Over the past few years we have experienced an extremely low interest rate environment, lowering product features, agent commissions and rates. This directly effects how the MVA is applied.
Nearly all annuity products
today are priced and built with a market value adjustment, also referred to as an interest adjustment.
What is an MVA? According to Jack Marrion and John Olsen’s outstanding book, “Index Annuities: A Suitable Approach” (p. 11-12):
An MVA feature means changes in the interest environment are taken into account if the annuity is cashed in before the end of the surrender charge period. What this can mean is if interest rates have risen since the annuity was issued, the penalties for cashing out could be higher than the schedule stated in the policy, and if rates have fallen since issued the penalties could be lower or even zero.
Interest rates at policy issue, current interest rates on new policies and time are the essential elements of any MVA formula. Over the past few years we have experienced an extremely low interest rate environment
, lowering product features, agent commissions and rates. This directly effects how the MVA is applied.
For example, a 14-year product at a major insurance carrier in January 2008 had a fixed rate of 5 percent; today that same product has a fixed rate of 1.9 percent. A policyholder who purchased this product in January would probably have a positive MVA. If a policyholder purchased the annuity
in December 2011 and in March 2015 interest rates have risen back to 5 percent (cross your fingers) it is very likely there would be a negative MVA, increasing the amount of surrender penalties if the policyholder were to take excess withdrawals.
This adjustment can be extremely useful for the issuing carriers when they price products, allowing them to offer higher premium and income bonuses, interest rates and rider features. Marrion and Olsen make this point in writing, “Because the MVA allows the insurer to share the risk of interest rate changes with the annuity buyer, the insurer may credit a higher interest rate to contracts with this feature than it credits to those without it.”
But, in a low interest rate environment this adjustment can lock consumers into hefty surrender penalty situations if they need to access extra cash above the penalty free withdrawal amount given in their policy.
Let’s look at an example. A typical MVA formula looks similar to this: (A – B – 0.005) * C, where A is the new money rate at issue, B is the current new money rate, and C is time left in the surrender period on the contract in question. This is the MVA factor.
For our example, we will use a contract with a current accumulation value of $150,000. The new money rate at issue was 4 percent, the new money rate on new contracts is 2 percent, and there are eight years left in a 14-year contract with a surrender charge of 12 percent.
The first step is to calculate the MVA factor, which is 0.12 ((0.04 - 0.02 - 0.005) * 8). Then we would subtract any penalty free value from the accumulation value, giving us $135,000 ($150,000 - $15,000). Then we would multiply this value times our MVA factor to get our market value adjustment, which in our case is +$16,200.
Our 12 percent surrender charge is also $16,200 ($135,000 * 0.12) eliminating all surrender penalties on the current contract. The hypothetical policyholder now has plenty of options: move the contract to a new savings vehicle, keep the funds in the annuity or buy something for themselves.
But what about policies that are issued today? Let’s invert our example. The MVA factor would then become -0.20 [(0.02 – 0.04 – 0.005) * 8], making our MVA -$27,000 [($150,000 - $15,000) * -0.20] increasing our total surrender charge to $43,200 [($150,000 - $15,000) * 0.12 - $27,000], or 28.8 percent.
That’s a client meeting I would want to avoid.
MVA products are incredibly suitable for many indexed annuity
candidates as long as they do not access the funds beyond the penalty free amount allowed in their contract before the end of the surrender period. It is absolutely essential to consider time horizon when an annuity producer makes a product recommendation.
For those who feel uneasy about MVAs there are still companies that offer competitive indexed annuities without MVAs; these products offer premium and income bonuses, income rollups, and competitive rates and caps.
The market value adjustment may be the most (seemingly) complicated feature of an indexed annuity. It is the obligation of the annuity producer
to do their due diligence by knowing the details of the products they sell in order to determine if a particular product is suitable for their client. Surrender charges, bonuses, caps, income riders and other features must each be kept in mind when making a product recommendation.
It is the
opinion of this author that the market value adjustment should be considered at the same level as all these other features. It could cost a client thousands.