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Interesting journal article on VAs and guarantees
Old 06-08-2008, 03:01 PM   #1
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Interesting journal article on VAs and guarantees

I am about halfway through an article in the Financial Analysts' Journal co-authored by Moshe Milevsky that discuses optimal and real world asset allocation in VA contracts when you buy a guaranteed minimum income benefit. Might be worth looking up if you care about this stuff, as it is interesting so far. Abstract:

Portfolio Choice with Puts: Evidence from Variable Annuities
Financial Analysts Journal
Moshe A. Milevsky and Vladyslav Kyrychenko
May/June 2008, Vol. 64, No. 3: 80-95
(doi: 10.2469/faj.v64.n3.8)

View Table of Contents

Abstract
This study investigated the asset allocation behavior of individuals who select an out-of-the-money long-dated longevity-put option on their investment funds. The asset allocations of these people within their variable annuity subaccounts are 530 percent more risky than the allocations of those who do not choose this protection. Investors who do not choose the longevity-put option follow the classic life-cycle, age-phased reduction in equity. A rudimentary model of utility-maximizing behavior is suggested that justifies the increased allocation to risk as long as the investor understands the payoff structure of the longevity put and is willing and able to exercise the annuity option if and when it matures in the money.
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Old 06-08-2008, 03:50 PM   #2
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A rudimentary model of utility-maximizing behavior is suggested that justifies the increased allocation to risk as long as the investor understands the payoff structure of the longevity put and is willing and able to exercise the annuity option if and when it matures in the money.
That pretty much sums up why not to do one.

I've been neglecting my JFP reading so I'm glad you're finding the highlights for me.
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Old 06-08-2008, 07:01 PM   #3
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indeed! just as i've always suspected. (does anyone have a translation in english?)
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Old 06-09-2008, 08:58 AM   #4
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indeed! just as i've always suspected. (does anyone have a translation in english?)
Rough translation: buying a guaranteed VA may be a good move if you really jam it to the insurer by investing the entire account in leveraged beaver-cheese futures and are smart enough to understand and actually use the guarantee if the beaver-cheese thing doesn't work out.
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Old 06-09-2008, 09:04 AM   #5
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beaver-cheese is a sure thing!
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Old 06-09-2008, 09:53 AM   #6
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beaver-cheese is a sure thing!
My dad used to say "Son, there are two things you can count on in life. First, your mom will always love you. Second, beaver-cheese is a sure thing... and, frankly, I'm not too sure about the first one."

He was also very bearish on beaver-cheese. He told me he liked to buy high and sell sober.
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Old 06-09-2008, 09:07 PM   #7
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What is the stock symbol for "beaver-cheese"?
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Old 06-10-2008, 07:01 AM   #8
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What is the stock symbol for "beaver-cheese"?
H05UC
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Old 06-10-2008, 07:31 AM   #9
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Seems like the insurance companies would have seen this coming and protected themselves. I'll bet they close the loophole/potential vulnerability, but I wonder how.
-- List of allowed investments? (Too cumbersome).
-- Guarantee only results as good as a standard index of some type (then, if you go off the reservation, you are on your own)?
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Old 06-10-2008, 08:02 AM   #10
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Most of the sensible companies impose restrictions on what you can invest in and how concentrated you can be within guaranteed VAs. Enough of them lost enough money in the 2000-2003 debacle to repeat that exact mistake again.
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Old 06-10-2008, 08:35 AM   #11
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"Smart Money" for July has an article on the new VA's.
The title gives it away--"Leap of Faith."
Besides making the point that these things are fee laden, the author worries about the issuers ability to make good in the out years.
Sales of VA products have doubled in the last ten years and the boomers will likely keep the trend alive.. But is this the next subprime explosion?
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Old 06-10-2008, 09:17 AM   #12
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"Smart Money" for July has an article on the new VA's.
The title gives it away--"Leap of Faith."
Besides making the point that these things are fee laden, the author worries about the issuers ability to make good in the out years.
Sales of VA products have doubled in the last ten years and the boomers will likely keep the trend alive.. But is this the next subprime explosion?
Anything's possible, especially lately when million-to-one chances seem to crop up nine times out of ten.

Having said that, with a few exceptions, most US domiciled life companies that sell these things protect themselves and their policyholders in several ways:

- They restrict the portfolios investors can choose when they guarantee a VA. The sensible companies will tell you no on the beaver-cheese thing. That I know of, one even does a risk tolerance assessment via questionnaire and then forces you to pick one of several pre-set asset allocation portfoilios.
- All the ones I have spoken to claim to hedge the exposure with futures, options, swaps, etc. Companies vary to the degree of sophistication they have in doing this, but most have some reasonably smart people running the hedge book and insurers have been hedging different types of risks for a long, long time.
- Most have substantial other businesses that bring in steady earings and may offset some of the risks of these products. Life insurance plus a book of payout annuities is not a bad start on a Texas hedge.
- Finally, the life insurance industry in general and most of the large VA writers in particular are well capitalized so they can absorb some bumps and bruises.

I don't mean to suggest that nothing can go wrong. Stuff can and will go wrong and any buyer of these products should be very careful about who they buy it from, but it is worth keeping in perspective some relative notion of the level of risk involved.
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Old 06-10-2008, 10:17 AM   #13
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Anything's possible, especially lately when million-to-one chances seem to crop up nine times out of ten.

.
I kinda like that line..Don't be shocked if I steal it



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Old 06-10-2008, 10:28 AM   #14
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Eh, I stole it from somebody else, so feel free.
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Old 06-10-2008, 07:53 PM   #15
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Anything's possible, especially lately when million-to-one chances seem to crop up nine times out of ten.

Having said that, with a few exceptions, most US domiciled life companies that sell these things protect themselves and their policyholders in several ways:

- They restrict the portfolios investors can choose when they guarantee a VA. The sensible companies will tell you no on the beaver-cheese thing. That I know of, one even does a risk tolerance assessment via questionnaire and then forces you to pick one of several pre-set asset allocation portfoilios.
- All the ones I have spoken to claim to hedge the exposure with futures, options, swaps, etc. Companies vary to the degree of sophistication they have in doing this, but most have some reasonably smart people running the hedge book and insurers have been hedging different types of risks for a long, long time.
- Most have substantial other businesses that bring in steady earings and may offset some of the risks of these products. Life insurance plus a book of payout annuities is not a bad start on a Texas hedge.
- Finally, the life insurance industry in general and most of the large VA writers in particular are well capitalized so they can absorb some bumps and bruises.

I don't mean to suggest that nothing can go wrong. Stuff can and will go wrong and any buyer of these products should be very careful about who they buy it from, but it is worth keeping in perspective some relative notion of the level of risk involved.
Brewer, I'd like your comment on this. An advantage of a VA over a SPIA is that I could always do a 1035 exchange and move to another company if things started to blow up. There might be surrender fees in the first 7 to 10 years but at least I wouldn't be locked for the rest of my life into a company that might be going down.
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Old 06-10-2008, 10:09 PM   #16
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Brewer, I'd like your comment on this. An advantage of a VA over a SPIA is that I could always do a 1035 exchange and move to another company if things started to blow up. There might be surrender fees in the first 7 to 10 years but at least I wouldn't be locked for the rest of my life into a company that might be going down.

You're really talking about two different issues. In a VA the money is held in a separate account. So the worst that can happen if the insurer goes belly up is that you get your current investment balance back (with a little delay).

What you would lose is any of the guaranteed living benefits.
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Old 06-11-2008, 07:47 AM   #17
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You're really talking about two different issues. In a VA the money is held in a separate account. So the worst that can happen if the insurer goes belly up is that you get your current investment balance back (with a little delay).

What you would lose is any of the guaranteed living benefits.
Yup.
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