Life insurance companies are now taking the concept of structured products and packaging them within a deferred annuity wrapper.
A structured product is nothing more than the union of an investment vehicle, offering what is commonly a long-term financial assurance, and some form of possible additional return. They are frequently seen wrapped in a registered note, trust certificate, or a not-so-traditional certificate of deposit–and what could also likely be annuities.
Typically, structured products have a maturity date of 10 years or less from purchase. At startup, the issuing company provides the purchaser a minimum guarantee, available only at maturity, plus some upside potential. The upside potential is often tied to the performance of the equity or bond market.
These recently introduced products not only allow the consumer to enjoy the benefits associated with deferred annuities–e.g., tax-deferred growth, the ability to select a settlement option, and the additional security provided by state guarantee associations–but they also are designed to guarantee a return.
The wrapping of a structured product in a deferred annuity is rather new, so the product does not yet have a common name. In this article, it will be referred to as a structured deferred annuity (SDA).
The upside potential associated with SDAs is often linked to the performance of an index. This creates similarities to indexed annuities. However, unlike many IAs, any interest credited above the minimum guarantee is available only at the end of the term period. This straightforward design makes SDAs easier to understand than many IAs presently available for sale.
Proponents like SDAs because there is a substantial likelihood the persistent policyholder will receive an amount in excess of the guarantee. Should the death benefit become payable prior to the end of the term period, many contracts will perform the extra interest calculation at that point in time. It is not currently necessary to register SDAs as they are categorized as fixed annuities.
Some critics do not like the idea of having to wait until the end of the term period before any excess interest is credited. Other products in the market address this concern, but the benefit of more frequent additional interest crediting often comes with the price of lower long-term growth.
Some in the industry say SDAs are an excellent way of rewarding individuals who are willing to sacrifice a small portion of guarantee for a much larger potential return. Hypothetical returns support this statement, as shown in the table on this page.
The guaranteed annualized rate (GAR) in the table represents the rate used to determine the daily credited interest to the SDA. If the GAR is lower, then the annualized return may be higher, when measured at the end of the term period. Notice that a low or even negative increase in the index will never cause the annualized return to be less than the GAR.
Not all the index performance is credited to the policyowner. A portion of the gain, if any, is declared by the insurance company at the time the premium is received. This percentage is a function of the capital market conditions, and can theoretically vary from day to day. But, once the SDA is issued, it cannot be changed.
The second table displays an interval of returns based upon reasonable range of declared percentages that insurers may be setting. A rational expectation would be mid-single-digit annualized returns in times of good index performance. Additionally, the presence of a GAR provides assurance that positive performance may be realized even in depressed economic times.
Many will notice the resemblance between these products and multiyear guaranteed annuities. The insurance company does not have any flexibility in adjusting interest crediting rate parameters after the product has been sold, and the surrender charge period typically does not extend beyond the end of the term period.
Keep an eye out for SDAs. They offer a unique option for individuals seeking upside potential while still strongly valuing safety, security and guarantees.
Chuck Preti is a co-founder of Life and Annuity Brokerage Solutions, LLC, an actuarial firm in Niagara Falls, N.Y. His e-mail address is [email protected]