PRODUCT REVIEW
Last month I addressed a variable annuity that protects retirees against the dreaded risk of inflation by offering a guaranteed payout rate linked to the Consumer Price Index (CPI), which is computed by the U.S. government via the Bureau of Labor Statistics. But there are many ways to offer inflation-protected income other than linking payouts to the CPI explicitly. A number of market-based instruments can perform the same task. In this month's column I will focus on a VA that helps retirees manage inflation risk (amongst other risks) using market methods, which also offers more flexibility than linking payments to the CPI. This month I will review the AXA Equitable Retirement Cornerstone VA.
The financial crisis of 2008/2009 forced many companies to fundamentally rethink and ultimately redesign their VA business to protect the insurance company as well as investors and policyholders, and AXA Equitable is no exception. Their Retirement Cornerstone VA is not just another tweak on an old theme — with quarterly versus daily ratchets, or simple versus compound interest — but is actually designed on a new chassis.
Astoundingly, the product takes 1,752 pages of prospectus to explain (I kid you not!) and the disclaimers are a spectacular monument to the litigious environment in which we now live. (Who in their right mind can absorb such a document? It's beyond me.) Your humble servant actually took the time to thumb through it (in PDF format — I would never massacre that many trees for a mere column) and can assure you that 50 percent of it could be summarized with a few basic equations. Perhaps Harry Markopolos is right and we should replace the SEC with quants, but I digress.
How Does it Work?
Boiled down to its essence the Retirement Cornerstone product isn't as complicated as it initially appears. In fact, the videos and other material on the AXA Equitable website were quite good in explaining the underlying concepts. The few remaining questions I had were promptly answered by their senior V.P. of annuity products, Steven Mabry. In fact the overall design philosophy makes a kind of intuitive sense once you actually think about it.
Here's how the product works, in a nutshell. Consider two different investment silos: An accumulation (A) silo and a benefit (B) silo. The company calls them "sleeves," or two sides of a ledger. In the A silo you deposit and invest premiums, select your investment funds and asset allocation, pay your minimal annual fees and hope the market cooperates so your money grows. The A silo, considered in isolation, is a garden-variety tax-sheltered VA. It doesn't offer any additional guarantees, but then again it doesn't charge for additional living benefits either. So far this is nothing to get excited about.
In contrast to the A (accumulation) silo, the B (benefit) silo is also a segregated pool of money, but with more limited investments and restricted portfolio models available. This silo, however, offers a guarantee of lifetime income if you "behave" by making "reasonable" withdrawals. To understand the concept behind silo B, think of a Guaranteed Minimum Income Benefit (GMIB) with a benefit base, roll-up rates, maximum allowable withdrawals, investment restrictions, etc.
Finally, the A (accumulation) and B (benefit) silos sit side-by-side, within the same general policy. So far a "cheap" VA (tax-sheltered growth) lives next door to an "expensive" VA (with a living benefit.)
But here is where it gets interesting. First, AXA Equitable allows the policyholder to move money from silo A to silo B whenever you or your client want and see fit. The transaction is seamless. So, if your A silo has done well — markets are up — you can move some of your gains into the B silo with its associated guarantees. It's like taking money off the table after a few good runs in your favor. This sort of transfer (partial 1035 exchange) isn't easy to do if you have two separate policies and especially if they are with different companies.
Secondly, the all-important benefit base "roll-up" rate — instead of being fixed forever at the time of purchase — is linked to the yield of the 10-year U.S. Treasury bond. On each settlement date it is fixed at the average rate during the past month plus an additional 1 percent. So, in contrast to the nominal 4 percent, 5 percent or even 6 percent that you might see credited to a benefit base (or guaranteed withdrawal) in a competitor's product, this rate will increase as market interest rates move up. In January 2010 they were offering 5 percent.
So, herein is the link or connection to inflation protection: If inflation expectations increase, so will the yield curve as proxied by the 10-year U.S. Treasury rate. Ergo, the roll-up rate will increase as well. Convoluted, perhaps…but effective. Moreover, for those of us who worry that the U.S. Government has an incentive to manipulate the calculation of the Consumer Price Index (CPI) downwards (please don't get me started) then a market-based adjustment offers some relief. You can't fool the bond market!
Now, I know that I am playing a bit loose with the description of this product. But this is as accurate as you can get on a first pass with approximately 1,752 words at my disposal. If you want the details, 1,752 pages await you.
