Financing Annuity Upsides
March 15, 2017 by Mike Janky
Back in the spring of 1995, a couple of insurance companies designed a new breed of fixed annuity where the interest credited was linked to the S&P 500 index.Fast forward to 2017 and indexed annuities have become a dominant force in the annuity world. What makes these products so attractive?
New Frontier
When these products where first developed, there were very few indexes that were used. The first wave of indexed annuities linked the returns to the S&P 500. Well like anything, there always seems to be a better way to build a mouse trap. Along came annuity products that linked the returns to the Dow Jones. After that we saw indexes being used like the Russell 2000, gold and bond indexes.
A few years ago we began to see indexes created specifically for the carriers. Many of these indexes are a combination of stocks, bonds, real estate, commodities and cash. They are also using volatility-controlled strategies to help with the overall volatility of these indexes.
Why go to all these extravagant efforts to create new indexes? Well there have been a number of issues that have forced these innovations. The first one is the low interest rate environment that we have been in for what seems like forever. When interest rates are low, it puts a lot of pressure on the carriers to design products that have good upside potential for their indexed annuity portfolio. The old saying of only 100 pennies in a dollar rings true here. At the end of the day, these products have to be designed to still be profitable for the carriers.
When interest rates are so low, there isn’t a lot left for the carriers to use to cover the upside potential of an index using call options. Also keep in mind that the more volatility there is associated with the index, the more expensive the options are. That combination over the last decade has been a pretty tough one. If there is very limited upside in the annuity product, then a client and agent are probably better served purchasing a MYGA at 2.5% and being content with that.
The good news is that with the new indexing strategies that have evolved and with the volatility controlled mechanisms on these indexes, the price of the options on these designs are much less therefore the participation rates can be ones that are higher and sometimes without any caps on the upside. In order for indexed annuities to work as they were originally designed, they have to have the opportunity to earn a better rate of return than a traditional fixed or MYGA annuity.
These new designed indexes have helped keep that upside potential as a possibility. Other carries have designed products that have a built-in fee that is used to help with the cost of purchasing the options for the contract. These products offer some uncapped indexing options along with capped options that are much higher than traditional indexed annuities.
Paying a small fee for a much better upside potential makes a lot of sense for those clients that are looking for a better rate than a traditional fixed rate annuity but are not willing to take the risk associated with being in the stock market.
Another often forgotten benefit of these products is that they have a minimum guaranteed interest rate that is credited to the policy. So if the index the annuity is linked to does not perform and the client is paying a fee each year for the better upside potential, that minimum guarantee will be there to make sure the client receives all their money back and interest at the end of the contract. For a lot of people, this is a very fare tradeoff.
Income riders
Income riders have been around for some time now and up until recently, they really haven’t benefited from having the index feature on the annuity.
The idea of a guaranteed increase in the income value for 10 to 20 years without regard to what the indexes do has been the primary focus of carriers, agents and clients. The question on these indexed annuities with income riders has always been, if the guaranteed roll-up is 6%, does it really matter what the indexing strategies are? For about 99% of the time, the answer is no.
Most carriers allow the client to use the greater of the account value or the income value in order to determine what the guaranteed income will be. So if you have a 6% guaranteed roll-up and you are not going to turn the income on for 5 or more years, it’s hard to imagine an indexed strategy that will create a higher account value than what the income benefit value is. It would be impossible if you were using a product that had a cap of lower than 6%. In addition, even if the cap were at say 7%, the odds of the index hitting 7% or higher 5 years in a row are slim, at best. Some carriers over the years have put a big premium bonus on the income rider side and the indexing strategies have been very limited with the caps and participation rates.
In these annuities, it really doesn’t matter that the index strategies have very little growth potential because the client is only concerned about the income value and turning on the income right away or in a few short years. This works well for those clients that know they want income to begin very soon after the policy is issued. But what about those clients in their 50’s that have 5 to 10 years before they turn the income on. For these clients, the high bonus, no real growth products fail to keep up. Some carriers have understood this challenge and have created income riders that allow the client to receive a guaranteed roll-up on their income value and also receive the indexed credits as well.
What’s important here is that the client actually has some growth potential in the indexing strategies so there can be years where there is a fair amount of interest credited to both the account value and income benefit base value. Having an indexed strategy with a strong participation rate and no cap is key. Some of these products also allow the income to begin and the roll up to continue for a set number of years.
This is important for those clients who want to start taking income early in retirement, but who are also concerned about having their income increase in order to keep up with inflation. Income riders can be a wonderful benefit on these indexed annuities if one pays attention to the real benefits and what is most important to the client.
LTC benefits
Another very important area of these products is the ability to increase the payouts if the policyholder comes to need long-term care. Unfortunately, the long-term care insurance industry has continued to both lose carriers offering plans while having to increase premiums for these plans. Over the last 20 years, many carriers have completed exited the long term care market and the ones that continue to stay, have had to increase dramatically their premiums to offset both the amount of claims paid and the actuarially underpricing of these products.
With the indexed annuities, some carriers have realized that this could be a top priority for a client to have enough income to help offset the costs of care. In these products, the carriers have put riders on the annuities to increase the amount of income available should a policyholder not be able to perform the activities of daily living and need extra income to pay for either a long term care facility or some type of assisted living. This could be a big benefit again for the right situation.
Bottom Line
As with most insurance products, as time passes and the needs of the purchaser continues to be redefined and modified, so too do the products. Insurance companies over the years have continued to advance along with the policy holder. There are many different designs of indexed annuities out there and most of them offer real value and benefits to the policy holders. It’s a matter of understanding your client and what they are trying to accomplish at the end of the day. Is it more income, better growth potential, best guarantees, etc.
The key in this is communicating with your client and understanding what is important to them and then being knowledgeable about what products can and can’t do. Our industry is one of the greatest in the world at helping people solve problems with using products specifically for that identified problem. Fact finding and really listening to what clients want is of utmost importance before any product or solutions can be recommended. The better job we do up front, the better we can match up solutions and have happy clients. ◊
Mr. Janky is President of Forward Strategies Insurance Brokerage, LLC., an Oro Valley, AZ based wholesaler specializing in the equity-indexed annuity concept. Visit fsib2000.com.
