Insurance Premiums for a Nonexistent Death Benefit

It’s late 2017, and we’ve been riding a pretty stellar bull market in (at least) US stocks for over 8 years. Markets are up, and everybody is happy.

You know who is really happy? Insurance companies that offer Variable Annuities. They are ecstatic. They are collecting a gold rush of revenue to protect a liability that, for many customers, no longer exists. It’s called a Guaranteed Minimum Death Benefit, and here’s how it works.

Let’s say Joan puts $200,000 into a variable annuity contract. It’s a simple, no-frills contract that doesn’t have a fancy living benefits rider like a Guaranteed Minimum Income Benefit or a Guaranteed Minimum Withdrawal Benefit. It has a basic internal expense (in the insurance world, this is “Mortality and Expense” – in theory, the cost of providing insurance) of 1.75%. Some of this money goes to pay back the commission the insurer fronted your salesperson. But in most annuity contracts, there is a basic insurance benefit called the Guaranteed Minimum Death Benefit (GMDB). In short, the GMDB guarantees to pay at the time of Joan’s death the higher of the cash value of the annuity or your “initial premium” aka the amount you invested into the annuity.

So if Joan invested $200,000 into her annuity in 2007 and got hit by a bus in February 2009, this insurance benefit would likely have kicked in and paid her beneficiaries the full $200,000, even if her cash value had fallen to, say, $120,000. Not bad! Her 1.75% expenses paid her an insurance benefit of $80,000 – the difference between the current cash value and the GMDB.

But, 9 years later, it’s a different story. Joan’s annuity contract is certainly worth more than $200,000 now. Maybe $300,000, depending on how it was invested and how good(/terrible) the investment options were in the contract. So now Joan is paying her 1.75% internal fee to protect a GMDB that is 33% less than the current cash value of her contract. And – get this – she isn’t paying 1.75% of $200,000 ($3,500/yr). She is paying 1.75% of $300,000 ($5,250).

Higher insurance costs for an insurance benefit that becomes less and less likely to pay out any value over time. Even if her contract value fell by 50% and a piano fell on her, Joan’s heirs would receive an insurance benefit of $50,000 ($300,000 / 2 =$150,000.  $200,000 GMDB – $150,000 Cash Value = $50,000 Actual Insurance Benefit). So this year she pays over $5,000 for a death benefit that might be worth $50,000.  That is some insanely expensive life insurance right there, unless Joan is 99 years old and is relatively certain a 50% market decline is coming before her 100th birthday. And she’ll pay that $5,000 this year, and next year, and over time, markets go up, so will her insurance costs, all the while the actual benefit she stands to claim recedes further and further into the sunset.

If you have an old (>5 years) variable annuity contract, this math might apply to you. The good news is that there are a few no-load (“fee only”) annuities out there that have much smaller internal costs and skip the whole GMDB charade. And if there are no surrender charges on an older contract, it’s often very easy to move from one (expensive) annuity to another (much cheaper) annuity without taxes. In doing so you might just quit paying insurance premiums for a benefit you may likely never see.

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