When 2012 arrived, some in the financial services community opined that the era of historically low interest rates was beginning to wind down. But this promising rise didn’t last. In early 2012, interest rates suffered a disappointing retreat, which is particularly challenging for retirement savings options such as money market accounts and certificates of deposit (CDs), which are highly sensitive to interest rates.
Traditional fixed annuities also have struggled due to the continued low interest rates. In fact, total sales of fixed annuities dropped 10 percent in the first quarter, according to a report by LIMRA in April.
Yet LIMRA’s report also pointed out a bright spot on the annuity front: fixed indexed annuity sales jumped 14 percent in the first quarter, outperforming traditional fixed annuities for the third consecutive quarter and capturing 45 percent of the fixed annuity market. It is widely understood that this growth is largely driven by consumer interest in the income riders that offer reliable guaranteed income. Such sales outperformance came as little surprise to financial professionals who are familiar with fixed indexed annuities and their specific characteristics. These products provide clients seeking retirement income with a sound combination of flexibility in interest-crediting options and limited upside potential.
Here’s how they do it.
Fixed indexed annuities depart from their traditional fixed annuity counterparts in that they give owners some interest-crediting potential, which is typically linked to the performance of one or more market indices. The owner can put all or some of the annuity’s value in the index-crediting strategy and/or elect to allocate some portion to the fixed interest rate strategy that is typically offered. If the index performs consistent with the index-crediting strategy, the owner benefits, yet if the index goes down, a credit may not be received. However, either way, the owner’s principal is protected. And every contract anniversary date, the annuity owner can re-allocate between the index and the fixed and index components of the product to seek a more appealing balance.
If rates rise, then what?
It’s clear from LIMRA’s findings that buyers are out there for fixed indexed annuities, yet many financial professionals may not fully understand what is driving this demand. After all, the interest rates on the fixed portions of these products have been nothing to write home about. Why are people buying these products? We can speculate that interest rates have been low for so long that, for many clients, these rates have become the “new norm.” As such, financial professionals must adjust their view of the interest rate hurdle and potential sales opportunity this product category represents.
The major hurdle to sales of fixed annuities is the prospect of future rising interest rates. Now, more than ever, financial professionals and clients alike are finding it hard to envision rates going any lower. They share the sentiment that rates will rise in the coming year or so, which can make a range of long-term interest-rate-linked instruments, including fixed annuities, seem less attractive at today’s rates.
In response to these concerns, some insurers have introduced new features on their fixed indexed annuities to credit interest if rates rise. Some carriers have introduced interest-rate-based crediting strategies that use a point on a published “swap curve” as the benchmark rate, while another approach provides the fixed indexed annuity owner with credit based upon an increase, if any, in the three-month London Interbank Offered Rate (LIBOR). This index strategy credits interest if the three-month LIBOR rises from one annuity anniversary to the next.