Guaranteed Income Wraps, also called Contingent Deferred Annuities (CDAs), are a new annuity innovation designed to offer longevity risk protection. These annuities are similar to living benefit riders to variable annuities but, instead of protecting funds or assets chosen by an insurer, the policyholder chooses the underlying investment vehicle, such as a 401(k), mutual fund or managed money account. The CDA establishes a life insurer’s obligation to make periodic payments for the annuitant’s lifetime at the time designated investments, which are not held or owned by the insurer, are depleted to a contractually-defined amount due to contractually permitted withdrawals, market performance, fees or other charges.
A CDA has three distinct phases. First, the CDA goes through an accumulation phase during which the amount of the CDA’s guaranteed annual payment is determined. The amount of the CDA benefit is set as a percentage of the total assets in the separately managed account. As those assets increase in value (for example through investment gains or additional deposits), the CDA benefit amount increases. However, once a benefit amount has been set, the CDA guarantees that the benefit amount can never decrease due to investment losses. In other words, should the underlying assets decrease in value due to poor market performance; the CDA’s benefit amount does not decline. In this way, a CDA provides a guaranteed lifetime income stream should covered assets run out.
The second phase of a CDA is the withdrawal phase in which the participant begins to draw funds from the separately managed account most typically upon retirement. During the withdrawal phase no benefit payments are made under the CDA. The CDA contract sets a maximum periodic withdrawal amount that a participant may take. Withdrawals at or below those permitted by the contract do not affect the benefit level established in the accumulation phase. However, should a participant withdraw funds above the contractually permitted amount, the amount of benefits available under the CDA decreases, potentially all the way to zero.
The third and final phase is the payout or settlement phase. Upon exhaustion of the separately managed account, the CDA begins making periodic benefit payments until the participant’s death. The amount of those payments is based upon the benefit amount set during the accumulation phase less any penalties or reductions for withdrawals above the contractual limits during the withdrawal phase.
Source: National Association of Insurance Commissioners and the Center for Insurance Policy and Research