Principal Protection: A Lighthouse For Consumers Seeking Security?
Lighthouses have become the new talisman for financial products. Even a casual survey of the pages of any finance publication will yield examples of lighthouses prominently featured in advertisements for all sorts of financial products.
In this time of economic and social turbulence, the reason for the potency of this image is not hard to discern. Lighthouses symbolize guidance to a safe place in uncharted or choppy seas. Safety and security are what insurance issuers and consumers are seeking.
In addition to losing market share in the past two years, innumerable variable annuity issuers have suffered losses caused by the payouts or reserving requirements attributable to optional enhanced income and death benefit features. VA premiums have declined significantly in the last two years–down approximately 15%. Meanwhile, indexed annuity issuers, like other fixed annuity issuers, have faced the rocks of state required non-forfeiture rates.
Additionally, consumers have seen a serious erosion of their retirement savings and few prospects for security.
Some financial product providers have recognized this need for security by offering principal protected mutual funds. This development has put added pressure on insurance companies to design products that capture the interest of consumers.
Fixed annuities were the traditional haven for insurers and consumers when the economy got rough. With interest rates as low as they now are, however, insurers are reluctant, if not unable, to provide fixed products with yields high enough to attract purchasers.
Several VA issuers have responded by launching or designing products that offer a safe haven by promising a return of principal.
In the mutual fund world, such products bear the label of principal protected funds. In the variable insurance market, no catch-all phrase has yet been adopted, though the words principal, protection, and guaranteed are all popular and the phrase “principal protection” is starting to become a universal moniker.
In any case, VA insurers are using two general methods to provide this protection. Some are following the mutual fund model by adding a principal protected fund to the investment options. Others are providing a guarantee of premium at the separate account or contract level. Within each model are additional variations.
The principal protected underlying mutual fund model has had somewhat rough going with the Securities and Exchange Commission. The SEC looks at two basic issues: Is the guarantee an affiliated transaction? And is the guarantee itself a security that should be registered under the Securities Act of 1933?