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Portfolio > ETFs > Broad Market

Do crediting systems perform the same?

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Based on 15 years of research, I have found annual reset index annuity crediting methods were priced to perform the same over time. What this means is if the same money is spent on options and the patterns of the historic stock market repeat, the returns come out pretty much the same over the long haul, whether you use an annual point-to-point or a yield spread or averaging or a monthly cap.

I am not saying a method crediting 100 percent of the annual point-to-point index gain delivers the same returns as another method crediting 100 percent of the averaged values of the index. What I am saying is if you had, say, 4 cents available to buy an option and got 100 percent participation in the average value, and if you spent a different 4 cents on an option and got 52 percent participation in the point-to-point gains, the gains you realized over time from both methods at these respective rates would be similar.

Results depend on market moves
This also does not mean if you spent 4 cents each to get the averaging method at 100 percent participation and 52 percent on the annual point-to-point, these two methods will produce the same return next year. Different methods produce different results depending on how the actual market moves. However, over time the returns are priced to average out about the same, except when the carriers ignore their formulas and play hunches.

For example, for a time in 2007, the yield spread method without a cap would have produced 40 percent higher returns than methods with caps within the same products at three different carriers. Instead of giving every method the same odds, they essentially said if the market performs as it did in the past and you earn 6 percent with our capped method, you’ll earn 10 percent with our yield spread method. During this period in 2007, these index annuity carriers were offering a roulette wheel paying 35 to one on some numbers, 45 to one on others and 25 to one on the rest. What was being said was, “I do not care what my pricing model says; I want to play a hunch. And my hunch is the market won’t go up much in 2008.”

Predicting the future
Because index returns were negative the following year, their hunch did not hurt them. However, there are times when a form of “index annuity arbitrage” is possible. Or, viewed another way, there are times when you can see how the carriers are predicting the future and perhaps use it to your advantage.


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