Indexed Annuities: Past, Present and Future
November 24, 2015 by Mike Janky
From the bull run of the ‘lost decade’ to the gyrations of 2015, the FIA continues to adapt
Indexed annuities have been around now for two decades. We have watched these products evolve from a relatively simple design from two carriers in 1995 to now hundreds of carriers offering an array of indexing strategies including new indexes designed exclusively for a carrier.
We have seen dramatic changes on these products especially over the last 10 years with carriers adding all sorts of twists to their products. Whether it’s a new index itself, indexing methodology or innovative living benefits, carriers have been designing new products to capture some of the trillions of dollars that the baby boomers have saved over their working careers and now looking to put those dollars to work during their retirement.
The main focus of these products is to have some growth potential along with the safety of principal that has always been an attractive benefit to the policyholder and also for many, to provide income one cannot outlive. Let’s take a look at the past, present and future of these products.
The Past
Beginning in the spring of 1995, two carriers had released their indexed annuities to the insurance industry with those carriers being Keyport and Lincoln Benefit. These designs were pretty straight forward with few moving parts. Now back in the 90’s we had the S&P 500 Index moving along pretty smoothly.
Having the interest credited on these contracts determined in part by the index, these products did relatively well providing good upside potential while protecting the principal. I remember a securities rep at the time asking me, “Why would I give up some of the upside potential of being in the market just to protect my principal?” Well the next decade would provide an excellent answer to that very question!
The lost decade, as some called it, began with a very disappointing year in 2000; just when everyone was thinking all you had to do was throw your money in the market and you should get about a 20 percent return regardless of whether you were in large cap, small cap, value or growth. It really didn’t seem to matter, the market was heading north at a neck-breaking pace and you were either on-board or missing the run!!
Beginning in January, the S&P was just a couple of points shy of 1,500. In the following 12 months, we watched the S&P drop to 1,160 equating a 22% decrease. People figured we were due for a minor correction in the market so the prognosis was “it’s just part of the game”. The next year was relatively flat and investors positioned themselves for a big run in 2002. Well unfortunately 2002 turned out to be another big decrease in the S&P with another negative year, except this year was even worse than 2000. The S&P was down approximately 26%. In just three years the S&P had decreased nearly 50%. Well what about those indexed annuities? In those contracts, the value had not decreased one cent.
This provided an excellent answer to those agents and reps who questioned why use an index annuity and give up all the upside. Over the next 6 years, the S&P was on a rollercoaster ride with the index ending up in 2009 about where it started in 2003. In January 2013, the S&P was still below what it had started at back in January of 2000. Now for those that were in indexed annuities beginning in 2000 through January 2013, they saw the index post positive gains for 8 of those years. So while they were locking in gains that could never be lost due to market decreased in the positive years, they were also getting new starting points each year the S&P lost ground. Many policy holders enjoyed very healthy returns during this time.
In 2009, we began what would be known as the longest bull-run in the history of the market. The S&P started just under 800 and over the next 6 years would climb over 2,000. Unfortunately even though this was the longest bull-run in history, it was also the least participated bull-run by the average investor. Many people were out of the market due to having their fill of volatility that the previous decade had produced. Those that had the indexed annuities would enjoy good returns relative to alternatives like CD’s and other guaranteed options while not worrying about the swings the market generates.
Present
So here were are in the fall of 2015 and have seen enormous gyrations over the first 9 months of the year. It’s not uncommon to see swings of 3% or more in a day! People who have recently retired are asking themselves “Can I really handle all this stress of being in the market and watching my accounts having huge swings from one day to the next? What happens as I start using my money for income and the market collapse?” Financial planning is so much more than just returns. Like most things, emotions play a huge part. Indexed annuities can offer a policyholder the ability to generate solid returns without the risk of losing not only principal but the interest that has been credited during the contract years the indexes have provided gains. Another big attraction of indexed annuities today is the income rider story.
Insurance companies have created products that will allow a person to create an account that will guarantee a certain amount of growth and then when a person is ready to turn the income on, they can guarantee an income stream that will never be outlived. There are currently many different riders available today for a client to select from. Some of these products are designed to have the income turned on right away and others are designed to give some guaranteed growth on the income value side so that when down the road the client is ready to start their income, they know their account will be there and also know how much income it can generate.
Some carries are providing a twist on the income rider that can provide a base growth rate and then on top of that, provide some additional growth that can be earned by what the indexes that they are linked to return. These income riders have been the saving grace of many insurance companies as billions of dollars are flowing into these policies for the main benefit of wanting to guarantee an income.
Future
As indexed annuities have tried to evolve, they have encountered some heavy headwinds in the form of low interest rates. The carriers have had to face the challenge of trying to provide growth and upside potential while still having to guarantee the principal and minimum interest in these contracts. A relatively new design of indexed annuities have allowed the policyholder to have much greater upside potential in the form of higher caps and participation rates by having the policyholder help pay for the options on the index in the form of an annual fee.
By taking a small percentage as a fee each year, the policyholder is helping the carrier have more money to go to the options market with and therefore, more upside potential. The client still has their principal guaranteed and usually some form of minimum interest on top of that. Most people, including myself believed that interest rates would be higher today than they currently are.
The Fed has indicated it will be raising rates but as 2015 has unfolded, it seems like there is always a reason for deferring that increase until the next Fed meeting and as we enter the fall, it may not be until the end of 2015 or even possibly 2016 that rates begin to rise and the increases look like they will be modest at best.
With that said, carriers will continue to have to be creative with new strategies and riders to make these products attractive and marketable. For the past 20 years, indexed annuities have adapted to what the consumer is looking for which is upside potential, guaranteed principal and income options. As more and more people retire without pensions and are looking for income guarantees, we should see increased premium flowing into these products. Please keep in mind that these products are not designed for the client that wants all the upside potential of being in the market but as the last few weeks in August so painfully displayed, not everyone has the stomach for that kind of volatility.
By Mike Janky
Mr. Janky,CLU,ChFC,CFS,RHU,CAS,CASL,RICP, RIA is President of Forward Strategies Insurance Brokerage, LLC., a Tucson, Az. Annuity marketing firm Connect with him by e-mail: mikejanky@fsib2000.com
