Fixed Annuity Details: What’s A Market Value Adjustment?
Matt Carey, February 13, 2020
Fixed annuities, also known as multi-year guaranteed annuities (MYGAs), provide a guaranteed rate of return for a fixed investment term. If you’re considering a fixed annuity, it’s important to understand that there are two types: those with a market value adjustment (MVA) and those without, known as book value (BV).
Your choice of MVA or BV will only be relevant if you decide to withdraw funds above the allowed amount from a fixed annuity during the surrender period. If you have a fixed annuity and you do not take any withdrawals over the allowed amount during the term when a surrender charge is enforced, the MVA product is better because it generally pays a higher rate. If you do take withdrawals above the allowable limit, which version provides a better experience will depend on how interest rates have changed since the time you purchased the policy. I’ll dig into the specifics in an example later on.
Before we get into the specifics on how the MVA works, it’s important to first understand terms like surrender period, surrender schedule, and free withdrawal allowance, that are common across all fixed annuities. Every fixed annuity will have its own unique withdrawal allowance. The most common types are (1) No Free Withdrawals, (2) Interest Only Withdrawals, and (3) Balance Percentage Withdrawals. If your fixed annuity allows for either interest withdrawals or balance percentage withdrawals, you will not be penalized for taking a withdrawal as long as it’s equal to or below the allowed amount. If you take a withdrawal that’s greater than the allowed amount, that’s when the surrender period and schedule come into play. Every fixed annuity has a surrender period, which is most often equal to the contract term. During the surrender period, there is a surrender schedule, which is defined at the time of purchase and specifies the percentage you’d pay for any withdrawals beyond the free allowance during each contract year. A common surrender schedule for a 5 year fixed annuity is 9% in year 1, 8% in year 2, 7% in year 3, 6% in year 4 and 5% in year 5. Just like the surrender charge, the market value adjustment will only be charged on withdrawals that occur during the surrender period that are greater than the withdrawal allowance of your contract.
In this article, I’ll go into detail about what exactly the market value adjustment is, how it’s calculated, and why it’s useful to take into consideration when purchasing a fixed annuity.
What Is a Market Value Adjustment?
As the name suggests, a fixed annuity with market value adjustment will adjust the amount you’re able to withdraw based on the market conditions at the time you request the withdrawal. If interest rates have gone up since you bought the annuity, there will be an additional fee on the amount you withdraw above the stipulated surrender rate which will lower the amount that you’d receive from the withdrawal. If interest rates have gone down since you purchased the annuity, the market value adjustment will actually be negative, partially offsetting the stipulated surrender charge and increasing the net withdrawal available.
On the other hand, book value fixed annuities allow you to withdraw the exact amount you request, less the surrender fees. Said differently, book value annuities do not take into account the market conditions at the time of the withdrawal request.
How Does the Market Value Adjustment Work?
MVA fixed annuities are more common and well-liked by consumers. This is generally because they provide higher rates than BV fixed annuities, and most fixed annuity consumers purchase with no intention of surrendering their contracts. In a rising rate environment, the MVA offers interest rate protection to the insurer by charging the consumer additional fees for surrender, which compensates them for having to sell assets at a loss (in the case of fixed income assets, an increase in rates leads to a decrease in prices). The additional charge essentially erases any potential benefit of higher rates a policy owner would be able to find elsewhere. Thus, the downside protection that the MVA fixed annuity provides allows the insurer to pass through higher rates since they are protected against an influx of liquidation requests if rates were to rise. In contrast, BV fixed annuities expose insurers to this exact type of interest rate risk since they promise to pay out the surrender value regardless of how interest rates have moved since the contract was purchased. Since insurers offering BV annuities don’t protect themselves against rising rates, BV annuities must pay lower rates to the customer.
In general, fixed annuities are used to provide a guaranteed interest rate for one's retirement savings. If you’re planning to buy a fixed annuity for this reason, purchasing a product with MVA will provide additional yield, and as long as you do not take withdrawals above the allowed amount, you’ll never be penalized by the MVA.
How to Calculate the Market Value Adjustment
While each insurer will have its own formula for calculating MVA, the example below is a simplified illustration of the MVA functionality.
Alex owns a 5 year fixed annuity with MVA that was purchased for $100,000 and she decides to surrender the contract at the end of year 3 because interest rates have risen steadily over the last few years. To calculate the change in interest rates since Alex’s original purchase, the insurance company uses a corporate bond index which, for this example, let’s assume has risen to 5% up from 3%. The MVA adjustment would then be calculated as:
((1+ Purchase Index)/(1+ Today’s Index)-1)
(1.03/1.05-1) = -0.019
The -1.9% MVA charge would be applied in addition to the surrender fees indicated on the surrender schedule and applied to all withdrawals taken above the allowed amount.
At the end of year 3, Alex’s fixed annuity is worth $110,711, of which she’s allowed to take 10% or $11,071 for free. The rest $99,640, will be subject to a surrender charge and the MVA adjustment calculated above. If the applicable surrender charge is 6% and Alex wants to withdraw all of her money, then Alex’s charges would be:
Free Withdrawal = $11,071
Surrender Charge: -6% * $99,640 = -$5,978
MVA: -1.9% * $99,640 = -$1,893
Giving her a net withdrawal of
$99,640 - $5,987 - $1,893 + $11,071 = $102,840
The example above illustrates how the market value adjustment works against the policyholder in a rising rate environment. The additional 1.9% charge on the amount withdrawn above the allowed amount causes Alex to lose an additional $1,893.
MVA calculation for illustration purposes only and not representative of any particular insurance company’s process. Assumes $100,000 5-year MVA accumulates at 3.45% for 5 years, 10% free withdrawal provision, and year 3 surrender charge of 6%. Makes use of simplified MVA of (1 + Purchase Index)/(1 + Today’s Index) – 1, with assumed index of 3% at purchase and 5% today.
Note that this is a basic, simplified illustration of the MVA functionality. Each insurance company will have its own formula and underlying index. Also not illustrated here but potentially applicable is a floor for the surrender value of the premium accumulated at the guaranteed minimum interest rate in the contract.
In general, most insurance companies only have MVA versions of products, but there are some insurers who offer both MVA and BV products so it’s important to understand what product you’re purchasing. If you’re looking to maximize the interest you earn and don’t intend to prematurely surrender the contract, it makes sense to purchase the MVA product. Real-time fixed annuity rates of MVA products can be found here. Before purchasing a fixed annuity it’s important to understand the details of the policy, and especially before taking withdrawals, you’ll want to make sure you’re educated on any MVA calculation.