October 14, 2013

Indexed Variable Annuities—a VA Product Curveball

Persistently low interest rates may have created a challenging environment for annuity carriers in recent years, but many clients remain deeply skeptical about the prospect of returning to the more volatile equity markets. Indexed variable annuities (IVAs), while developed to help insurance carriers manage risk more accurately, can represent the perfect solution for these market-shy clients.

IVAs—known to some as structured annuities—offer clients an investment alternative that can provide the stability and many of the product offerings associated with annuity products but also the potential for participation in any equity market gains. However, they also offer substantial downside protection to cushion against potential investment losses.

Indexed Variable Annuity Basics 

Although known by several different names and subject to a broad range of potential product features, an IVA is essentially an annuity product where investment returns are tied to the performance of one or more stock indexes (e.g., the S&P 500 or the Dow Jones). Unlike straight equity investing, however, the product itself offers a cushion against investment losses in exchange for a cap on the potential for investment gains.

The carrier may offer 10%, 15% or 20% (or more) buffers against investment losses, meaning that if the underlying investments generate a loss, the insurance carrier absorbs a set percentage of that loss before the client experiences any loss. As such, if the chosen index declines, for example, by 10% and the client has chosen a 15% buffer, the client’s account value will decline only by the 5% loss that exceeds the contract’s downside protection.

However, as a trade-off for the downside protection afforded by these contracts, participation in the linked index’s gains will be subject to a cap for a fixed term of years. Despite this, the term of years can be as short as a single year for some contracts, allowing the client a degree of flexibility that he might not otherwise find available in a fixed indexed annuity product. Further, some contracts provide for an upside cap that fluctuates annually—or, in some cases, as frequently as weekly or monthly. 

Some insurance carriers even offer products that cover 100% of the downside risk of the investment, but these carriers also set the upside caps on these contracts at a lower percentage (in some cases, as low as 1.5%) that resets frequently (for example, every two weeks). 

Despite their lack of guaranteed income, in addition to these product-specific features, IVAs continue to offer many of the benefits that traditionally accompany an annuity product, including the valuable elements of tax deferral and death benefits for account beneficiaries. 

Why Choose IVAs? 

Unlike a traditional variable annuity product, IVAs do not come with the types of lifetime income guarantees that are typically associated with today’s annuities. Despite this, as most financial advisors are already well aware, it is these guaranteed benefits that have caused many carriers to seek modifications to existing contracts or to exit the annuity business altogether through implementing a buyback strategy. 

Because the performance of an IVA is tied to the market, and performance gains are capped, insurance carriers are able to more accurately measure their risk exposure to ensure proper reserve levels. This reduces the risk that a client will be faced with a product modification or buyback offer down the road. 

Conclusion

While not all insurance carriers currently offer IVAs, depending on the carrier and jurisdiction, those products that are on the market may be fairly diverse in the potential options offered to the client. Accordingly, it is more important than ever that advisors review the fine print on any IVA contract to determine whether the product is right for the individual client.

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