Eyeing the Benefits of Interest-rate Benchmark Feature for Fixed Index Annuities
December 9, 2011 by Kenneth L. Brown
December 8, 2011
Today’s
historically low interest rates may be a boon to mortgage-seekers and other
borrowers, but they can be a curse for market-weary consumers seeking interest
income or long-term growth options. As of fall of 2011, traditional savings
accounts are bearing negligible interest, and money market accounts aren’t
faring much better. Even certificates of deposit (CDs), long the fallback
instrument for security-conscious consumers, are offering uninspiring rates
even for longer-duration commitments.
These
low interest rates and other factors have put a dent in sales of traditional
fixed annuities. According to LIMRA, 2nd quarter 2011 fixed annuity sales were
$21.5 billion, down significantly from their most recent peak of $36.7 billion
in 1st quarter 2009. Over that same time period, sales of fixed index annuities
have fared better, and in fact have risen slightly—$8.1 billion in sales in the
2nd quarter 2011 compared to $7.2 billion in the 1st quarter 2009.
While
many factors impact these sales numbers, we can deduce that the relative
success of fixed index annuities has to do with their flexibility and potential
for additional interest upside. These annuities give consumers a chance to
better many standard fixed-income alternatives by providing interest-crediting
potential that’s linked in part to the performance of one or more market
indexes or benchmarks.
In
essence, contract owners can direct part or all of the annuity’s value to the
index, while retaining the ability to use the fixed-interest strategy. If the
index rises, the consumer gets a credit (subject to limits specified in the
contract). And if it drops, the consumer’s principal is still preserved. At the
contract anniversary date, the consumer can re-allocate among available
strategies.
Fear
of locking in
Despite
the attraction of fixed-indexed annuity products, many producers and consumers
still are hesitant to put money into fixed products when interest rates seem to
have nowhere to go but up. Consumers instead are being encouraged to park their
money in CDs or other short-term instruments, enduring the paltry interest
gains in order to maintain liquidity.
Insurers
are well aware of how low interest rates create a park-and-wait mentality. And
they are innovating quickly to avail wary buyers, and the producers who serve
them, of new options. For example, several carriers have introduced
interest-rate-based crediting strategies that use a point on a published “swap
curve” as the benchmark rate. As another option, ING USA Annuity and Life
Insurance Company recently introduced a feature that allows fixed index annuity
owners to capitalize on, rather than be undermined by, potential increases in
interest rates.
This
new feature, available only on certain fixed-indexed annuities, bases interest
credited on an increase, if any, in the 3-month London Inter-Bank Offer Rate (LIBOR),
the interest rate banks use to lend money to each other. If this benchmark
rises from one annuity anniversary to the next, then so does the interest
credited. This interest rate benchmark feature offers a few advantages:
● No
matter what equity markets do in a given year, if interest rates rise while the
annuity’s balance is allocated to the interest rate benchmark strategy, your
clients gain the rewards.
●
There now are three options within the annuity—guaranteed fixed rate, equity
index and interest rate benchmark—from which to choose based upon the client’s
needs. In essence, there is the potential to execute a diversification strategy
within the product.
●
Clients can use the feature opportunistically, taking advantage of the interest
rate benchmark strategy in certain years, but not in others, depending on their
outlook.
● If
the benchmark rate drops during a particular contract year, while the feature
will provide zero credit, the client’s principal is protected.
As
with other indexes in fixed index annuities, the interest rate floor resets
every contract anniversary date. So regardless of the previous year’s ups or
downs, the client has a new opportunity for pursuing potential interest
benchmark- crediting in the new contract year.
Clarifying
the Facts
Many
consumers are wary of annuities, which can make it difficult for producers to
start a discussion about the relative merits of these products. Here are a few
points to reinforce with clients when explaining how a fixed-indexed annuity
works:
●
Limits on market upside—Some consumers imagine that limits on index
crediting are in place so that, if the market or interest rate outperforms, the
insurer can keep the difference. But, the reality is that insurers purchase
hedges to cover the cost of index credits paid to consumers. There is no
“windfall” effect when markets perform well.
● Fees
and charges—Similarly, some prospective fixed annuity
buyers imagine that a range of fees and charges are hidden in the product. The
reality is that there are no direct fees in most standard fixed annuities. The
only fees that come into play are to cover value-added riders, such as those
that guarantee a certain level of retirement income, or that provide an
enhanced death benefit.
●
Surrender charges—Annuities are designed for the long-term,
particularly for people who do not expect to make withdrawals for at least 10
years. As such annuity contracts have surrender charge schedules, which are
applicable if annuity owners make withdrawals before that time.
However,
many insurers allow withdrawals of up to 10% of the annuity’s value each year
without penalty.
Clients
and producers may want to consider annuities that comply with the so-called
10/10 rule, which limits surrender charges to 10 years and 10 percent in the
first year of the annuity. Surrender charges diminish over time, going away
entirely after 10 years for each premium payment.
Out of
the Parking Lot
Consumers
who park their long-term money in short-term savings vehicles may be missing
important years to potentially build up nest eggs for their retirement years.
Low interest rates and fears that rates will rise soon can sideline many
people, but new interest-rate benchmark features on certain fixed index
annuities can offer an appealing strategy for countering these fears.
Producers
can use this new feature as a way to start discussions with clients who are
looking for ways out of the “parking lot” and into more appropriate savings
strategies for their long-term goals. Such discussions, including an honest and
balanced explanation of the role annuities can play in a retirement plan, may
help to get these stalled assets on the highway again.
Kenneth
L. Brown is the vice president of sales development & strategic support for
the annuity and asset sales business of ING U.S. Insurance, Des Moines, Iowa.
