Often you hear the statement, “past experience is not an indication of future results.” This statement is a fair warning regarding back-casting used to illustrate fixed indexed annuities. But, I believe that this can be taken further by saying that back-casting results are not even accurate indicators of past results.
Back-casting attempts to show how a particular indexing strategy would have performed in the past by applying current caps, participation rates, or other product features to prior performance of the applicable index. I will describe why this approach is not valid and why using this information is misleading. Furthermore, using such information to advise clients could subject you to liability for giving investment advice – and potentially bad advice.
Why is back-casting misleading? Annuity product pricing is a highly dynamic process that is dependent upon bond yields, option pricing, carrier profit requirements, expenses and capital markets. The pricing factors are constantly changing and are occasionally subject to substantial shifts. For example, stock market volatility, a key ingredient of option prices, significantly increased after 9/11. Assuming that today’s pricing can apply to past years is like trying to figure out how much a DVD player would cost in 1950 … you can’t! Give me enough time and I can provide evidence that any crediting method is better than any other as long as I can self-select the time period and the current pricing rates.
Not only does back-casting not accurately demonstrate past performance, it also does not accurately compare relative performance of one crediting method over another. Different crediting methods have different pricing levers that can create swings in results relative to other strategies depending upon the time period illustrated.