Exchanging Variable Annuities: an Optional Test for Suitability

Milevsky, Moshe A.; Panyagometh, Kamphol
April 2004
Journal of Financial Planning;Apr2004, Vol. 17 Issue 4, p56
Academic Journal
The article offers an impartial method for assessing whether exchanging one variable annuity (VA) for another makes economic sense. The method is based on an options-pricing model that aggregates the value of three embedded financial guarantees or options: lapse value, death value and guaranteed annuity rates. An appendix describes the details of computing the option values. The paper applies the options-pricing model to several case studies of VA exchanges involving annuitants of different ages and different policy guarantees. Based on the series of exchange scenarios, the authors make several observations. First, all else being equal, the greater the contingent deferred surrender charges, and the higher the mortality and expense risk fees relative to the old policy, the less likely the exchange will add value to the investor. Switching variable annuities later in life, assuming the old VA has a lower or no exit penalty, is more likely to have economic value than switching to a VA earlier in life at a higher exit penalty. While considering these economic trade-offs is important, they are not as complicated as making the decision of the suitability of the annuity per se and the need to match financial products to the actual needs of the consumer.


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