Producers consistently ask 3 questions about index annuities when they go through training courses on the products.
o How do insurance carriers invest premiums?
o Why do participation rates, asset fees/spreads and caps change?
o What is the “best” crediting strategy for the client?
Here are some answers, and some thoughts on the value of the training itself.
Generally, insurance carriers issuing index annuities use the first few pennies of every premium dollar to cover overhead expenses. This includes items such as employees’ salaries, marketing expenses, and commissions.
Next, they use a certain amount of the premium to buy government bonds to back the minimum guaranteed contract value. The higher the minimum guarantee, the more of the premium is required to support this promise. Carriers use the remaining premium to buy index options to cover the excess interest credited to the annuity based on its crediting strategy.
Many producers do not connect the fact that higher minimum guarantees impact the moving parts of the index crediting strategy. (For example, a contract paying 3% on 100% of the premium requires more money to be spent on bonds than one paying 3% on less than 100% of the premium.) Although the cost of bonds is considered to be an internal pricing component, the result is that, in the first scenario, fewer premium dollars remain to buy index options used to credit the policy’s excess interest.
This means lower participation rates, higher asset fees/spreads and higher caps. There are only so many pennies in each dollar, and each part affects the whole.
Confusion sets in because carriers tend to purchase index options differently and for varying lengths of time. In view of that, producers in my training classes take great interest in discussing the fluctuation among participation rates, asset fees/spreads and caps. Once they understand that these moving parts are not arbitrarily determined, but rather each is related to the investment of premium dollars and the cost of the asset being used to back the guarantee, producers seek out as much information in this area as possible.