base’, whether the original deposit amount or the adjusted capital base after taking market value resets into account and for between periods ranging up to twenty years.

A Guaranteed Lifetime Withdrawal Benefit (GLWB) provides a percentage – usually 5% — of the original or adjusted capital base for life, usually with an age restriction as to when with when the withdrawal can begin. The GWB amounts to another permutation of segregated fund offerings. “It’s another benefit, not unlike a death benefit guarantee or maturity guarantee that is only available through a segregated contract,” says Geraldo Ferreira, Vice-President, Investment Products Development & Management at Toronto-based Transamerica Life Canada. Some advisors believe that the GWB’s attractiveness increases with the decline in defined benefit pension plans.

GWB’s manage market risk, inflation risk and longevity risk, suggests Troy Rumpel, Regional Vice President Estate Planning at Assante Estate & Insurance Services, Certified Financial Planner and 17-year veteran of financing planning. He sees the addition of the lifetime guarantee as one of the most important changes in these plans.

These plans have undergone several other changes in the past eighteen months, according to Brad Brain, a Certified Financial Planner, president of Fort St. John- British Columbia-based Brad Brain Financial Planning Inc. and fifteen-year veteran of financial planning. The most important changes include a reduction by some companies in the maximum allowed in equities – often as balanced funds – with the remainder held in cash or fixed income instruments along with removal of some fund choices, increased fees and reduced guarantees. These changes have made GWB’s less permissive, somewhat more restricted and in some cases more expensive, he says. Fee increases do not erode all of the upside potential, he points out. “We’re still cognizant of the fees and we don’t use the products that cost the most.”

The reduced guarantees may not have a very serious impact, according to Rumpel. “On the surface (they) seem like a reduction but at the end of the day, people are buying (GWB’s) for those three risks … so does having a 75% maturity benefit really matter in the long run because clients aren’t going to be surrendering (them)?”

Brain sees several specific uses for GWB’s including as a supplementary source of retirement income. In one scenario, an individual works part-time after formal retirement to supplement pension income and begins drawing from the GWB after the end of the part-time employment. In another scenario, an individual may begin drawing from the GWB immediately after retirement and becoming bored, begin working part-time and cease taking payments. Brain also sees GWB as a possibility for the fixed income component of a retirement portfolio. “What we’re thinking about here is not replacing annuities but rather replacing a bond fund or even a bond.”

Notwithstanding their security and guaranteed payouts, GWB’s offer little prospect of net capital growth, according to Robert MacKenzie a Certified Financial Planner, 14-year veteran of financial planning and independent advisor in Ottawa. MacKenzie acknowledges the advantages but questions the potential for returns above the guaranteed amount, even with re-sets. (See Figure 2.) He points out that the 5% guaranteed payout plus fees and expenses means that the threshold for exceeding guaranteed returns ranges around 8.5%. “Can you make over three years an average of 8.5 %,” he asks. “In essence it comes to 25.5%. (Where the specific plan has a three-year reset feature) You have to make that in three (years) in order to get anything added to your plan,” he says, a prospect that he considers almost impossible.

Meanwhile, several factors appear likely to affect sales competition in the near and middle-term, according to Ferreira. For example, increasing standardization of features such as resets and bonuses means companies are going to be competing against other based on investment choices and other benefits and services that they provide. Meanwhile, the number of players offering GWB’s will increase from the current eight insurers, he predicts, suggesting that all companies offering segregated funds will eventually offer GWB arrangements.

“Because of the bear market that we had they (insurers not currently offering GWB’s) may be feeling uncomfortable because the benefit might be too expensive to offer at the present,” he says, adding that advisor demand and other marketplace factors may lead them to revisit the decision.

Al Emid, a Toronto-based financial journalist, covers insurance, investing and banking.