I Bought my First VA...Just in the Nick of Time

Even though I am at least 20 years away from retirement — and lucky enough to be a member of a defined benefit pension plan at my university — I recently purchased my first variable annuity with a GLWB rider attached. Much to my surprise, the insurance company slammed the door shut on everyone else just as I was leaving with my brand new policy! Good thing I didn’t stop for coffee before I handed over the premium check or I would have missed the boat entirely. It seems I’m now in an exclusive club: No more members allowed.

Allow me to explain.

In the May 2010 issue of this column, I wrote an evaluation of the Purchasing Power Protector (PPP) variable annuity from Penn Mutual. Recall that the key feature of this VA (or at least the one that drew my attention) was its inflation-adjusted income benefit fused on a very flexible asset allocation platform. PPP policyholders could select from over 50 funds with absolutely no investment restrictions. Even 100 percent equity was allowable. And, when it came time to turn on the income stream, the 5 percent guaranteed for life was specified in real (that is, inflation-adjusted) terms — which means that your guaranteed income would keep up with the cost of living even if the market didn’t co-operate and generate a reset. The all-in management fees plus insurance cost for this package was less than 300 basis points. No surprise then that I scored Penn Mutual’s PPP a 9/10, which is the highest grade I have given to date.

But alas, this product was apparently too good to be true. Just a few short weeks after the May issue of Research hit the stands and my column was available online, Penn Mutual announced it would be discontinuing its PPP. The company still offers some other GLWBs, with standard bonuses and guarantees, but the inflation-protected lifetime income rider on the VA is no longer available.

Soon after the company announced this decision, I received quite a number of e-mails from financial advisors and brokers who informed me of this looming change. How odd, they said. Normally one would expect to see a pick-up in advertising after a good review, not the exact opposite. Some actually suggested Penn’s decision to shut down PPP was my fault because they were inundated with business they didn’t really want! One e-mail went so far as to suggest that because of me — and the sudden closure of this business — he wouldn’t be able to afford the next payment on his kid’s braces.

So, I decided to buy one before they went out of existence.

Heck. I have been preaching the benefits and value of some of these riders for the last few years, and I am well aware that the companies are scaling down the arms race. So, although I am not the ideal candidate for a VA (too young…and too tenured), I decided to rush in before they closed the door.

Alas this was easier said than done. The company listed a deadline of July 1 for the final PPP purchase date, which was just a few days away, so with the help of an eager advisor from Raymond James, I rapidly completed the necessary paperwork, selecting the owner, annuitant and beneficiary and couriered the package to Penn Mutual’s head office. In fact, I was thinking of using an alias or pseudonym on the paperwork, but suspected the state insurance regulators and compliance folks would have frowned on that. I have certainly come to appreciate the hassles involved in getting through the insurance red tape and getting VA business done. This was not as easy as buying an ETF in my Fidelity brokerage account!

Anyway, once the policy was finally approved (phew!), I selected the most aggressive and volatile allocation I was allowed within their sub-accounts. This was a small-cap index fund and I allocated 100 percent of my premium to this fund. Yes, I know this is not a very balanced asset allocation at all, but (as regular readers will know) diversification, prudence and safety are not how you optimize the put option embedded inside a GLWB. Rather, to counteract this new investment risk in my life, I tilted my non-annuity portfolio away from small-cap equities so that my entire holdings in aggregate remained well balanced. In the language of the insurance actuaries and financial engineers who design and manage these things, I “anti-selected” against the company — and I feel great about it! Additionally, I will begin making inflation-adjusted withdrawals from my GLWB just as soon as the underlying “diffusion process” touches the “early exercise boundary”. (That’s geek-speak for the point at which I’ll extract the most value from the policy.)