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Back-casting FIAs - The crystal ball has some cracks

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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.

The only way one can accurately determine how a policy would have behaved in the past is to look at actual returns on actual products offered. Fixed indexed annuities are first and foremost fixed products. Thus, the insurance carrier has discretion over what level of participation the product provides. So, if someone is telling you that one crediting method is better than another based on back-casting, don’t believe it.

What is the best indicator of a product’s potential future returns? Many factors impact the carrier’s pricing of a product, including expenses, surrender charges, the carrier’s profit objective, etc. But here are the biggest two that are visible to the producer:

  1. Carrier option budget: The larger the budget, the larger the potential returns. While a carrier will typically not explicitly tell you what is its option budget, the higher the commission and the higher the premium bonus, the lower the option budget.
  2. Carrier integrity on renewal rates: The carrier ultimately has discretion on how it sets rates, such as caps and participation rates, after the first contract year. A carrier that maintains fair pricing through the life of the product will provide better long term value.

By the way, telling consumers which crediting method may perform better could be interpreted by regulators as giving investment advice. This is helping to fuel the fire with the SEC and FINRA on getting their hands in our business.

So, what strategy should you put your client in? A great answer is to use the strategy that you and your client understand. Another perspective is put even amounts in each strategy to give your client an increased chance of positive returns each year. The bottom line is: don’t advise on which one is best.

Let’s all work together to keep our annuity marketing and sales focused on the real needs of customers and the benefits of annuities. This will help assure that these valuable products continue to be available for agents to distribute and to consumers who need them.


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