By Cary J. Carney
InsuranceNewsNet Magazine, December 2011
The recent low interest rates—a boon for consumers seeking great mortgage deals—have also been a bust for those seeking income from interest-linked financial instruments.
In early October, the three-month London Interbank Offered Rate (LIBOR) rate, which drives a range of such instruments, was below 0.4 percent. Such a rock-bottom rate has taken much of the attraction away from many savings and money market savings options. And, certificates of deposit (CDs) are delivering paltry rates—even for the longer-duration varieties.
As producers know, such low rates have persisted for several years now, having a highly negative effect on fixed annuity sales in recent years. For example, sales of traditional fixed annuities in the second quarter of 2011 were $21.5 billion, far below their most recent peak of $36.7 billion in the first quarter of 2009, according to LIMRA. Yet, indexed annuities have weathered the recent interest rate environment a little better: second-quarter 2011 sales were $8.1 billion, compared to $7.2 billion in the first quarter of 2009, just after the economic collapse.
We can guess why producers and consumers have held indexed annuities in higher favor: upside potential and flexibility. Indexed annuities, unlike traditional fixed annuities, offer interest-crediting potential that’s linked to how one or more market indexes or benchmarks perform. The consumer can put all or part of the annuity’s value in the index (anything remaining goes into the fixed-interest strategy). If the index rises, the consumer enjoys a credit. And, if it drops, the consumer’s principal is still protected. On the anniversary date of the contract, the consumer has the flexibility to re-allocate between the index and fixed components.
The Interest Rate Conundrum
Although these features have helped fixed income annuities maintain their relative popularity, sales have been hindered by a lingering worry among consumers—the prospect that interest rates could rise soon. Many of them, and the producers who advise them, have been wary of any fixed annuity products when interest rates seem to have nowhere to go but up. As a result, many consumers are sitting in short-term instruments such as CDs, waiting out the uncertainty.
Fortunately for consumers, insurers have been innovating in order to help mitigate the effects that rising interest rates could have on indexed annuity performance. Several carriers have introduced interest rate based crediting strategies that use a point on a published “swap curve” as the benchmark rate. And ING has developed a new feature that bases credit on an increase, if any, in the three-month LIBOR. This credits interest to the consumer if the three-month LIBOR rises from one annuity anniversary to the next.
Consumers are scared to invest these days—and for good reason. Market volatility has shaken their confidence in equities and the fear of rising interest rates has made them wary of any products that they think will “lock them in” to unsatisfactory future rates.
Few have considered, however, how much growth opportunity might be missed for their future retirement prospects when they keep their long-term money in short-term instruments for several years. Producers can provide guidance about key innovations in indexed annuities that can help to address clients’ fears and encourage exploring or participating in other strategies. When they are aware of the options available to them—such as interest rate benchmark crediting as a hedge against potential interest rate increases—clients can more confidently take steps to leave their financial holding pattern and get back on the journey toward their long-term financial goals.
Fixed Annuities: Dispelling Three Common Myths
Fixed annuities might be a great fit for a particular client, but a producer won’t be able to make that case if the consumer has misconceptions about the product. Here are three common myths about fixed annuities—and the facts producers can share in their client discussions:
MYTH: Fixed annuities have a lot of hidden fees and charges.
FACT: There are no direct fees in most standard fixed annuities. The only fees that come into play are to cover value-added riders, such as those that guarantee a certain level of retirement income or that provide an enhanced death benefit.
MYTH: Crediting limits in indexed annuities are designed solely to increase insurers’ profits.
FACT: Insurers don’t experience a windfall effect if the market or interest rate outperforms. They purchase hedges to fund the index credits paid to consumers and the cost of those hedges determines the limits that are set for each annuity.
MYTH: Surrender charges are unreasonably high so you can’t get any of your money if you need it.
FACT: Annuities by nature are designed for the long term. As such, annuity contracts have surrender charge schedules. To give consumers some access to their contract’s funds, many insurers allow withdrawals of up to 10 percent of the annuity’s value each year without penalty. And many annuities comply with the “10/10 rule,” which limits surrender charges to 10 years and to 10 percent in the first year of the annuity. Surrender charges diminish over time, vanishing entirely after 10 years for each premium payment.
Cary J. Carney is the vice president of independent distribution for ING US Insurance’s annuity and asset sales business, overseeing business development from the national marketing organizations, external wholesaling efforts and providing support for product development and marketing initiatives for the company’s annuity business. He can be reached at [email protected].