The question was: What is the potential effect of low interest rates and market volatility on indexed interest strategies in fixed indexed annuities, and how do I position fixed indexed annuities when economic conditions are driving the stock indexes lower?”
The answer is: To answer the first part of the question, fixed indexed annuities typically offer the client a choice of allocating their premium amongst one or more indexed interest strategies and a fixed interest rate option.
As regards the indexed interest strategies, there is a correlation between current interest rates and market volatility and the caps or spreads associated with the indexed interest strategies (typically referred to as the “moving parts”).
Caps and spreads are driven by a combination of interest rates and market volatility. In general terms, as interest rates decline and market volatility increases, caps tend to go lower and spreads tend to increase.
Therefore, in times of low interest rates and market volatility, you can generally expect to see current caps decrease and current spreads increase, reflecting the “cost” to the insurer to support the indexed interest strategy and provide the underlying guaranteed minimum contract value. Conversely, when things improve in the form of higher interest rates and/or less market volatility, you can generally expect to see caps increase and spreads decrease.
It is important to understand that the insurance companies generally do not decrease caps or increase spreads arbitrarily, but do so in reaction to the interest rate and market volatility environment. The first duty and requirement of the insurance company is to ensure that the guaranteed minimum contract value of an FIA is assured, with the potential performance of the indexed interest strategy as the secondary priority.
The underlying guarantees inherent in FIAs provide the answer to the second part of the question. In times of significant market volatility and particularly in times of “bear markets.” you should position FIAs to your clients based upon the underlying guarantees of protection against potential losses, and the guaranteed minimum contract value. You might also want to consider recommending that the client allocate a significant portion of the premium to the fixed interest rate option when it appears that a period of prolonged poor index performance could occur, thus guaranteeing the client will earn at least a fixed interest rate gain on their premium.
The flexibility of FIAs allows the client, in most designs, to reallocate values to an indexed interest strategy at contract or crediting period anniversaries when it appears that the “bear” market conditions may be passing. So, in summary, in conditions such as we are currently experiencing, sell guarantees.