Variable Annuities, an insurance product?

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tacitus7
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Variable Annuities, an insurance product?

Post by tacitus7 » Sat Jun 02, 2007 9:05 pm

I can understand the value of insurance when one purchases a fixed annuity or an immediate annuity as they are sometimes called.

But what role does insurance play, or what insurance benefit is conferred to one who purchases a variable annuity? No particular interest rate is promised.

thanks,
Joe E.

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bob90245
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Re: Variable Annuities, an insurance product?

Post by bob90245 » Sat Jun 02, 2007 10:19 pm

tacitus7 wrote:But what role does insurance play, or what insurance benefit is conferred to one who purchases a variable annuity? No particular interest rate is promised.

There is the Assumed Interest Rate (AIR). More on this topic from the Reference Library:

Barry Barnitz wrote:2. Annuities and Inflation by Thomas G. Walsh, F.S.A., C.F.P.

A guaranteed lifetime annuity can maximize a retiree's annual income and provide an income that cannot be outlived, as discussed in our first paper, "The (Mostly) Pros and (Few) Cons of Lifetime Payout Annuities." However, fixed-rate annuities do not protect a retiree's income from purchasing power losses because of inflation (e.g. as measured by changes in the CPI). The purpose of this paper is to describe types of annuities and other strategies that will offer the possibility of growing payments during retirement.

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Dale_G
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Post by Dale_G » Sat Jun 02, 2007 10:25 pm

I can only speak to my "old" Vanguard VA annuities.

1. I believe all companies provide a guaranteed rate at the time of annuitization. There is a put here. If market rates are higher at the time of annuitization you can get the higher rate, by changing providers if necessary. If market rates are lower you can take the guaranteed rate. (maybe not too important because the vast majority do not annuitize.

2. In case of death before annuitization, return of original investment is guaranteed. This is included as part of the M&E fee" in old policies, but may be a separate surcharge in newer policies.

3. You can also pay a fee (cheap in the case of Vanguard) to "step up" the guaranteed value of the account each year (only in the case of death).

Frankly, these "insurance benefits aren't worth a whole lot, but the insurance companies had to have some insurance component in order for congress/IRS to confer tax deferral on the vehicles.

My VAs made sense at the time: high income and tax rate, and very limited deferred opportunities ( 2K IRA, but not if you had a 401k - 6k max).

For new investments, VAs don't make much sense (for most people) at present tax rates. If dividend and capital gains taxes are raised significantly, but ordinary rates are relatively static, VAs will again make sense for some investors.

Dale
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LH2004
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Post by LH2004 » Sat Jun 02, 2007 11:19 pm

Dale_G wrote:Frankly, these "insurance benefits aren't worth a whole lot, but the insurance companies had to have some insurance component in order for congress/IRS to confer tax deferral on the vehicles.
It may be necessary under some states' insurance laws, but not for tax qualification. Fidelity offers VAs that have no insurance component (death benefit just equal to account value). I thought Vanguard did, too.

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Dale_G
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Post by Dale_G » Sun Jun 03, 2007 12:10 am

Fixed payment rates on annuitization are certainly an insurance component.

Unfortunately, I cannot access either the Fido or Vanguard prospectuses on line at the moment, but I'll bet a dollar to a donut (favorable rate in the old days) that both guarantee payments on annuitization - based on the value of the contract.

My "old" Vanguard annuity guaranteed return of principal - a joke today since the VA has quadrupled. I think the annual "step-up" on my policies cost 7-15 basis points. Since I expect to die without ever withdrawing from these contracts, it amounts to a fairly cheap "put" for my heirs. Definitely an insurance component.

Dale

tacitus7
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Thanks for the posts

Post by tacitus7 » Tue Jun 05, 2007 1:02 am

Thanks for the responses.

But to be clear, are you saying then that a variable annuity gaurantees the original investment? Is that the insurance component?

That just doesn't seem feasible for insurance companies.

Joe E.

SteveB3005
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Post by SteveB3005 » Tue Jun 05, 2007 8:57 am

tacitus,


That just doesn't seem feasible for insurance companies.

If you mean feasible like why would they just hand me all my invested money back, they don't because they took a cut along the way with the Mortality and Expense Risk Charge that is part of the total expense ratio.

The tax deferral is probably the number one selling point of VA's but also ranking very high in a lot of peoples mind is the fact that in many states they are protected assets.

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Not all VAs are alike

Post by crefwatch » Tue Jun 05, 2007 11:53 am

A guarantee of principal (or the payouts from such a principal) are not an essential part of a variable annuity. I say that not because I'm in the business, but because I've had a TIAA-CREF variable annuity since 1975.

When you look at the Vanguard VA prospectuses (and here, I'm referring to the plain retail variable annuities, available to anyone), you will see that there is a choice of expense ratios. With increased expense ratios, there are increasing guarantees. A "low" level of guarantee might simply be that the expense ratio of the underlying investment will not increase. (That's the E part of "M&E" expenses.)

In the case of TIAA-CREF, the mortality charges are exceptionally low. That's not a free ride; Rather, it's that the mortality risk is borne by the annuitants.

Your question is a good one. The original TIAA product was an annuity based on (primarily) fixed-income investments (but also, for example, direct real estate, and direct mortgages.) Today, that product is called "TIAA Traditional Annuity". It has a number of guarantees, including a minimum "interest" rate. But when the investment results are good (which is almost every year!), additional interest is declared and credited. In this case, the annuity is backed by the General Account of the best rated insurance company in the business, TIAA.

The more commonly known variable annuities at TIAA-CREF are issued by CREF, which was set up in 1952 to provide an Equity-based investment to supplement the original TIAA annuity.

The reason I mentioned the General Account of TIAA is that there is no Net Asset Value asssociated with TIAA Traditional. Rather, it's backed by the promise of the insurance company. On the other hand, TIAA Real Estate Account, a variable annuity product, is a Separate Account of TIAA, and cannot be commingled with the General Account. That account is valued and apportioned in the way we are used to mutual funds being apportioned. But it is, purely, a product of an insurance company.

tacitus7
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Post by tacitus7 » Tue Jun 05, 2007 9:22 pm

SteveB3005 wrote:tacitus,

The tax deferral is probably the number one selling point of VA's but also ranking very high in a lot of peoples mind is the fact that in many states they are protected assets.


Thanks for the response Steve. Could you elaborate on what you mean by protected assets? From what are they protected? My father has a variable annuity and I am trying to understand how it is different from a regular 401K retirement plan. I know both are tax sheltered.

Joe E.
Last edited by tacitus7 on Tue Jun 05, 2007 9:31 pm, edited 1 time in total.

tacitus7
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Re: Not all VAs are alike

Post by tacitus7 » Tue Jun 05, 2007 9:30 pm

crefwatch wrote:Today, that product is called "TIAA Traditional Annuity". It has a number of guarantees, including a minimum "interest" rate. But when the investment results are good (which is almost every year!), additional interest is declared and credited. In this case, the annuity is backed by the General Account of the best rated insurance company in the business, TIAA.

The more commonly known variable annuities at TIAA-CREF are issued by CREF, which was set up in 1952 to provide an Equity-based investment to supplement the original TIAA annuity.

The reason I mentioned the General Account of TIAA is that there is no Net Asset Value asssociated with TIAA Traditional. Rather, it's backed by the promise of the insurance company. On the other hand, TIAA Real Estate Account, a variable annuity product, is a Separate Account of TIAA, and cannot be commingled with the General Account. That account is valued and apportioned in the way we are used to mutual funds being apportioned. But it is, purely, a product of an insurance company.


Thanks for your in depth response. My father has a variable annuity. Trying to understand it. I am not following all of your response.

Are you saying the prospectus would state a minimum gauranteed interest rate? And if there is no Net Asset value associated with TIAA Traditional, does that mean that the holder of the annuity actually doesn't own stocks, but something else? What is that something else?

I think my father, and I if I ever need to, buy these products as another avenue for tax exemption of retirement monies. But I just want to understand exactly what these things are a little better.

For example, my father owns an annuity that he says is the equivalent of the Wellington...but when I look at it on line with him, I can't seem to find the prospectus.

Thanks for your help with this.

Joe E.

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Dale_G
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Post by Dale_G » Tue Jun 05, 2007 10:25 pm

Read the prospectus

A modern prospectus for a variable annuity may run 100 pages or more - and it will be pretty dense reading.

To simplify it a great deal:

1. You give money to the insurance company
2. The money may be invested in mutual funds or mutual fund clones
3. No taxes are due, except on profits when the funds are withdrawn
4. The insurance company withdraws fees from the account because:
A. They offer a guaranteed rate of return if you annuitize
B. They may guarantee the return of your contributions if you die
C. They guarantee their expenses will not increase

There may be other guarantees for which you will pay fees.

They collect these fees because there is a chance (slim) that they will pay out more than they have taken in. This is the very nature of insurance.

There are thousands of different Variable Annuities. Some are decent, some are terrible. The only way to tell the difference is to read the prospectus.

At the very least, whoever sold the annuity ought to be able to explain it.

I own VAs, but they are not appropriate for everyone - and they must be purchased with care.

Dale
Volatility is my friend

tacitus7
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Thanks Dale

Post by tacitus7 » Tue Jun 05, 2007 10:34 pm

Thanks Dale,

It would seem that they guarantee that upon my father's death the monies will be returned and that the fees will not go up, your B and C.

But you are right, I have to find the prospectus and read it. At least I am not going into the topic totally blind now.

thanks,
Joe E.

crefwatch
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More than one kind of VA

Post by crefwatch » Wed Jun 06, 2007 8:04 am

tacitus7, I was trying to emphasize that simply saying "variable annuity" does not specify all of the characteristics of an investment. TIAA Traditional is a contract with an insurance company which offers variable amounts of annual interest, but a guarantee backed by the insurance company (and no one else...) that the accumulated total (at any and every given time) will not decrease. TIAA Real Estate is more "like" a mutual fund, in that a pool of assets are valued every day, and belong to the investors, with their value going up and down with the real estate (not, in this case, the stock ...) market.

Unfortunately, TIAA Traditional does not have a prospectus, because it is a pure insurance company product. As I said, it's backed by the General Account of a very safe insurance company. I don't want to create unnecessary worry, but there have been occasional insurance company failures in my lifetime. The most important one on the East Coast was Mutual Benefit Life, in Newark, NJ. Their annuitants had to wait several years, at lower interest rates than they expected, before the state insurance fund (as I remember) returned their investments.

Other variable annuities, I would say the more common ones, offer various guarantees about the initial deposit amount, or about some minimum portion of some market index return. (Naturally, you give up some upside potential to get this guarantee, as well as paying ongoing fees.)

I don't think it's the topic of this particular thread, but I should add that there are also variable annuities that are sold improperly to elderly people who shouldn't have them. But I believe this discussion is about long-term investments chosen by people who are appropriate customers, and who will never pay a "surrender charge" because they will hold the investment for at least seven years.

tacitus7
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variable annuities are variable

Post by tacitus7 » Wed Jun 06, 2007 1:55 pm

I just found the prospectus for the WA balanced fund, the one my father is in. It is over 130 pages. It is an interesting read.

Thanks for your input, I am starting to get a better handle around how a variable annuity still having insurance properties.

always learning,
Joe E.

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