Maximizing a Client's Variable Annuity Income

Proxy ITM vs. Software-Estimated ITM

A proxy ITM is a simple estimate of the real ITM. For example, a contract might have a guaranteed life withdrawal benefit (GLWB) that's based on the greater of shadow fund value, accumulated at a guaranteed fixed 5%, and the account value. If the account value drops below the shadow fund base, then a policyholder might believe that their contract has ITM.

The proxy ITM here is a very simple comparison of two numbers. However, the much more accurate software-estimated ITM needs a complicated method of calculation and requires the use of a sophisticated app.

But How Will I Recognize ITM When It Occurs?

First, let's look at the proxy ITM that seems to have real ITM.

Even if all these parameters look favorable, the contract might still not have ITM. This is because, for the real ITM, we should not be comparing the bases. We should be comparing the present value of future income payments to the account value. The real value to the policyholder is the present value of these payments, which could be less than the account value, and sometimes significantly so.

There's a Timeline of ITMs for Each Future Year

All future years have an ITM metric. Each one would have its own current value as of today. This metric would be determined by comparing the present value of income, started in any future year, with the current account value.

Needless to say, the policyholder would want to exercise income in the year when ITM has the greatest value, as of today, and that would mean deferring the income election till that year. For example, if there's a very rich income benefit at some future retirement age that is more generous than the ones in between.

So, How Do I Calculate These Critical ITM Metrics?

Calculating ITM is a serious challenge and requires the use of a non-trivial software app. In addition, for the policyholder, the ITM must be calculated from the policyholder's point of view and based on the policyholder's financial preferences and personal attributes and not from the insurer's point of view.

So, you will need an app that calculates the ITMs in this fashion.

It's the ITM Stupid!

After the purchase of a variable annuity contract, it's critical that an adviser constantly monitor the contract's current ITM. These ITMs can change very quickly and sometimes in a dramatic fashion. For example, think of the 2008 crash, or early 2020 during the start of the pandemic.

An advisor needs to be prepared for any contingency. Knowing an accurate estimated ITM for the contract puts the advisor in the driver's seat for providing the client with the best options. Armed with the ITM metric, advisors will know if they need to take immediate action or defer a specific benefit election to a later period to maximize the present value of their client's income.

By definition, the ITM metric is, by far, the most important piece of information about a client's variable annuity contract. Not putting in a reasonable effort to obtain the ability to monitor a good estimate of this metric, should constitute a failure to provide due diligence for an adequate risk-management of a client's contract.

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James Kavanagh is the organizer of BI-SEM, a nonprofit group that's trying to develop a method that advisors can use to update deferred annuity valuations.