Structured Notes: The Perfect Complement To FIAs?

By Cyril Tuohy

InsuranceNewsNet

It's not easy being a financial advisor these days, with fixed income portfolios yielding so little in this era of low interest rates.

Shortly after the financial crisis began, when interest rates dived, advisors were content to wait for rates to rise once more. Today, advisors and their retail investor clients are still waiting.

In the meantime, their clients aren’t getting any younger. Retirees who were 65 in 2008 are approaching 71.

Not quite as limber as they used to be, retirees feel the changes afoot in their bones — and in their wallets, as the $5,000 in out-of-pocket health care expenses back in 2008 crest the $6,500 mark in the closing weeks of 2014.

Nor do those long-term care facilities come cheap: $80,000 a year in some places at last count.

It’s a high stakes game of chicken: Anemic yields due to low interest rates aren’t generating enough to sustain a certain lifestyle. How long are advisors prepared to wait?

Fixed index annuities (FIAs), a no-lose proposition when the market dips, limit volatility of the retirement portfolio when the chips are down. This means retirees can sleep at night.

FIAs, though, only offer a “limited win” when the market turns upward. Upside caps mean investors miss out on yield.

For the typical FIA buyer profile — a 63-year-old male with $250,000 in investable assets and an average of $82,114 in average FIA premium — what’s an advisor to do?

Enter the structured note, the high-net-worth investor’s tactical “yin” to the middle market FIA’s strategic “yang.”

“Structured notes and index annuities serve different needs,” said Thomas Haines of UBS Securities, a leader in the structured notes market.

Structured notes, which can last anywhere from six months to seven years, amount to a debt issuance from a bank, and they are typically sold though the broker/dealer or the high-net-worth advisor channel.

In the first quarter, about $12 billion worth of structured notes were sold in the U.S. structured notes market, an increase from $11.1 billion in the year-ago period, according to Bloomberg data. Banks led the way.

Indexed annuity sales in the first quarter reached $11.3 billion, an increase of 43 percent from the year-ago period, according to LIMRA.

Available through brokerage accounts, not fee-based accounts, structured notes are debt obligations for the short haul: An example of such a note would be a five-year bond tied to an option contract as a way to boost the bond’s return.

Structured notes offer no living benefits and they don’t come with long-term or critical illness riders of any sort, and the payoff is different from an annuity, said Haines, executive director and head of North American Equities Solutions Structuring at UBS.

For advisors looking to place “tactical money” in the market, structured notes “can really shine,” Haines said. Haines is one of several experts who spoke this week during an S&P Dow Jones Indices-sponsored webinar on FIAs and structured notes.

Advisors on the hunt for equity income, callable securities or options should think about structured notes as a wealth management tool. Yes, notes are useful for more immediate income compared to annuities, but they also present advisors with a riskier bet, Haines said.

“That’s where they are complementary to an index annuity,” he said. “The index annuity is a more conservative profile and tax efficient.”

Retail advisors should also be aware of a new generation of tools to help control the volatility of index-based annuities and structured notes, said Vinit Srivastava, S&P Dow Jones Indices senior director of strategy indices.

“Risk control indices keep volatility at a certain target,” Srivastava said.

That’s helpful because advisors no longer have to fret over the relative volatility of the index underlying the annuity or structured note.

“All they need to worry about now is rates,” Srivastava said.

Indeed, volatility control strategies surrounding crediting methods used by index-based investments had advisors abuzz at meetings recently, said Jason Krohnke, vice president of regional and field marketing with American Equity Investment Life.

The broader financial market began to take notice of risk-control indices in 2009 in the wake of the financial crisis, and it’s only in the past 18 months that insurers have begun to take a shine to them, Srivastava said.

S&P Dow Jones Indices lists nearly 50 indices belonging to six asset classes: equity, fixed income, commodities, real estate, strategy and even a “custom” category.

Blended indexes -- used by Allianz, Security Benefits and Barclays -- meld a bond index with equity indexes as a means of diversification and smoothing out volatility.

Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. Cyril may be reached at cyril.tuohy@innfeedback.com.

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Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. He can be reached at cyril.tuohy@innfeedback.com.