Today’s historically low interest rates may be a boon to mortgage-seekers and other borrowers, but they can be a curse for market-weary consumers seeking interest income or long-term growth options. As of fall of 2011, traditional savings accounts are bearing negligible interest, and money market accounts aren’t faring much better. Even certificates of deposit (CDs), long the fallback instrument for security-conscious consumers, are offering uninspiring rates even for longer-duration commitments.
These low interest rates and other factors have put a dent in sales of traditional fixed annuities. According to LIMRA, 2nd quarter 2011 fixed annuity sales were $21.5 billion, down significantly from their most recent peak of $36.7 billion in 1st quarter 2009. Over that same time period, sales of fixed index annuities have fared better, and in fact have risen slightly—$8.1 billion in sales in the 2nd quarter 2011 compared to $7.2 billion in the 1st quarter 2009.
While many factors impact these sales numbers, we can deduce that the relative success of fixed index annuities has to do with their flexibility and potential for additional interest upside. These annuities give consumers a chance to better many standard fixed-income alternatives by providing interest-crediting potential that’s linked in part to the performance of one or more market indexes or benchmarks.
In essence, contract owners can direct part or all of the annuity’s value to the index, while retaining the ability to use the fixed-interest strategy. If the index rises, the consumer gets a credit (subject to limits specified in the contract). And if it drops, the consumer’s principal is still preserved. At the contract anniversary date, the consumer can re-allocate among available strategies.
Fear of locking in
Despite the attraction of fixed-indexed annuity products, many producers and consumers still are hesitant to put money into fixed products when interest rates seem to have nowhere to go but up. Consumers instead are being encouraged to park their money in CDs or other short-term instruments, enduring the paltry interest gains in order to maintain liquidity.
Insurers are well aware of how low interest rates create a park-and-wait mentality. And they are innovating quickly to avail wary buyers, and the producers who serve them, of new options. For example, several carriers have introduced interest-rate-based crediting strategies that use a point on a published “swap curve” as the benchmark rate. As another option, ING USA Annuity and Life Insurance Company recently introduced a feature that allows fixed index annuity owners to capitalize on, rather than be undermined by, potential increases in interest rates.
This new feature, available only on certain fixed-indexed annuities, bases interest credited on an increase, if any, in the 3-month London Inter-Bank Offer Rate (LIBOR), the interest rate banks use to lend money to each other. If this benchmark rises from one annuity anniversary to the next, then so does the interest credited. This interest rate benchmark feature offers a few advantages:
No matter what equity markets do in a given year, if interest rates rise while the annuity’s balance is allocated to the interest rate benchmark strategy, your clients gain the rewards.
There now are three options within the annuity—guaranteed fixed rate, equity index and interest rate benchmark—from which to choose based upon the client’s needs. In essence, there is the potential to execute a diversification strategy within the product.
Clients can use the feature opportunistically, taking advantage of the interest rate benchmark strategy in certain years, but not in others, depending on their outlook.
If the benchmark rate drops during a particular contract year, while the feature will provide zero credit, the client’s principal is protected.
As with other indexes in fixed index annuities, the interest rate floor resets every contract anniversary date. So regardless of the previous year’s ups or downs, the client has a new opportunity for pursuing potential interest benchmark- crediting in the new contract year.
Clarifying the Facts
Many consumers are wary of annuities, which can make it difficult for producers to start a discussion about the relative merits of these products. Here are a few points to reinforce with clients when explaining how a fixed-indexed annuity works:
Limits on market upside—Some consumers imagine that limits on index crediting are in place so that, if the market or interest rate outperforms, the insurer can keep the difference. But, the reality is that insurers purchase hedges to cover the cost of index credits paid to consumers. There is no “windfall” effect when markets perform well.
Fees and charges—Similarly, some prospective fixed annuity buyers imagine that a range of fees and charges are hidden in the product. The reality is that there are no direct fees in most standard fixed annuities. The only fees that come into play are to cover value-added riders, such as those that guarantee a certain level of retirement income, or that provide an enhanced death benefit.
Surrender charges—Annuities are designed for the long-term, particularly for people who do not expect to make withdrawals for at least 10 years. As such annuity contracts have surrender charge schedules, which are applicable if annuity owners make withdrawals before that time.
However, many insurers allow withdrawals of up to 10% of the annuity’s value each year without penalty.
Clients and producers may want to consider annuities that comply with the so-called 10/10 rule, which limits surrender charges to 10 years and 10 percent in the first year of the annuity. Surrender charges diminish over time, going away entirely after 10 years for each premium payment.
Out of the Parking Lot
Consumers who park their long-term money in short-term savings vehicles may be missing important years to potentially build up nest eggs for their retirement years. Low interest rates and fears that rates will rise soon can sideline many people, but new interest-rate benchmark features on certain fixed index annuities can offer an appealing strategy for countering these fears.
Producers can use this new feature as a way to start discussions with clients who are looking for ways out of the “parking lot” and into more appropriate savings strategies for their long-term goals. Such discussions, including an honest and balanced explanation of the role annuities can play in a retirement plan, may help to get these stalled assets on the highway again.
Kenneth L. Brown is the vice president of sales development & strategic support for the annuity and asset sales business of ING U.S. Insurance, Des Moines, Iowa.