Variable SPIA: Why Not?

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powermega
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Variable SPIA: Why Not?

Post by powermega » Tue Sep 27, 2016 9:17 am

SPIAs are generally recognized as a useful tool for retirees to reduce risk (longevity risk) and simplifying their personal finances and wealth management. Virtually all of the talk about SPIAs around here involve fixed SPIAs, or fixed SPIAs with a known annual adjustment (3%, etc). I rarely hear anyone mention the possibility of the variable SPIA. Why not?

Current fixed SPIAs are calculated with a low interest rate since the annuity company will typically use US Treasury bonds to finance the future payouts, and those rates are quite low by historical standards. One of the weaknesses I see with a fixed SPIA is that you "lock in" the current low interest rates for a long period of time. I think a good strategy with a variable SPIA would be to use the lowest possible Assumed Interest Rate (AIR), like 3% or 3.5%, then allocate your investments to a simple 3-4 fund portfolio, or even just use a single balanced fund (LifeStrategy Income or LifeStrategy Conservative, etc) for the entire portfolio. The SPIA's portfolio could be aligned with the rest of your overall investment portfolio too. A 30/70 or a even a 40/60 stock/bond allocation could provide for a fairly consistent income stream that has a high likelihood of increasing since those kinds of portfolios have historically returned more than the AIR. If bond interest rates were to rise, your SPIA income would (eventually) reflect that. An equity bull market would also get reflected in your variable SPIA incomes. Yes, a variable SPIA's income can go down when the SPIA's portfolio doesn't outperform the AIR, and in that sense, they are riskier than fixed SPIAs. Is that the primary criticism, or are there others?

For reference:
Variable SPIA Wiki
Vanguard SPIA Wiki

A two-year old article from ThinkAdvisor about this topic that explains this reasoning more.
Even a stopped clock is right twice a day.

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David Jay
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Re: Variable SPIA: Why Not?

Post by David Jay » Tue Sep 27, 2016 10:59 am

What is your purpose? Is it longevity insurance or investment?

1. Fixed SPIA guarantees longevity cash flow. The primary reason for good payouts is NOT investment return but mortality credits. The survivors are guaranteed higher payouts primarily because of the shrinking pool, not first and foremost because of the yield on Treasuries.

2. I would never recommend the use of an insurance company as an investment vehicle.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

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powermega
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Re: Variable SPIA: Why Not?

Post by powermega » Tue Sep 27, 2016 11:09 am

David Jay wrote:What is your purpose? Is it longevity insurance or investment?

1. Fixed SPIA guarantees longevity cash flow. The primary reason for good payouts is NOT investment return but mortality credits. The survivors are guaranteed higher payouts primarily because of the shrinking pool, not first and foremost because of the yield on Treasuries.

2. I would never recommend the use of an insurance company as an investment vehicle.
A variable SPIA would be both longevity insurance (primary role) and provide some level of investment market performance (secondary role). The calculation of the initial annuity income amount is very similar to a fixed SPIA. Mortality credits and mortality pooling are exactly the same, but the interest rate used for discounting the variable SPIA income is a level interest amount (AIR), whereas for a fixed SPIA the discounting interest rate(s) is going to be based on the Treasury bond market's yield curve.
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freebeer
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Re: Variable SPIA: Why Not?

Post by freebeer » Tue Sep 27, 2016 11:13 am

David Jay wrote:... Fixed SPIA guarantees longevity cash flow. The primary reason for good payouts is NOT investment return but mortality credits. The survivors are guaranteed higher payouts primarily because of the shrinking pool, not first and foremost because of the yield on Treasuries.
....
Well depending on your age the drop in expected real return (due to having to meet fixed obligations and therefore needing to invest in things like Treasuries) as well as insurance company overhead can be larger than the mortality credits.

So in principle OP's suggestion of having higher-expected-returns AND getting extra mortality credits (at the expense of giving up a guaranteed payout) is feasible. Also in principal this path could be "low fees" - since there is no guarantees, the offerer wouldn't have to be literally an insurer but more like a holding company that is constantly reallocating assets across customers. But there are some flies in the ointment, including that gets exponentially more difficult to fairly allocate the mortality credits across survivors given variable payouts. In effect we need a return to "tontlines" to make this fly, yet one problem is that they are basically illegal. See:
viewtopic.php?t=139401

I do think that as we get into the world of robo-advisors we could easily get into the world of a robo-tontine that would be "actuarially fair", low cost to administer, and give much higher expected payout than simply drawing down from a portfolio (which necessarily is highly inefficient, assuming no bequest motive).

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Re: Variable SPIA: Why Not?

Post by moshe » Tue Sep 27, 2016 11:25 am

I have a fundamental problem with annuities based on our or at least my boogleheadish belief system of investing.

I/We believe in safety in numbers and the general LT growth of capital markets. We diversify our investments because we do not have perfect market participant information so cannot possibly know who the next Enron WILL be.

If you accept the philosophy that diversification of investments reduces investor's risk then why would you choose one insurance company to hold a very large, in most cases, percentage of your investable assets with a paper promise of future payments? You cannot possibly know where the time bombs are located. Relying on state insurance in some cases may help you recover losses but do you really want to deal with this process, especially if this loss is wide-spread?

What am i missing? Do others avoid the thought of investing in annuities because of these concerns?

~Moshe
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powermega
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Re: Variable SPIA: Why Not?

Post by powermega » Tue Sep 27, 2016 11:38 am

moshe wrote: If you accept the philosophy that diversification of investments reduces investor's risk then why would you choose one insurance company to hold a very large, in most cases, percentage of your investable assets with a paper promise of future payments? You cannot possibly know where the time bombs are located. Relying on state insurance in some cases may help you recover losses but do you really want to deal with this process, especially if this loss is wide-spread?
With a variable SPIA, the annuity company is absolved of any guarantees since the performance of the portfolio will determine the subsequent annuity income amounts, not the performance of the annuity company's bond investments. I don't know for sure (this is a good question), but would imagine that the company risk you speak of would be higher with a fixed SPIA than a variable SPIA. With a variable SPIA like this, the annuity company is acting as more of a custodian for your investments than anything else (though they are charging more in fees, like 0.5%, than a typical custodian would charge, which I see as the primary disadvantage of a variable SPIA). Have you ever asked yourself how comfortable you are with Vanguard (or whoever your custodian is) having so much of your money?
Even a stopped clock is right twice a day.

informal guide
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Re: Variable SPIA: Why Not?

Post by informal guide » Tue Sep 27, 2016 11:44 am

If one is convinced that a SPIA is appropriate (a big if!) the question is the mortality assumptions that go into calculating the initial (variable) payout and the comfort level with a variable payment. Also, the backing for variable SPIA's are indeed the "separate accounts" that hold mutual fund like investments, rather than the insurance company's general account that backs fixed SPIAs.

Many years ago, my mother had cash value in a small paid up whole life insurance policy, with a company that had gone through "rehabilitation" (i.e., bankruptcy for insurance companies). She was in excellent heath, over 75, and had no need for the insurance or the funds. The revised offer from the insurance company was a lousy deal with no upside and about 2% annual growth in cash value after the cost of insurance (which she didn't need, to begin with). But taking the cash value (surrendering the policy) wold have generated significant immediate income tax liabilities. She did a 1035 exchange of this cash value into a variable SPIA at Vanguard /Transamerica with a 4% annual adjustment (not widely advertised, but I think is still available), invested in the VVA Balanced Fund (a clone of Wellington). Over the 12-14 years before she passed, the payment grew by about 50%, although it did decline slightly in the 2008-09 era. Until about a year before she died, the payments were only partially taxable, because part of each payment was a return of principle.

With 20/20 hindsight, it was a significantly better deal than a fixed SPIA.

The math of variable SPIA's is devilishly complex - in reality one likely has to trust the insurance company. Also, optional riders available on fixed SPIA's, such as a 10 year certain or return of premium feature (which reduce payouts) are typically not available on variable SPIA's

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Re: Variable SPIA: Why Not?

Post by moshe » Tue Sep 27, 2016 11:52 am

powermega wrote: .. Have you ever asked yourself how comfortable you are with Vanguard (or whoever your custodian is) having so much of your money?
Thank you for your thoughts!

Absolutely, which is why i have diversified our holdings also and do not hold all our investable money with Vanguard even though i understand that their corporate structure makes the possibility of a melt-down much less likely.

My main concern is with the stability of the underlying firm which has made a commitment to make future payments to me and/or my heirs. If the whole financial system melts down i cannot diversify away that risk but to rely on one firm to make me whole sometime in the future makes me a bit too nervous to consider any type of annuity.


~Moshe
My money has no emotions. ~Moshe | | I'm the world's greatest expert on my own opinion. ~Bruce Williams

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powermega
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Re: Variable SPIA: Why Not?

Post by powermega » Tue Sep 27, 2016 12:03 pm

moshe wrote:Absolutely, which is why i have diversified our holdings also and do not hold all our investable money with Vanguard even though i understand that their corporate structure makes the possibility of a melt-down much less likely.
Like you, I am happy to have my money diversified across multiple custodians (Vanguard, Schwab, Great West for 401k). If all three of them were failing, I think we would be in the midst of a zombie apocalypse, where canned food and ammunition would be the best "investments" to hold! :shock: :twisted:
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Re: Variable SPIA: Why Not?

Post by The Wizard » Tue Sep 27, 2016 12:07 pm

I have two different "variable SPIAs" with TIAA.
One is based on Commercial Real Estate (TREA) and one is based on the broad stock market (CREF Stock).
I've been pleased with their contribution to my monthly income since 2013...
Attempted new signature...

ralph124cf
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Re: Variable SPIA: Why Not?

Post by ralph124cf » Wed Sep 28, 2016 9:17 pm

The Wizard wrote:I have two different "variable SPIAs" with TIAA.
One is based on Commercial Real Estate (TREA) and one is based on the broad stock market (CREF Stock).
I've been pleased with their contribution to my monthly income since 2013...
+1

No additional costs, but I do not know of anybody else that offers this type of contract.

Ralph

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Re: Variable SPIA: Why Not?

Post by jalbert » Thu Sep 29, 2016 1:16 am

You can achieve the benefit of a variable SPIA, but at lower cost, by separating the longevity insurance component from the investment component, and just integrating a fixed SPIA into an investment portfolio, providing a variable return and longevity income.

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Re: Variable SPIA: Why Not?

Post by patrick » Thu Sep 29, 2016 1:50 am

The variable SPIA could be a good choice if you are willing to take market risk but not willing to take longevity risk. It may well make sense if market risk is the more likely risk to be rewarded fairly. But then again, maybe a person relying on a SPIA should avoid market risk too just to be really safe. And don't forget inflation risk!

The risk isn't the only problem tough. There is also the matter of fees -- both the explicit fee in the portfolio and the implicit fee built in to the payout rate.

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Re: Variable SPIA: Why Not?

Post by Johnnie » Thu Sep 29, 2016 7:39 am

powermega wrote: .. Have you ever asked yourself how comfortable you are with Vanguard (or whoever your custodian is) having so much of your money?
What I ask myself is if I really have any money. What I do have are symbols on a computer screen sent through a monumentally complex suite of technologies that I suspect is both robust in some areas and very fragile in others.

I hate to even write the words - I'm not really a tin-foil hat type hand-wringing about EMP and similar mysteries - but if internet went down for days or weeks that would be - trouble.

(If your solution is greenbacks in a safety deposit box you better make sure the local bank could even open the doors without electronics and web access.)

</end threadjack>
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Oicuryy
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Re: Variable SPIA: Why Not?

Post by Oicuryy » Thu Sep 29, 2016 9:44 am

Does anyone have a source for historical daily Annuity Unit Values for any immediate variable annuities? How volatile have they been? What does the long-term trend look like?

Vanguard's website used to show the current Annuity Unit Values for the Vanguard Lifetime Income Program. But they are gone now.

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Re: Variable SPIA: Why Not?

Post by Stonebr » Thu Sep 29, 2016 10:47 am

ralph124cf wrote:
The Wizard wrote:I have two different "variable SPIAs" with TIAA.
One is based on Commercial Real Estate (TREA) and one is based on the broad stock market (CREF Stock).
I've been pleased with their contribution to my monthly income since 2013...
+1

No additional costs, but I do not know of anybody else that offers this type of contract.

Ralph
My company's 401k plan used to offer a variable annuity option at retirement. It was tied to the S&P500 index. The monthly amount was set each year based on prior year's index performance together with remaining reserve in the account and mortality projection. Expenses were the same as the underlying index fund -- high by current Vanguard standards, but this was a long time ago. An older friend took the option in the 1980s and made out like a bandit for many, many years. When 2000 and 2008 bear markets hit, the annuity payout took an unfavorable adjustment. His personal financial situation made it a non-event, however. He was in a unique situation -- single, frugal, highly compensated and extremely knowledgeable about investments and finance. He also had a retirement job as a tenured full Professor at a large university with international reputation. An annuity like that is not for the faint of heart and not for your grocery money.
"have more than thou showest, | speak less than thou knowest" -- The Fool in King Lear

itstoomuch
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Re: Variable SPIA: Why Not?

Post by itstoomuch » Thu Sep 29, 2016 11:04 am

^
I got concerned with our retirement accounts when they had total swings of $ten K.
I really got concerned with our retirement accounts when they had total swings of $tens of K.
Something to think about. :annoyed
YMMV
Rev012718; 4 Incm stream buckets: SS+pension; dfr'd GLWB VA & FI anntys, by time & $$ laddered; Discretionary; Rentals. LTCi. Own, not asset. Tax TBT%. Early SS. FundRatio (FR) >1.1 67/70yo

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Re: Variable SPIA: Why Not?

Post by MN Finance » Thu Sep 29, 2016 1:22 pm

I think variable spia is a fantastic income option. This allows someone less concerned with legacy to maximize current income without sacrificing long term market growth, while absorbing potential variables to income. The variable income is a much smaller risk than might seem when including social security and non annuitize assets which can be drawn on.

The primary problem is not the concept, but the entirely empty list of quality insurance providers. Tiaa is obviously a wonderful option, but not available to many people. I for one plan to annuitize a large portion of my assets via TIAA when that day comes, but if anyone has researched other options I would love to hear the results.

[No, I don't want to hear about your glwb riders on your vas toomuch]

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Re: Variable SPIA: Why Not?

Post by itstoomuch » Thu Sep 29, 2016 3:19 pm

^it's about the closest stuff you can get to a variable SPIA or tier 1-PERS. The getting may already been gone.
Interesting cites by powermega.

As my BIL says, insurance companies hate anything that had "Variable" in the title.
Rev012718; 4 Incm stream buckets: SS+pension; dfr'd GLWB VA & FI anntys, by time & $$ laddered; Discretionary; Rentals. LTCi. Own, not asset. Tax TBT%. Early SS. FundRatio (FR) >1.1 67/70yo

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