The success of guaranteed minimum withdrawal benefit products (GMWBs) and guaranteed lifetime withdrawals benefits (GLWB) is founded in fear, suggests a veteran actuary who says the guarantee is expensive and of little value.

This controversial view, however, has sparked a strong reaction from many in the industry who see these products as a valuable, potential component of a diversified retirement income plan.

With a long career in the insurance and investment business, actuarial consultant William Solomon does not mince words when it comes to guaranteed withdrawal benefits (GWBs). An article he wrote last spring for a Toronto-based financial publication is still being talked about.

In September, Mr. Solomon was visiting the Montreal offices of a life insurance company in his role as a pension plan consultant. While he was in town, he granted an exclusive interview to The Insurance and Investment Journal.

Scare tactics

Mr. Solomon attributes the success of GWBs to scare tactics that exploit people's ignorance and fears about retirement planning. The title of the article he wrote was trenchant: Beware of the Great GMWB Fraud.

In the interview, Mr. Solomon explained his reasoning. “I didn't try to be controversial using that word. I’ve been in insurance for 50 years and there are a lot of good insurance products in the industry. But at the same time, I think that some insurance products are bad products.”

The GWB is an example of a poor product because it preys on retirees' fears and covers a risk that is too limited, commented Mr. Solomon. He took the opportunity to reaffirm other points he had expressed in the article, which amongst other things describes GWBs as an expensive option. The cost of the guarantee varies from 0.4% to 1%, and management fees range from 2.25% to 3%.

He also says that the guarantee is of little value. In his opinion, in most cases it would be limited to returning the investor's initial deposit. Under most withdrawal guarantees, the investor receives an annual payment that is equal to 5% of the initial investment. The payments continue for life, or for a set period of time  for the GMWB product. Mr. Solomon believes that the guarantee will only kick in if the capital is exhausted after 20 years.

Little risk for insurer

He notes that the insurer runs little risk of having to pay out large sums. The life expectancy of people who are 65 today is 18 years for men and 21 years for women. Mr. Solomon points out that the guarantee is only useful when the average annual return of the fund is less than 3% and when a 65-year-old retiree lives for an additional 25 years. “You might need this guarantee when you’re well into your nineties,” he says.

Mr. Solomon also believes that the risk of low life expectancy and good performance are mutually exclusive. “If your longevity is short, you don’t need the guarantee. If your rate of return is high, you don’t need the guarantee. When longevity is high and returns are low is the only situation when the guarantee is worth it,” he comments.

But since 1960, there has not been a 10-year-period of extremely low rates of return. The markets have also not experienced a five-year-period of negative returns since 1960.

He agrees with the industry on one point: this type of product does encourage investors not to panic when markets fall. It is a tool to keep clients' assets in place. “Thanks to this product, advisors can reassure their clients and encourage them not to sell in a bear market,” comments Mr. Solomon.

He thinks the product is appropriate for a specific demographic who want above all else to retire with peace of mind. These are people who are risk averse and who do not want to buy an annuity.
Insurers’ marketing materials emphasize retention of assets and that's fine, said Mr. Solomon. However, he says it's a pity that some of this material also focuses on generating fear.

He notes that insurers show disastrous annual rates of return sequences that have no historical basis, and says the insurers themselves would be in danger of insolvency if such scenarios came to pass.

Mr. Solomon's views have enraged many financial advisors. Throughout the summer, financial bloggers in Toronto expressed their displeasure.

Allan Bulloch, president of the Independent Planning Group (IPG) in Ottawa, is one of those who is upset. “I just don’t see where there is a fraud. If it was, police should be called and people may be going to jail. Titles like this one is what cause fraud. This article has done a lot of damage,” he comments.

Mr Bulloch does not sell the product indiscriminately, and points out that there are plenty of other products to choose from, including traditional segregated funds, annuities, and mutual funds. GWB products account for 10% of his investment sales, he says. If advisors with IPG want to offer GWBs, they are obliged to go through a rigorous training course and due diligence where they deal with all of the products available in the market. There is no way an IPG advisor would sell nothing but GWB products to his clients, says Mr. Bulloch.

He also defends the product itself. When Mr. Solomon writes that the guarantee is simply a promise, Mr. Bulloch replies that this is the very nature of insurance: making promises. “When I take out auto coverage, I never plan to have an accident. If I buy a T10 and I don’t die during this period of time, did I win? Did I lose?” he asks.

As far as the GWB is concerned, he says it's a win-win proposition. “With GWBs, if I have low returns for a long period of time, the insurance comes in. If I experience a long period of positive returns, I can reset the value.”

Bruce Hammond, chairman and CEO of Concord, Ontario-based MGA Performins Canada, says GWBs represent 50% of his RRSP investment sales.

He says while some of Mr. Solomon’s arguments make sense in “certain circumstances” he believes the GWB can be targeted efficiently to specific segments of the population. ”

Target clienteles

As they approach retirement, RRSP holders ages 55 and older, as well as those who absolutely need these funds to have enough money in retirement, are the best target clienteles, says Mr. Hammond. “I wouldn’t sell it to a 45-year-old whose funds are not in an RRSP. It would be too expensive for them.” He compares the GWB to house insurance. “You have a less than 1% chance of your house burning down. You pay each year at least $600. If your house doesn’t burn, is that a waste of money? The chance of your money running out because of the market five years before or after your retirement is a much higher risk. This is the retirement risk zone.”
So a lifetime guaranteed annual income of 5% of the initial assets for a premium of about .05% is not much, says Mr. Hammond, adding that the price of the insurance on $350,000 under a GWB amounts to $1750.

He adds that the de-accumulation phase puts those near retirement at risk of short-term volatility. If the market does the same thing as in 2008, the three to four next income years are totally gone.”

At Force Financière Excel, CEO James McMahon says that the product is a big seller when people are looking for retirement income. But in some cases, he says that combining an immediate annuity with mutual funds or term deposits may be more advantageous than GWBs. But he believes that the product can play a role in many situations.

“An actuary has the knowledge to take apart any product and find better ways of investing,” he comments. But what if someone from the typical investing public considers the rates of return that the big money managers have obtained over the last ten years?” Mr. McMahon suggests that he will think that, with the GWB product, at least there are some guarantees.

He believes that longevity is a very real risk as it is constantly improving. As well, clients have been affected by events in the recent past. “When the product was launched in 2006, people remembered the bursting of the tech bubble,” comments Mr. McMahon. He suggests that the level of uncertainty prevalent today reinforces how relevant the product can be.

As for the insurers, they believe that the views expressed by Mr. Solomon tend to detract from the value of the product when used judiciously and based on a good understanding of the client's profile. So says Kari Holdsworth, vice president of individual wealth management at Sun Life Financial. She refutes Mr. Solomon's claim that the product is worthless.

She says that GWBs address the needs of those who value a guarantee on principal while also allowing access to returns by locking in the growth. “It’s an estate planning tool that avoids probate fees. There’s also the feature that can guarantee in SunWise Essentials that the income continues to the surviving spouse,” she adds. For those who do not want these kinds of features, Ms. Holdsworth suggests that a life annuity is an excellent alternative.

“The key word is diversification,” says Ms. Holdsworth. She points out that GWBs are simply one piece of the overall retirement income plan, and that the same strategy will not work for everyone. She also notes that GWBs are often issued alongside other products.

The product may not be suitable for everyone, but Ms. Holdsworth believes it can play an important role in retirement planning if it meets the client's needs and risk tolerance. To those who say that the product is meant for customers age 55 and over, Ms Holdsworth believes that, even in this segment, the product is not for everyone. On the other hand, she thinks there is one thing this product allows anyone to buy, and that is peace of mind.

Michel Fortin is vice president of business opportunities and pricing for retail and pension products at Standard Life. He believes that Mr. Solomon has not dealt with certain aspects in his article. For example, in Mr. Fortin's opinion, Mr. Solomon did not explore the various risks that arise while the investor is accumulating funds and the risks he faces at the moment he begins to withdraw funds.

Mr. Fortin says an investor who obtained an average yield of 5% over 15 years of accumulation will not be able to draw down at that rate for 15 years if he or she were to experience negative returns during the early years of the disbursement period.

Not an exact science

The article also discounts the principle of insurance. “Determining life expectancy is not an exact science. The withdrawal guarantee is important for those who live beyond the average age. This is insurance so that people do not outlive their income,” comments Mr. Fortin.

Mr. Fortin points out that retirement planning aims to provide an overall solution, and that each product will have a different weighting depending on the customer's risk profile. GWBs offer a choice of investments, unlike an immediate annuity. A 5% guaranteed lifetime withdrawal may pay out less than an annuity, but reset provisions could make up the difference.

The message has made it through to advisors. Mr. Fortin says that sales of Standard Life's Ideal Segregated Funds (Signature Series) have exceeded expectations since they were launched in May. The product gathered 18% of its assets in sales made as of July 31. “The growth in sales compared to last year reached 25%,” adds Mr. Fortin.

BY ALAIN THÉRIAULT