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Introduction
Market Value Adjustments (MVAs) can be a significant component of some annuities, particularly those with multi-year guaranteed periods. These adjustments enable insurance companies to manage interest rate risks when policyholders decide to surrender their policies before the accumulation period ends. By understanding MVAs and how they are (generally) calculated, individuals can make more informed decisions about their retirement income planning. MVAs are typically applicable to fixed annuities with multi-year guarantees or fixed index annuities.
How MVAs Work
What is an MVA? A market value adjustment (MVA) is an annuity contract that determines how much money the owner receives from an early withdrawal or surrender. This protects the insurance company from interest rate risk when an annuitant takes their money out during the accumulation phase. When an owner of an annuity takes money out of the annuity early, they’ll be given what’s called the surrender value. This value (less surrender any surrender fees or penalty free amounts) is adjusted based on the current interest rate environment.
Typically, the MVA is inversely related to interest rates. If interest rates fall after issuance, then the MVA may increase the surrender value. This is because the insurer has invested the original funds in a bond. If the reference index price has dropped since the purchase, then the insurer holds higher yielding bonds and will share a portion of that gain. If interest rates have risen after issuance, then the MVA may decrease the surrender value. In this case, the insurer has lower yielding bonds at the time of sale passes that difference onto the annuitant.
Insurance company MVA formulas vary quite widely. But in general, they will reference a standard index (S&P, Moody’s, Treasury bonds, etc.). The formula may include caps on how much the MVA can increase/decrease the surrender value.
Example Scenarios
Rising Interest Rate Environment
Below are the inputs for a purchased fixed annuity:
| Principal | Term | Interest Rate at Purchase (IP) | Interest Rate at Withdrawal (IW) | Penalty Free Amount |
|---|---|---|---|---|
$100,000 | 10 years | 3% | 5% | 10% of principal |
Below is the surrender schedule:
| Year | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 |
|---|---|---|---|---|---|---|---|---|---|---|
Surrender Fee (%) | 10 | 9 | 8 | 7 | 6 | 5 | 4 | 3 | 2 | 1 |
In year 7, the annuitant decides to withdraw $50,000 from the annuity. The following is just an example formula that may be used by an insurance company. Check with your insurance company to find out what formula they use.
[(1+IP) / (1+IW)] – 1 = MVA Rate
So, for our example the MVA Rate is: [(1+0.03) / (1+0.05)] – 1 = -0.019 or -1.9%
The gross withdrawal is $50,000. The penalty free amount is 10% of the principal. So, the withdrawal amount subject to penalties is $45,000.
The surrender fee for year 8 is 3%.
Surrender fee: $45,000 * 3% = $1,350
MVA: $45,000 * 1.9% = $855
The net withdrawal then: $50,000 - $1,350 - $855 = $47,795
Keep in mind though, that if this withdrawal was taken out prior to 59 ½ years old, there is an additional 10% tax penalty. This withdrawal will also be subject to ordinary income tax as well. All of these added up may make an early withdrawal relatively expensive.
Falling Interest Rate Environment
Below are the inputs for a purchased fixed annuity:
| Principal | Term | Interest Rate at Purchase (IP) | Interest Rate at Withdrawal (IW) | Penalty Free Amount |
|---|---|---|---|---|
$100,000 | 10 years | 5% | 3% | 10% of principal |
Below is the surrender schedule:
| Year | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 |
|---|---|---|---|---|---|---|---|---|---|---|
Surrender Fee (%) | 10 | 9 | 8 | 7 | 6 | 5 | 4 | 3 | 2 | 1 |
In year 7, the annuitant decides to withdraw $50,000 from the annuity. The following is just an example formula that may be used by an insurance company. Check with your insurance company to find out what formula they use.
[(1+IP) / (1+IW)] – 1 = MVA Rate
So, for our example the MVA Rate is: [(1+0.05) / (1+0.03)] – 1 = 0.019 or 1.9%
The gross withdrawal is $50,000. The penalty free amount is 10% of the principal. So, the withdrawal amount subject to penalties is $45,000.
The surrender fee for year 8 is 3%.
Surrender fee: $45,000 * 3% = $1,350
MVA: $45,000 * 1.9% = $855
The net withdrawal then: $50,000 - $1,350 + $855 = $49,505
Keep in mind though, that if this withdrawal was taken out prior to 59 ½ years old, there is an additional 10% tax penalty. This withdrawal will also be subject to ordinary income tax as well. All of these added up may make an early withdrawal relatively expensive.
Pros and Cons of MVAs
Although the drawbacks of MVAs seem obvious enough, there are some benefits to the annuitant.
| Benefits | Drawbacks |
|---|---|
Higher guaranteed rates: Insurers can offer more competitive rates due to risk sharing. | Complexity: Harder for consumers to understand compared to traditional fixed annuities. |
Transparency: MVA mechanism is disclosed up front; allows investors to plan accordingly. | Downside risk: Potential for significantly lower surrender value if rates rise sharply. |
Market-linked surrender value: May benefit policyholders in falling rate environments. | Not suitable for short-term liquidity needs: MVA can penalize early withdrawals heavily. |
Regulatory and Disclosure Requirements
MVAs are regulated to an extent as well. Below is some guidance on what governing bodies require or provide.
| Category | Details |
|---|---|
State Insurance Regulations | MVAs must be approved by state departments of insurance. Disclosure of MVA formulas, index sources, and maximum penalties is typically required. |
NAIC Guidelines | National Association of Insurance Commissioners provides model regulations on MVAs. |
Agent/Advisor Responsibilities | Must explain how MVAs work and when they apply. Suitability standards: Ensure the product aligns with the client’s time horizon and risk tolerance. |
When MVAs Matter Most
Decide early when you will need access to funds when choosing an annuity. If you think there’s a good chance you may need funds earlier than later, then a longer-term fixed annuity with an MVA may not be a good decision.
| Feature | MVA Annuities | Non-MVA Annuities |
|---|---|---|
Interest Credit Rate | Typically, higher | Typically, lower |
Surrender Risk | Subject to MVA | No MVA risk |
Rate Risk Sharing | Shared with policyholder | Borne entirely by insurer |
Suitability | Best for long-term horizons | Better for short-term flexibility |
Conclusion
Market Value Adjustments serve as a tool for insurers to manage interest rate risk and offer better crediting rates to investors. Understanding the mechanics, scenarios, and contract terms associated with MVAs is important for making informed decisions. Investors should weigh the trade-offs between potential benefits and the risks of early surrender before choosing an annuity with an MVA feature. With proper planning and the right time horizon, an MVA annuity can be a valuable component of a retirement income strategy.