A commonly misunderstood and/or overlooked annuity feature is the Market Value Adjustment. This provision will influence the value of your account during its term. It can have a noticeable effect on the account should you surrender your annuity early.
And in some cases, it can help you exit an underperforming annuity with gains that wouldn’t otherwise be available. In this post, we’ll discuss what it is and why you should watch it carefully.
What Is A Market Value Adjustment?
Simply speaking, it’s an annuity provision that affects the value of your annuity during the surrender phase. It’s not a feature on all contracts. To understand it, we have to first understand the investments annuities typically hold.
There are a lot of rules and regulations governing insurance companies and the annuities they offer. Insurance companies are not lending institutions like banks. They have much higher reserve requirements and purchase investments accordingly.
Insurance companies purchase debt (think government treasuries and highly-rated corporate bonds) to fund their operations and provide products. The treasuries and bonds purchased are packaged into annuities and sold to consumers at a known rate.
Sometimes the rate is fixed like in the case of a Multi-Year Guaranteed Annuity – or MYGA for short. You might see 5% for 5 years, for instance. In other cases, the rate can and will fluctuate over the annuity term.
Insurance companies profit on spreads – the difference between what the debt pays them and what they offer to the consumer. If they are offering 5%, then we might expect the debt to be paying them 5.50%. The 50 basis points are the spread that provides profit.
Bonds Will Increase And Decrease In Value
Over the course of their maturity, government and corporate bonds will fluctuate in price. When interest rates go up, bond values go down. When rates decrease, the value of the bonds increases. The two move inversely.
And that’s why many insurance companies use the Market Value Adjustment as a hedge to protect themselves and their policyholders. An MVA is only used during the surrender phase of an annuity contract. If you surrender your contract before maturity, your account may be worth more or less than what you might anticipate. Most insurance companies document that value on your statements.
In an environment where rates have increased dramatically, the bonds the insurance company purchased previously would have less value. If many policyholders decided to surrender their contracts early, this would negatively impact an insurance company’s profitability. In fact, it could cause significant financial strain.
However, we are witnessing a moment in time when interest rates have been increasing quickly. This has caused bank failures and that’s concerning. Market Value Adjustments protect consumers and insurance companies during times like these. This makes annuities much safer if there’s a run on financial institutions.
How Does The MVA Help Annuities?
We know rates decrease when the Federal Reserve tries to stimulate the economy. This means bond (debt) prices increase. That can be advantageous for certain fixed and indexed annuities with a Market Value Adjustment.
The lower rates are causing the underlying investments behind annuities to increase in value. Thus, it might be a good time to examine your current annuity account value. It may be worth considerably more than you thought.
If it is worth more – and there are no significant surrender penalties – you could consider exiting the contract. You may be able to lock in a higher rate with another insurance company through a 1035 tax-free exchange.
Will A Market Value Adjustment Hurt My Annuity?
Of course, the MVA can decrease your account value when interest rates increase, but this is only true if you surrender your annuity before it reaches maturity. Once mature, the MVA no longer applies.
Most owners don’t surrender their contracts early unless they have no choice. Annuities are longer-term investments. Most policies provide liquidity to their owners in the way of yearly free withdrawals. Accumulated interest, ten percent annual, and Required Minimum Distribution, terminal illness, and/or catastrophic health withdrawals are features many accounts provide. These withdrawals would not be affected by an MVA.
And insurance companies are careful to account for the death of the owner. Market Value Adjustments do not apply at passing. However, not all annuities offer a death benefit that’s free from surrender fees. Be sure to ask your agent if you’re uncertain about death benefit provisions.
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Annuities do have some moving parts – some more than others. If you do have a Market Value Adjustment on your contract, you want to know what it means. It can be a helpful feature in an environment where interest rates are falling.