Deviled eggs and FIA annual reset — who knew?

Like a lot of us, I love deviled eggs, and I tend to enjoy more than my fair share of them at parties. That is, until I made them for the first time.

My wife warned me it wouldn’t be a simple task. “They’re a lot of work,” she said. “A lot.” She wasn’t kidding.

Boiling the eggs and cooling them down — do these steps just right or you might as well start over. And then the peeling! It’s almost impossible to do this perfectly. Cutting, scooping, mixing, more scooping. The dishes! When the eggs were finally made, the kitchen was a disaster area.

But what does this have to do with annual reset? Well, when you know what happens behind the scenes, you appreciate the final product even more.

What is an annual reset, and how do carriers offer it?

Annual reset is a key feature of a fixed index annuity. To be able to lock in gains each year on a product layered with guarantees is a story that interests plenty of clients.

How does a carrier provide such a valuable feature?

To answer that question, we must look at the underlying investments the carrier must make to support the guarantees and provide the upside potential of an FIA. Generally, it’s a mix of longer-term bonds with call options for the index crediting strategies. The bonds provide the guarantees, and the call options provide the upside growth potential on the index.

How does it impact renewal rates?

Here’s the "how do they do that" part. To provide annual reset, the carrier must purchase call options on the index each year from an investment bank. And the cost of those call options is unknown until the time of purchase. Again, that’s each year.

Generally, at the time of the client's anniversary, if circumstances are more volatile for the index, or if short-term interest rates have increased, the investment bank may charge the carrier more for the call options than they did a year ago. This could result in lower renewal rates for the upcoming contract year.

If circumstances are less volatile than a year ago or short-term rates have come down, the call options charged by the investment bank could be less. This could result in an increase in renewal rates. If volatility and short-term rates are mostly unchanged from a year ago, there may be no change in the cost of the call options, thus no change for the renewal rates.

Digging deeper into how a carrier can provide a feature as beneficial as annual reset helps us uncover why and how renewal rates are affected each year.

Indices and call option costs

It’s important to recognize that a carrier makes their profit only on the spread on the bonds, and not on the call options.

Some caveats:

• Each crediting option has its own unique call option to purchase.
• Monthly cap, also known as monthly sum, is an index crediting strategy that is affected differently when it comes to volatility. The call option costs can actually go down if volatility is higher than a year ago. And the costs can go up if volatility is lower.
• Point-to-point participation on a non-volatility-controlled index can be more sensitive to changes because this design has no “cap” to it.
• Daily or monthly averaging strategies tend to be less sensitive to changes because the averaging creates a bit of volatility control inside the strategy.
• Call option costs on a volatility-controlled index are affected less because of the nature of the design, and more because the design itself is made to reduce volatility. That means call option costs are generally more stable and can result in more stable renewal rates.
• If the crediting option credits every two years, then call options on that strategy are purchased every two years.

Knowing how a carrier provides annual reset and being aware of the factors that influence renewal rates can help you manage a client's expectations at anniversary time. When you see a client's annual statement showing a lower renewal rate, look at two things: what strategy it is what has happened with short-term rates and the volatility of the index from a year ago.

And, please, the next time you’re at a party and someone shows up with a tray of deviled eggs, pull them aside and say, "Thank you. I know what you went through to bring these today."

Jeff Barnes is regional vice president, EquiTrust. Contact him at [email protected].

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