As insurance companies continue de-risking their annuity products, by effectively reducing guarantees, only a handful of companies marketing guaranteed lifetime withdrawal benefits (GLWBs) offer true protection against longevity, sequence of return and (potentially) inflation risk. I believe one of them is Transamerica.
Although Transamerica offers a bewildering array of variable annuity products, one that has caught my fancy is the Transamerica Principium II (TPII).
The May 2010 version of the prospectus for the TPII, which is the main source of my information for this particular review, was a manageable 279 pages long.
Here’s how TPII works and the features I like:
The basic chassis imposes a 0.70 percent mortality and expense (M&E) risk fee plus an administrative charge of 0.15 percent, which is extremely low compared with other variable annuities, mainly because there is no guaranteed minimum death benefit (GMDB). The death payment is the policy value only. So, if you happen to pass on during a bear market, Transamerica will offer nothing beyond the value of the subaccount at that time. Now, while some might dislike the lack of legacy guarantee, I actually think it fits quite nicely with the raison d’être of the next generation of VA products meant to provide a guaranteed living benefit. Moreover, those clients who want more can pay extra for the return of premium (1 percent) or annual step-up (1.2 percent) options. In my book, the TPII scores extra points for offering this choice.
The living benefit guarantee — which they call the “Retirement Income Choice 1.2 Rider” — works in the following way. Once the initial premium is allocated across the many subaccounts or model portfolios, the company keeps track of every monthly account or statement value. They have a cute name for this value, which they call the Monthiversary™. At the end of the policy year they look back at the best Monthiversary™ value and increase the guaranteed base to the highest of these 12 numbers. In addition to this look-back option, Transamerica guarantees that the guaranteed base will increase by at least 5 percent each year.
Alas, this 5 percent guaranteed growth rate doesn’t continue indefinitely. It ends after a 10-year lifespan. After that, all you get are the Monthiversary™ increases, if any. Either way this product ensures your retirement income base can only increase over time, and potentially by quite a bit if the market “pops” sometime during the year. Of course, it would have been nice if the guaranteed base actually increased more frequently (and some companies do this) and if the 5 percent guarantee continued beyond 10-years, which is especially important for people who purchase this in their 40 and 50s.
Likewise, now would be a good time to remind readers of the by-now tedious proviso — think of this like the Surgeon General’s warning on cigarettes — that this guaranteed base is only used for calculating income and is not a walk-away, or maturity value. It will be used to compute your client’s allowable withdrawals. It shouldn’t be compared to the (miserly) rates available from a long-term government bond or a bank deposit.
Moving on to the income stage, TPII allows for a (single life) withdrawal of 4 percent starting at the age of 59, 5 percent starting at the age of 65 and then 6 percent at the age of 75. These numbers are consistent and competitive with other companies. The company does allow for a joint life option, with a reduced rate of 0.5 percent in each band. In other words, you or your spouse can get 3.5 percent or 4.5 percent or 5.5 percent for life, depending on the youngest age. Moreover, if your account value steps up, you can move into the next age band. This is not quite inflation protection — and I would prefer a real, guaranteed cost of living adjustment — but that train has long ago left the station.
Finally, when it comes to the allowable investments in the subaccounts, TPII offers an array of Vanguard-based exchange-traded funds. I’m a fan of Vanguard (full disclosure here: I own a number of their ETFs), so I am partial to a variable annuity which allows the index-hugging EMH-believing masses the ability to participate in the GLWB world. Transamerica offers a variety of model portfolios mixing numerous Vanguard ETFs. In fact, there is an option to allocate 100 percent of the premium to stocks, but this choice allows the company to utilize something called the “Open Allocation Method” (yes, more jargon), in which your money may be re-allocated into investment funds of its choice (not yours) to help Transamerica protect itself. Think of it as the company dynamically hedging, but with your money. Giving over this type of control leaves me queasy, but you can always retain control by selecting from the designated allocations. Of course, you never really have full control of anything in the VA world, since any company can yank funds, change sub-accounts and alter investment choices at whim.
In fact, the algorithm by which Transamerica re-allocates money from the open 100 percent equity allocation to the ProFunds UltraBear sub-account (yes, you read that correctly) is worthy of its own Ph.D. thesis — well beyond the scope of this article.
This all leads us to the topic of fees. As I mentioned earlier, TPII allows for a variety of death benefit options and charges accordingly. The same philosophy applies to their pricing for the guaranteed living benefits, which is one of the features I most admire in the TPII and the reason it scores highly in my book.
How so? For many years I have been puzzled by the lack of correlation between rider fees and the risk being assumed by the insurance company. Let’s explore this. If the money inside your variable annuity is allocated to 100 percent cash (which you should never do, by the way), the company faces absolutely no stock market risk. On the other hand, if the funds are 100 percent allocated to an emerging market fund, the company has assumed quite some risk indeed. After all, if Indonesia or Malaysia defaults or absconds with your money, the company (not you!) is on the hook. Why, then, do insurance companies charge the same rider fee, without regard to what kinds of assets are in the subaccounts?
Here is where TPII distinguishes itself. The fees they charge vary with the risk they are assuming. If the policyholder selects the Transamerica Index 75 VP, which is an approximately 75 percent equity and 25 percent bond portfolio, the company charges 1.25 percent of the guaranteed base in annual rider fees. If the policyholder selects 50 percent equity and 50 percent bonds, the fee is only 0.90 percent, and at 35 percent equity and 65 percent bonds the fee drops to 0.40 percent.
Let’s add-up the fees then. Assume you want a 35 percent equity and 65 percent bond ETF-based portfolio. You pay 85 basis points for the ME&A charge (no GMDB), another 79 basis points in fund operating expenses (service class), and then 40 basis points in rider fees (as a percent of the base, computed annually). Although it’s not quite accurate to add these numbers together, this totals 204 basis points for a product that offers tax-sheltered growth, some exposure to the equity markets and an option on guaranteed income for life.
And, while normally I would never endorse a 35 percent equity allocation inside a GLWB — after all, why pay for insurance on something that doesn’t need protection? — when all you are paying is 40 basis points, you can’t really complain. Alas, if you want 100 percent equity, add another 70 basis points. That would be my preferred allocation.
Finally, there are a few other nice features about the TPII. In particular, there is an income enhancement benefit that allows policyholders to double their rider withdrawal percentage to help with long-term-care expenses. Transamerica also allows policyholders to drop the rider and stop paying on the fifth anniversary of the policy. These are all extra choices, which you pay for when checking-out of the variable annuity buffet.
In sum, all things considered I would score the Principium II an 8/10. Indeed, I think the Principium II deserves its name, as it conforms to some of the “first principles” which I’ve outlined previously in these pages. In fact, I’m thinking of perhaps buying a small one for myself as yet another pet, assuming they don’t shut it down before I get the chance.