The motto for the real estate world might be “location, location, location,” but for fixed annuities, it’s “rate, rate, rate.”
Sales compensation, liquidity, and features can be important, but the fixed annuity focus usually comes down to rate. So, what is a company to do when it can only earn gross returns of 3.75% to 4.5% on its own A-rated securities and 4.25% to 5% on its BBB-rated bonds?
This is the dilemma that declared rate fixed annuity insurers are facing. The above gross yields must be further reduced by investment expense, default risk charges, and required product spreads in order to arrive at the policyholder’s yield.
In today’s environment, fixed annuity carriers have begun to search for rate “nuggets” in their product design and pricing, like the 49′ers of the 1800′s. These chunks of rate boosters may be small on their own, but together, they can turn a disappointing fixed annuity return into one with marketplace appeal. Here are 11 rate boosters to consider:
1. Effective yields. First, although obvious to most, make sure the investment professionals in the company are passing along annual effective yields, and not nominal yields, to the credited rate setters. It is amazing how often these few basis points of rate have been left on the table.
2. Minimum size. Increase it if the policy does not vary credited rate by premium band. A $25,000 minimum (and even $50,000) can help credited rates by a tick.
3. Surrender charges. Most distributors believe that the length of the surrender charge is more important than its level. A one percentage point change in one year for a surrender charge will change the required interest spreads (and credited rates) by one basis point, according to an approximate rule of thumb. So changing a 5-year surrender charge schedule from 6, 5, 4, 3, and 2 points to 6, 6, 6, 6, and 6 points, respectively, frees up 10 basis points of rate under that rule of thumb.
4. Add a market value adjustment. Depending on the type of MVA and its protective value, rates can be increased by 10 to 25 basis points. Make sure the MVA behaves consistently with real changes in asset value, however.
5. Drop the principal guarantee. It rarely comes into play, but everyone pays for it, to the tune of 6 to 10 basis points. Adding a bailout instead in this environment can be more capital efficient.
6. Adopt the Change-in-Fund Method of reserving. This statutory reserve approach can help when future interest rates are expected to increase. Even if rates stay level, this approach can generate some rate pickup.