The provision of the “Guaranteed Lifetime Withdrawal Benefit” (or GLWB) is a key element of most of the current market efforts to provide guaranteed lifetime income programs from defined contribution plans-and with good reason. The GLWB is one of a class of annuity payment programs referred to as “living benefits” which seek to remove the “pain” of the “old time annuity”( usually referred to as the “straight life” annuity). Straight life annuities payments act a lot like the traditional defined benefit plan distributions, where the participants’ monthly benefit was generally set for life and where there was no way to access any of the funds which were used to pay for that benefit.
The GLWB addresses those problems by providing the participant at least some access to those funds in the program; guarantees lifetime benefits and minimum account values, even in changing markets; while providing the participant the ability to grow that benefit with some sort of equity market exposure. The nature of these programs requires that insurance be used. They do attach to all sorts of annuity “types” available in the retirement plan space, including Fixed Indexed Annuities, Variable Annuities, and Contingent Deferred Annuities, among others. Living Benefit guarantees also are not new to the market: versions of them have been available in the retail market for years.
GLWBs almost sounds too good to be true, and you have to wonder how an insurance company can make this all work. Well, sophisticated mathematics is at the heart of it all.
There are actually two pieces to the math used by these programs. The first is the actual GLWB guarantees to the individual participant, themselves, which make them so attractive to plan participants and fiduciaries. These guarantees are based on actuarially determined and mathematically computed values. The amount used to compute these guarantees are far different from the actual cash value of the annuity contract carried as part of the participant’s account balance in the plan. This value is typically referred to as the “benefit base” (or something very similar), and is the value upon which the insurer is willing to base its “living benefit” guarantees.
This then leads to the second set of sophisticated mathematics that is in play. Advanced investment hedging programs must be used by insurers in order to be able to fund these guarantees, which utilize extraordinarily complex mathematical algorithms. The secret sauce is really a combination of this math, science, sophisticated trading protocols-and sound risk management. These programs have also been around for a while, with most insurers having some sort of version of them in place even prior to 2007.
The quality of the operation of these hedging programs is not equal, as each insurer maintains their own programs with varying levels of success. It is worthwhile to note that a number of insurers were terribly stressed by the 2008 market turmoil, caused by the extreme and unexpected financial conditions which were not well accommodated by their protocols.
This is really where the SECURE Act’s insurer safe harbor rules become invaluable. The fiduciary will be deemed to be fulfilling its obligation to assess the insurer’s capability to back the guarantees (which would include how good they are at those those hedging activities, for example) if, at the time of the annuity contract is selected, the insurance company makes a number of representations to the plan.
Math plays a surprisingly unique role in the successful lifetime income program. Though most of us need not be able to do the math, understanding its role in the scheme of things is part of the “fabric” with which we must be familiar.