When I began to urge advisors to consider incorporating fixed indexed annuities into their practice back in 2006, I highlighted the importance of keeping the story simple. Specifically, I stressed the need to be able to answer the question: “How did the insurance company calculate the interest they credited to my policy?” To answer this question, I offered a simple solution – stick with one-year cap strategies on the S&P 500 (SPX). Why needlessly complicate things?
Increasingly, advisors are exploring other options within the indexed annuity space. According to Wink’s Sales and Market Report, in the third quarter of 2022, only 44% of fixed indexed annuity sales were in a cap rate strategy tied to the S&P 500 Index.1 In other words, more than half of all sales were tied to indices other than the S&P 500.
In addition, the Life Insurance Marketing and Research Association (LIMRA) noted in its 2021 Fixed Indexed Annuity Sales and Assets report that only 16% of total sales were allocated solely to a cap rate strategy, while participation rate strategies captured 39%. Another 22% of total sales were allocated to a combination of participation and cap rate strategies.2
Obviously, there are a lot of advisors today who are not following my 2006 guidance. Is it time for me to follow their lead? Let’s take a look at a sample of fixed indexed annuities on the market and see.
Using SIMON from iCapital’s Annuities Platform, we can view the hypothetical performance metrics across one-year indexed terms between April 18, 1957 and March 10, 2023. The best return in any of those one-year indexed terms would have been 11%, or the cap. Since a fixed indexed annuity without a fee cannot have a negative return, the worst return would have been 0%. The average return across all of the observed one-year indexed terms would have been 6.64%. It is also worth noting that 72.31% of the observed one-year indexed terms would have resulted in a positive return, while 27.69% would have resulted in a 0% return.
Since its inception in 1957, the S&P 500 has an average annual return of 10.67%.3 If an indexed annuity policyholder had a 11% cap rate on the S&P 500 for every possible one-year period, the average return over time would have been 6.64%. In a world where protection is a primary goal for many investors, it’s easy to understand the attraction of an expected 6.64% return with full protection of principal. No one should be surprised, therefore, that LIMRA reported that indexed annuity sales hit record levels in the third quarter of last year, and then broke that record in the fourth quarter.4
Despite these expected results, I have to admit that it’s time for me to join those advisors who have already moved beyond the simple one-year point-to-point strategies on the S&P 500. My message today is if you have not considered some volatility-controlled indices, the time to do so is now. The rapid increase in interest rates over the course of 2022 has led to a corresponding increase in the general accounts of insurance companies, enabling them allocate more funds to the “options budget” of the indexed annuity and offer more attractive rates across the board.5
Volatility-controlled indices also have another important advantage. Since these indices are designed to manage volatility within the index, hedging is much less costly than hedging the S&P 500, according to Barclays’ Index Pricing Model.6 In other words, the insurance company can buy more options with less money, given the lower cost of the options. To better understand this concept, compare the cost of buying options on a relatively stable stock, like IBM, compared with a highly volatile stock, such as Tesla – as volatility increases, the prices of options tend to rise.
Participation rates on these indices have become very competitive relative to cap rates. As an example, consider an indexed annuity from Forethought Life Insurance Company, a Global Atlantic Company. It offers a 195% participation rate on a one-year point-to-point on the PIMCO Balanced Index (PIMBAL). While this particular index doesn’t have as much history as the S&P 500, we can observe returns that would have been generated by a 195% participation rate back to the beginning of the century. The results are in Exhibit 2 below.
Using SIMON from iCapital’s Annuities Platform, we can view the hypothetical performance metrics across one-year indexed terms between December 31, 2001 and March 10, 2023. The best return in any of those one-year indexed terms would have been 35.33%. Since a fixed indexed annuity without a fee cannot have a negative return, the worst return would have been 0%. The average return across all of the observed one-year indexed terms would have been 9.28%. It is also worth noting that 85.07% of the observed one-year indexed terms would have resulted in a positive return, while 14.93% would have resulted in a 0% return.
Historically, the current pricing on this strategy would have provided an average annual return of 9.28%, much higher than the 6.64% generated from the S&P 500 strategy with the 11% cap.7 In addition, this strategy would have provided significantly more positive one- year returns.
Some carriers now offer the option of paying an annual fee of 1.0–1.5% in order to add to the options budget and, therefore, increase the participation rate even further. For example, consider a fixed indexed annuity from Eagle Life Insurance Company offering 140% participation rate on a one-year point-to-point strategy on the Invesco Dynamic Growth Index (IIDGROW). In exchange for paying a 1.25% annual fee, the participation rate goes up to 220%. Advisors should keep in mind that this is a true fee, therefore, if the index does not increase in price by at least 1.25% during the year, the policyholder would get a negative return of up to … 1.25%. “Zero will no longer be your hero.”
How would these options stack up? Let’s review the data from SIMON from iCapital’s Annuities Platform.
In reviewing the performance metrics, we can observe that paying the annual 1.25% fee would have led to over a 4% greater annual average return per year. However, the trade-off is that in 12.5% of the observed one-year indexed terms, the policyholder would have suffered a 1.25% loss. Is it worth the trade-off? The answer will depend on the individual client’s investment objectives and risk profile. However, it is definitely worth considering.
SIMON from iCapital gives you the data you need to weigh the pros and cons of each option.
Regardless, of whether you stick with the simple S&P strategy or venture into one of the many volatility- controlled reference indices, the current interest rate environment provides an opportunity for investors to lock in attractive fixed indexed annuity rates while managing downside risk.
Annuities and insurance services provided by SIMON Annuities and Insurance Services LLC, an affiliate of iCapital, Inc. Structured investment and certain annuities products and services may be offered through SIMON Markets LLC (“SIMON”). SIMON is a registered broker/dealer, member FINRA and SIPC, and is affiliated with iCapital, Inc. and its subsidiaries. Please see the disclaimer at the end of this document for more information about these entities.
1. Source: Wink’s Sales & Market Report Q3 2022, as of Nov. 22, 2022.
2. Source: LIMRA, “A Deeper Dive: 2021 Fixed Indexed Annuity Sales and Assets,” 2022.
3. Source: Seeking Alpha, as of Jan. 2, 2023.
4. Source: LIMRA, “2022 U.S. Retail Annuity Sales Shatter Annual Sales Records Set in 2008,” Jan. 26, 2023. 5. Source: Financial Advisor, Ben Mattlin, “How Rising Interest Rates Affect Annuities,” March 1, 2022.
6. Source: Barclays’ Index Pricing Model, as of Jan. 2023.
7. Source: SIMON from iCapital, as of March 10, 2023.
IMPORTANT INFORMATION — DISCLAIMER
ANNUITIES ARE CONSIDERED COMPLEX PRODUCTS AND MAY NOT BE SUITABLE FOR ALL INVESTORS.
This is not intended to be an offer or solicitation to purchase or sell any security or to employ a specific investment strategy. This material is intended as general background information, for educational purposes only, and should not be used as a primary basis to make a decision to purchase an annuity contract. This material is being provided for informational purposes only and does not take into account any specific investment objectives or financial situation of any investor. The information is not intended as investment advice and is not a recommendation about managing or investing retirement savings. Actual annuity contracts may differ materially from the general overview provided.
Prior to making any decision with respect to an annuity contract, purchasers must review, as applicable, the offering document, the disclosure document, and the buyer’s guide which contain detailed and additional information about the annuity. Any annuity contract is subject in its entirety is to the terms and conditions imposed by the carrier under the contract. Withdrawals or surrenders may be subject to surrender charges, and/or market value adjustments, which can reduce the owner’s contract value or the actual withdrawal amount received. Withdrawals and distributions of taxable amounts are subject to ordinary income tax and, if made prior to age 591⁄2, may be subject to an additional 10% federal income tax penalty. Annuities are not FDIC-insured. All references to guarantees arising under an annuity contract are subject to the financial strength and claims-paying ability of the carrier. This does not constitute legal, accounting or tax advice, and the recipient should consult with his or her legal, accounting or tax adviser regarding the instruments described in this material.
This material may not, without the prior written consent of iCapital, Inc. or an iCapital, Inc. subsidiary, be (i) copied, photocopied, or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorized agent of the recipient. iCapital, Inc. and its subsidiaries shall have no liability, contingent or otherwise, to the user or to third parties, for the quality, accuracy, timeliness, continued availability, or completeness or to update any data contained in this material nor for any special, indirect, incidental or consequential damages which may be incurred or experienced because of the use of the data made available herein, even if iCapital, Inc. or any of its subsidiaries has been advised of the possibility of such damages. This material was not prepared with a view to public disclosure or to conform with any disclosure standards under any state, federal or international securities laws or other laws, rules or regulations, and iCapital, Inc. and its subsidiaries do not take any responsibility for the use of the information in this material.
Annuities and insurance services provided by SIMON Annuities and Insurance Services LLC, an affiliate of iCapital, Inc. Structured investment and certain annuities products and services may be offered through SIMON Markets LLC. Alternative investment products and services may be offered through iCapital Securities, LLC. iCapital Securities LLC and SIMON Markets LLC are each a registered broker/ dealer, member FINRA and SIPC, and an affiliate of Institutional Capital Network, Inc. (“iCapital”). These registrations and memberships in no way imply that the SEC, FINRA, or SIPC have endorsed the entities, products or services discussed herein. iCapital and iCapital Network are registered trademarks of Institutional Capital Network, Inc.
© 2023 SIMON Markets LLC. All rights reserved.
© 2023 Institutional Capital Network, Inc. All Rights Reserved.