Introduction | Regulation | Annuity Rates |
Crediting Methods | History |
Fixed Annuities have an interest rate that is declared annually by the insurance
company. Multi-Year Guaranteed Annuities are like traditional Fixed
Annuities in that their interest rate is also declared by the insurance company.
However, Multi-Year Guaranteed Annuities’ interest rates are guaranteed for longer
than a one-year period. Guarantee periods on these annuities may range anywhere
from two to ten years.
Most Indexed Annuities today offer some form of fixed bucket strategy.
This would be a premium allocation option that receives credited interest in a manner
like that of a traditional Fixed Annuity. A declared rate is set for the fixed strategy,
and the annuity purchaser receives that rate if the annuity is held for the strategy
term (usually one year). Most Variable Annuities also offer a fixed bucket for clients
desiring a more conservative allocation mix. However, the line between Fixed, Indexed,
and Variable is drawn when it comes to differentiating how the non-guaranteed rates
are credited on these products.
Remember that with a Fixed Annuity, the insurance company declares a stated
credited rate for the non-guaranteed, current interest rate. A Variable
Annuity is very different in that the insurance company does not limit the potential
gains of the product; the client is investing directly in the market. Therefore,
a Variable Annuity purchaser may realize a gain of 18.00% if the fund they invested
in grows that much over a one-year period. With an Indexed Annuity, the insurance
company purchases options based on an external index’s performance, and the annuity
purchaser receives non-guaranteed, current interest that is limited in growth (based
on the option price).
Like the handful of crediting methods that can be confusing on some Indexed
Annuity products, the pricing levers that are used to determine the actual rate
credited can perplex others. There are three simple pricing levers
that are used when calculating potential interest on Indexed products:
Participation Rate—the percentage of positive
index movement in the external index that will be used in the crediting calculation
on an indexed product. (Note that a product with a Participation Rate may also be
subject to a Cap and/or Spread.)
Cap—the maximum interest rate that will be used
in the crediting calculation on an indexed product. (Note that a product with a
Cap may also be subject to a Participation Rate and/or Spread.)
Asset Fee/Spread—a deduction that comes off of
the positive index growth at the end of the index term in the crediting calculation
on an indexed product. (Note that a product with a Spread may also be subject to
a Participation Rate and/or Cap.)
Now that all of the disclaimers are aside, it can simply be said that most indexed
strategies that have 100% Participation utilize a Cap as the pricing lever.
In turn, most indexed strategies that have less than 100% Participation utilize
the Participation Rate as the pricing lever. There are also trends among indexed
crediting methods; averaging strategies tend not to have Caps more often than others,
and utilize Spreads more frequently. Annual point-to-point methods generally utilize
the Participation Rate or a Cap to limit potential indexed gains.
It is really quite simple when you break it down. For example,
on an Indexed Annuity over a one-year term where the S&P 500® has experienced an
increase of 20%:
- A Participation Rate of 55% would afford the client
potential indexed crediting of 11% (20% x 55% = 11%)
- A Cap of 8% would pass on potential gains of 8% to
the client (20% limited by an 8% cap)
- A Spread of 3.00% would leave the client with 17% interest
credited (20% - 3% = 17%)
Typically, an Indexed Annuity utilizes only one pricing lever on each strategy.
This means that when the insurance company changes the annuity’s rates, or the contract comes upon the
policy renewal, only the one pricing lever will be adjusted upward or downward.
However, an insurance company may reserve the right to adjust more than one pricing
lever in the event of declining rates. This does not necessarily mean that they
alter more than one pricing lever by practice. Generally, the less “moving parts,”
the easier the product is to convey to both the salesperson and the purchaser. For
that purpose, insurance companies try to limit the number of variables needed to
describe each crediting method. It is important to note that there are a handful
of products that use a moving part that is unique specifically to that product.
These are just other pricing levers where potential interest crediting has been
Indexed Annuities are also like Fixed Annuities in that they have minimum guarantees
to protect the purchaser from a downturn in current credited rates or Caps, etc.
Fixed and Multi-Year Guaranteed Annuities generally offer a minimum guaranteed floor
of 1.00% or more. Indexed Annuities offer a guaranteed floor of no less than 0.00%.
In addition, Indexed Annuities have a secondary guarantee that is payable in the
event of death, surrender, or if the external index does not perform. This secondary
guarantee is referred to as a Minimum Guaranteed Surrender Value (MGSV); it credits
a rate of interest between 1% and 3% on a percentage of the premiums paid in to
MGSVs can be stated in two methods: as Account Value guarantees, which must deduct
the surrender charges from the calculation, or as Surrender Value guarantees, which
are net of the surrender charges on the contract. An Indexed Annuity
with a first-year surrender charge of 10%, and an Account Value guarantee of 100%
@ 3% may be equivalent to the Surrender Value guarantee of a second product with
an MGSV of 90% @ 3%. (100% - 10% surrender charge = 90%).
When Indexed Annuities first emerged in 1997, their MGSVs were often based on
90% of premium, credited at 3% interest; i.e. 90% @ 3%. However, when
market conditions began declining and insurance companies weren’t able to offer
indexed products with these guarantees, we saw MGSVs drop as low as 65% @ 3% for
first-year premiums. It is important to note that annuity MGSVs most adhere to state
Standard Non-Forfeiture Laws (SNFL), which are enforced by the state insurance departments.
Today, more than three quarters of Indexed Annuity products have MGSVs that are
based on 87.5% of premiums, and credited interest is based on the 5-year Constant
Maturity Treasury rate (a rate between 1 – 3%). Today, annuity MGSVs cannot be less than 87.5% of premiums paid, credited at 1% interest.
Another very important rate to consider when evaluating which product to purchase,
whether Fixed or Indexed, is the renewal rates. These are the new interest
crediting rates, Caps, Participation Rates, etc. that are declared at the end of
the interest crediting term (typically one year). So many products today are copied
off of another popular insurance company’s product. If you want to evaluate the annuity beyond
the contractual features, and the service and integrity of the insurance company;
renewal rates should be taken into consideration. That being said, renewal rates
are one of the most difficult pieces of information to get your hands on. A scant
number of insurance companies feel that their renewal rates are an integral part
of their sales story, and actually publish marketing pieces publishing these rates.
This gives the potential annuity purchaser an idea of what the insurance company may do to
the future rates on the product that they purchase, based on past renewal rate histories.
If you do not have access to renewal rates, it may be helpful to research Fixed
and Multi-Year Guaranteed Annuities’ minimum guarantees and an Indexed Annuity’s
minimum Participation Rates and Caps, as well as their maximum Spreads.
These can be an indicator of just how low the insurance company could reduce the
rates on the product after it is purchased. Note however, that due to policy filing
efficiencies, many insurance companies opt for unusually low rate guarantees, Participation
Rates and Caps, and rather high Spreads. (This avoids the cost of potentially re-filing
the product in the event that market conditions decline, forcing the insurer to
dramatically lower rates.) Often, salespeople are surprised when they see the maximums
and minimums on the pricing levers for Indexed Annuities in particular. From a marketing
standpoint, it is important to remember that the insurance companies would most
likely discontinue selling the product(s) before rates were ever reduced to these