Allocation to Deferred Variable Annuities with GMWB for Life

Xiong, James X.; Idzorek, Thomas; Peng Chen
February 2010
Journal of Financial Planning;Feb2010, Vol. 23 Issue 2, p42
Academic Journal
• This article explores a variety of asset allocation issues associated with deferred variable annuities with guaranteed minimum withdrawal benefits for life (VA+GMWB) to develop a framework for optimal retirement portfolios. • We begin by analyzing the value of the guarantee (GMWB) and its role in the portfolio context. It will lower the net return of the VA account; however, it provides a hedge against market downside risk, and if the investor holds the contract for the rest of his or her life, the VA+GMWB should provide him or her with an income stream for life. • We present an optimization framework for making this very important tradeoff that considers the investor's unique financial situation as well as his or her specific preferences. Over the long term, the VA+GMWB return distribution is expected to be more conservative than the VA alone, which adds complexity to the determination of an optimal product mix. • In the spirit of Sharpe's method for estimating the 'effective mix' of a mutual fund, we develop a method for estimating the effective mix of a VA+GMWB. • This study centers on a Monte Carlo simulation-based optimization to find an optimal product type mix by maximizing a utility function at the life expectancy. • All other things being equal, the study finds (I) The higher the risk tolerance, the lower the VA+GMWB allocation; (2) The higher the age, the lower the VA+GMWB allocation; (3) The higher the subjective life expectancy, the higher the VA+GMWB allocation; (4) The higher the ratio between wealth and income gap, the lower the VA+GMWB allocation; and (5) The preference for bequest has almost no effect on the VA+GMWB allocation.


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