Should AXA Equitable's Variable Annuity Customers Accept Its Offer?
Posted at Advisors4Advisors.com on June 18, 2012
I believe that the complexity of many insurance products has outpaced the ability of conscientious advisors to offer reliable advice for a reasonable fee. When I say "reliable advice," I mean advice that our clients can rely on without fear that we have overlooked something that would cause them to change their decision. And "reasonable fee" means a fee that can be justified in relation to the benefit provided, taking account of the risk that there may actually be no financial benefit.
Insurance companies have found that they are losing money on some of the variable annuity guarantees that they offered in the past, so they are looking for ways to reduce the burden. How will you deal with offers like this one?
As reported by Darla Mercado ("Axa looks to terminate 'costly' VA death benefits with swap deal," InvestmentNews, 6/14/2012), AXA Equitable Life Insurance Company has filed a Guaranteed Minimum Death Benefit and Earnings Enhancement Benefit Offer with the U.S. Securities and Exchange Commission. The offer is being sent to owners of Accumulator variable annuities that have an optional guaranteed minimum death benefit (GMDB) or earnings enhancement benefit (EEB).
The Accumulator GMDB is generally the greatest of (1) the account value; (2) the contributions accumulated at a specified rate; and (3) the highest anniversary account value. The EEB is equal to a specified percentage of the excess of the death benefit over contributions.
If the contract owner accepts the offer, the optional GMDB or EEB will terminate and the death benefit will be equal to the account value. Ongoing charges for the optional GMDB or EEB will also terminate; however, AXA Equitable will not reduce the mortality and expense risk charge for the implicit cost of the standard death benefit (greater of account value or contributions) which is not available.
AXA Equitable's offer is the greater of (1) approximately 70% of its actuarial valuation of the GMDB/EEB and (2) 200% of the annualized charge for the GMDB/EEB. Each benefit is valued separately, and the total offer is the sum of the two calculations.
The actuarial valuation is based on "standard actuarial calculations for determining contract reserves," which take account of life expectancy, current and projected account values, current and projected GMDB/EEB values, current allocation of account value among investment options, and interest rates.
Here are a few questions that AXA Equitable left out of its filed offer:
1. What is the relationship between actuarial and economic valuations?
Actuaries and economists do not value things the same way. Actuarial valuation is usually based on the principle of actuarial equivalence: the expected present value of premiums equals the expected present value of benefits. Economic valuation agrees with this in spirit, but economists have more rigorous valuation procedures, based on consistency with market prices or other measures.
When the actuarial valuation is based on reserve requirements, we are dealing with real-world practicality and politics, because that is how reserve requirements evolve.
The economic valuation of variable annuity guaranteed minimum death benefits was presented in Moshe A. Milevsky and Steven E. Posner, "The Titanic Option: Valuation of the Guaranteed Minimum Death Benefit in Variable Annuities and Mutual Funds," Journal of Risk and Insurance, March 2001. They modeled the GMDB using stochastic calculus and evaluated the resulting stochastic differential equations using numerical methods. Later research includes Eric R. Ulm, "The Effect of Policyholder Transfer Behavior on the Value of Guaranteed Minimum Death Benefits," North American Actuarial Journal, March 2010 and Hans U. Gerber, Elias S.W. Shiu and Hailiang Yang, "Valuing equity-linked death benefits and other contingent options: A discounted density approach," Insurance: Mathematics and Economics, July 2012.
What is the relationship between an economic valuation and AXA Equitable's actuarial valuation? Should a client care about the economic valuation?
2. What is the relationship between an economic valuation and market value?
If the economic valuation is significantly higher than AXA Equitable's offer, can you find a third-party buyer who will be willing to pay more? Will taxes wipe out any advantage?
3. What is the effect of the annuitant's or contract owner's health on the value of the GMDB or EEB?
AXA Equitable is not doing medical underwriting, so it is basing its offer on estimated mortality rates for the entire pool. The economic or market value of the GMDB or EEB should be higher if your client's health is worse than average. You can get a life expectancy appraisal from several sources (for example, the eCLPR offered by 21st Services), but that won't tell you the impact on the valuation.
4. Can you take actions to boost the offer?
If the GMDB has a dollar-for-dollar (rather than proportional) reduction for withdrawals, can you boost the offer by withdrawing money from the annuity, leaving only a minimal amount to keep the contract alive?
Can you boost the offer by shifting money to the riskiest funds?
5. What is the effect of accepting the offer on the economic value of other benefits, such as guaranteed minimum withdrawal or income benefits?
An increase in the account value should reduce the value of guaranteed living benefits, but by how much?
These are five questions that come to mind. There are probably others that are equally important.
AXA Equitable's customers have 90 days to make a decision.
Other companies are preparing to make buy-out offers on variable annuity guaranteed benefits. Here’s a simplified example to show the importance of having reliable valuation information.
Suppose you pay $80 to the insurance company for an optional benefit that has two possible outcomes: a 75% chance of getting nothing and a 25% chance of getting $400. The expected value is $100, so this looks like a good deal.
Now suppose the good scenario occurs, and the insurance company offers to pay you $300 instead of $400. Retrospectively, the expected value has dropped to $75.
If you erase all of the numbers except the $300 buy-out offer, you’ll be in the position of variable annuity owners. When they buy the guaranteed benefit, they don’t know the probabilities of the various outcomes or the relationship between value and cost. And when they get the buy-out offer, they know what they are being offered, but they don’t know the value of what they are giving up.
They may expect that financial advisors can fill in the missing information to help them make an informed decision for a reasonable fee. Can we?