Which Fixed Annuities Are Best For Renewal Rates?
There seems to be a lot of confusion about how different fixed annuities (FAs) credit renewal rates. The following should help explain the 2 basic approaches.
1. CD-Type Annuities. These FAs basically work like certificates of deposits do in banks. For example, XYZ Annuity offers to pay 5% guaranteed for 5 years or 6% guaranteed for 6 years. When the selected period ends, the client can surrender the policy for its accumulated value.
Two sub-categories are:
a) Penalties Expire Forever: With some CD-types, after the initial guaranteed rate period ends, surrender penalties expire forever. Future renewal rates are based on a portfolio rate, as explained below.
b) Forced Renewal: With other CD types, at the end of the initial guaranteed rate period, the owner has a window, typically 30 days, to surrender the contract. If the annuity is not surrendered, it will automatically renew for a new period with a new set of surrender penalties, exactly the way bank CDs do.
CD-type annuities may also be called multi-year guarantee (MYG) contracts.
2. Portfolio-Type Annuities. This type of FA normally has a rate guaranteed for a portion of the length of the contract. As an example, the ABC annuity offers 6% guaranteed for 1 year, but the surrender penalties last for 7 years. After year 1, the renewal rate is based on what the insurer earns in that portfolio of funds. Renewal rates will float up or down but can never go below the contractual minimum guaranteed rate.
The basic sub-categories are:
a) Indexed Rates: The policy guarantees renewal rates will be based on an outside index, such as Treasury Bonds or some Lehman Brothers Bond Index, etc.
b) Trust Me: The insurer essentially says “give us your money. After the first year, trust us to be fair with you. Well invest the money, take what we want for a profit spread and pay you the rest.”
c) Guaranteed Spread: The insurer guarantees the renewal rate will be a stated percentage less than the gross amount earned in the portfolio. For example, the annuity guarantees the insurer will earn 2% and the balance is credited to the annuity.