The coming of guaranteed benefits for CAPs

“Gumwib?”
The complexity of these products make it impractical to go into a detailed description here, but essentially, GMWB’s allow an investor to progressively lock-in an increasing guaranteed minimum annual lifetime payout based on the evolution of the market value of his investments over the accumulation period. Locked-in payouts cannot go down and are therefore protected in case of a market downturn (there are many bells and whistles in addition to this). Obviously, this comes at a cost—an insurance premium, really—which takes the form of an increase in investment management fees or an explicit monthly charge.

Prior to 2008, most analysts would have thought this premium was outrageously too expensive – a point of view which thereafter evolved, as insurers have since all increased the premium (or reduced the benefits) on new contracts.

GMWB’s entered Canada a few years ago and have rapidly become very popular in their retail version. The group version has been much slower to emerge as it is somewhat trickier to implement. Other reasons for its slow development may include the stir created by the 2008 market meltdown and the increased scrutiny on fees for group products.

Only two DC administration providers currently offer group GMWB’s, but we expect most of them to offer their version soon enough. So as a CAP sponsor, should you consider them? How do you decide?

Things to consider
As GMWB’s are only offered on a proprietary basis, there is no shopping around for the best option—unless you are implementing a new plan and are looking for a provider. However, GMWB’s would hardly be considered a provider selection factor at this point.

While the principle behind the two existing group products is the same, the features are quite dissimilar. Here are a few observations:

• the guaranteed benefit formulas are different, including how the minimum payout increases (usually referred to as “resets”);
• the cost to members are also different both in level and in structure; it is difficult at this time to compare costs due to the difference in benefit formulas;
• the investments covered also vary: one provider offers the guarantee over a fairly wide choice of funds, whereas the other’s investment coverage is very limited (one fund);
• the minimum time period over which members need to pay the premium prior retirement to get the guaranteed benefit is also is quite different;
• mobility remains a critical issue with these products, as members are effectively “locked-in” with the provider if they want to maintain the guarantee. For a sponsor looking to change providers and transfer plan members’ assets, some transition clauses exist allowing for instance GMWB members to recuperate part of the premiums paid, but no way to transfer the guarantee. The only option is to convert the GMWB product into a retail or quasi-retail equivalent (i.e., much costlier) with the same provider;
• this is a very complex product, which represents a huge communication challenge if you want members to truly understand what they are getting themselves into—a key plan sponsor risk management element.

What’s next?
GMWBs represent an important step in providing income security at retirement. Encouragingly, the second generation is more flexible than the first and provides broader investment option coverage. Price appears to be somewhat of an issue however, as the product has no competition and is impacted both by the significant development costs incurred and the novelty factor.

We expect the arrival of new entrants in this market will increase competition and continue improving the attractiveness of “Gumwibs”.