Valuing Variable Annuities with Guaranteed Minimum Lifetime Withdrawal Benefits

Variable annuities with guaranteed minimum lifetime withdrawal benefits (VA/GLWB) offer retirees longevity protection, upside exposure to equity markets, and access to savings in case of emergencies. Despite these benefits, few researchers have explored how risk-averse retirees might value VA/GLWBs.

Summary

Variable annuities offer retirees the security of a lifelong retirement income stream combined with capital market access via an investment portfolio. A popular option is the guaranteed minimum lifetime withdrawal benefit (GLWB) rider, which provides the buyer lifetime income benefits along with flexible withdrawals. This study investigates how risk-averse retirees can optimally withdraw from these products, balancing returns and the embedded longevity protection. The researchers also gauge the product’s utility value for risk-averse retirees, concluding that the value generally exceeds that of a similar mutual fund.

Key Insights

• A retiree with a plain VA/GLWB, compared to a non-annuitant using only an investment brokerage account, has slightly lower consumption early in retirement, but higher consumption later in life.
• A retiree with a ratchet VA/GLWB – which raises the VA’s guaranteed value if certain conditions are met – consumes slightly less than a retiree using a plain VA/GLWB or only a brokerage account until her mid-80s, but then her consumption is much higher.
• The longevity protection of a VA/GLWB is worth more to a risk-averse retiree than the extra costs embedded in the product devoted to loads and protections.

Methodology

The researchers used Monte-Carlo simulations to generate a range of possible consumption outcomes for a stylized VA/GLWB product and developed two ways to assess its appeal: expected money’s worth ratios (MWR) and annuity equivalent wealth (AEW) values. The MWR compares the expected present value of the annuity’s payment stream to the money paid for the annuity. AEW is a widely used measure of how much non-annuitized wealth someone lacking access to an annuity would be willing to pay to purchase the VA product. To make results comparable across products, the researchers used anticipated portfolio return rates minus fees for the non-VA investment and set its MWR to one. Any divergence from one in the MWR of the VA products indicates how the VAs’ higher fees reduce net returns compared to not holding the annuity.