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Consumers wary
of future fixed annuity performance
Can interest-rate benchmark features offer a viable solution?
By Kenneth L. Brown
Mr. Brown is the vice president of Sales Development & Strategic Support for ING U.S. Insurance's annuity and asset sales business, overseeing marketing, product development, regional wholesaling, sales training and development, and wholesale operations for the company's annuity business.
Interest rates continue to bob around at historically low levels. In early October 2011, the 3-month London Interbank Offered Rate (LIBOR) rate, which underpins a range of interest-sensitive consumer products such as mortgages, was below 0.4%. This has made home refinancing the topic of headline news- but the story surrounding interest-based financial instruments has been a disappointing one.
Consumers looking for interest income in this environment are short on options. Traditional savings accounts today provide only negligible interest, with money market accounts being only slightly more generous. And while certificates of deposit (CDs) are still the go-to instrument for many consumers seeking security for their money, the rates even for longer-duration commitments have been very low.
Not surprisingly, sales of traditional fixed annuities have been severely affected by these low interest rates and other factors. Second-quarter 2011 fixed annuity sales were $21.5 billion, according to LIMRA, which is a big drop from their most recent peak of $36.7 billion in the first quarter of 2009. Fixed index annuities have fared better over that same period, rising slightly: Sales in the second quarter of 2011 were $8.1 billion, compared to $7.2 billion in the first quarter of 2009, LIMRA said.
The durability of fixed index annuities clearly has to do with their interest upside potential and greater degree of flexibility than traditional fixed annuities. Consumers with fixed-indexed annuities have the opportunity for interest-crediting potential linked to the performance of one or more market indexes or benchmarks. This lets the consumer direct all or part of the annuity's value to the index, while still being able to use the fixed-interest strategy. The consumer gets a credit if the index rises (subject to their contract's specified limits), and their principal is protected if the index drops. They also have the option to re-allocate between the fixed and index components, but only on the contract's anniversary date.
What if interest rates rise?
With interest rates so low, however, many producers and consumers are wary of fixed annuity products. After all, it seems as if interest rates have nowhere to go but up. As a result, even though fixed index annuities offer some attractive flexibility, many consumers are sitting on the sidelines with their cash, waiting out the current uncertainty in short-term instruments such as CDs.
Acutely aware of this sidelining of consumer cash, insurers are innovating rapidly to give consumers and producers additional options to deal with the interest-rate uncertainty. For example, several carriers have introduced interest-rate-based crediting strategies that use a point on a published 'swap curve' as the benchmark rate. For its part, ING USA Annuity and Life Insurance Company has developed a new feature that bases credits on an increase, if any, in the 3-month LIBOR. If this benchmark rises from one annuity anniversary to the next, so does the interest credited. This interest rate benchmark feature, which is available only on some of the company's fixed index annuities, works like this:
- 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, the client gets a credit.
- Producer and client can execute a diversification strategy within the product itself, adapting the product by balancing the effects of the annuity's three options, guaranteed rate, equity index and interest rate benchmark.
- 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 will be protected.
Since the interest rate floor resets on every contract anniversary date, just as annuity index floors do, the client has the potential for new credits based on interest rate increases, regardless of the previous year's ups or downs.
Consumers still wary of annuities
As many producers know, consumers can be skeptical of annuities across the board, even when the merits of some varieties may be a good fit for the client's need. When launching a discussion, consider that the client may have certain misconceptions about annuities that will need to be addressed. Here are a few common ones:
- Misconception #1: Fixed annuities have a lot of hidden fees and charges.
Some consumers think that fixed annuities have a range of fees and charges, many of them large and hidden away. Yet, in reality, there are no front-end charges in the base fixed annuity. The only fees deducted from the contract's value, which producers are obligated to explain, are to cover value-added riders, such as those related to guaranteed retirement income features or enhanced death benefits.
- Misconception #2: Crediting limits are just designed to increase insurers' profits.
Some consumers believe that limits on market upside are put in place so that insurers can 'keep the difference' if the market or interest rate outperforms. Yet, in reality, insurers purchase hedges to cover the cost of index credits paid to consumers. There is no 'windfall' effect.
- Misconception #3: Surrender charges are unreasonably high.
Annuities by nature 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. Many annuities comply with the so-called 10/10 rule, which limits surrender charges to 10 years and to 10 percent in the first year of the annuity. Producers and consumers also should know that surrender charges diminish over time, vanishing entirely after 10 years for each premium payment. To give consumers some access to their contract's funds, many insurers allow withdrawal of up to 10 percent of the annuity's value each year without penalty.
Off the sidelines, into the game
Consumers who have sidelined their long-term money in short-term instruments run the risk of missing out on key opportunities for growth in the coming years, which could reduce their prospects for a secure retirement. While fears that rates could rise soon are understandable, producers can provide guidance and information about key innovations in fixed index annuities that can help to address these fears.
By introducing clients to new features such as interest-rate benchmark crediting, producers can launch a dialogue with their clients about the potential value of fixed index annuities in an uncertain market and interest rate environment. Such discussions can help these clients come off the sidelines and get back into the game, taking advantage of financial strategies that may give them greater momentum toward their long-term goals.