Indexed variable annuities (IVAs) and structured annuities are two relatively new types of hybrid annuity products that are causing rampant confusion in today’s annuity marketplace. Used properly, these products can perform a significant role in a client’s portfolio, making it more important than ever to understand the nuances of these two annuity types.
The investment options offered by IVAs and structured annuities are extremely varied — in terms of opportunities for both market participation and downside protection — making the issue of client suitability particularly important. Today’s clients are looking for a customized product, so it is time to begin asking: When it comes to IVAs and structured annuities, which product is the right fit?
IVAs and structured annuities: next generation hybrid annuities
The basic distinguishing feature of both the IVA and structured annuity products is that they combine elements of both a variable annuity and a fixed index annuity, regardless of how the particular product is characterized by the insurance carrier. Both IVAs and structured annuities allow your client to participate in upside market potential by offering a number of investment options that are tied to market performance (similar to variable annuities).
Further, the investment options are often linked to the performance of one or more specific index (such as the S&P 500), a traditional characteristic of the indexed annuity. The insurance carrier uses options to both replicate the performance of these indices and to protect against downside risk. The product curveball comes in because both IVAs and structured annuities can also provide a fixed account option in order to protect the client’s principal investment.
Each of the individual investment options offered within the contract will offer varying degrees of downside protection and upside potential (options with the highest level of downside protection usually offer the lowest potential for upside gain and vice versa). Many insurance carriers, however, set a cap on the level of upside returns that a client may be entitled to receive.
The true value of these hybrid products lies in the fact that the producer can cater to each individual client’s risk tolerance level by allocating the client’s premium between the various investment options offered within a single product.
Both IVAs and structured annuities also offer many of the common benefits of any other traditional annuity — including tax deferral, death benefits and the potential to exchange the hybrid for another annuity product in a tax-free 1035 exchange.
Is a hybrid right for your client?
Typically, hybrid products will be most attractive to clients with conservative risk tolerance levels who still want to participate in the equity markets — but with solid protection against losses. The variety of investment options offered within a single product allows the client to determine exactly how much risk he is willing to tolerate.
While IVAs and structured annuities do not (yet) provide the guaranteed living benefit riders that many clients have grown accustomed to seeing, for some risk-adverse clients this may be viewed as a plus in today’s market. Because of the modifications and buyback offers that many annuity carriers have put on the table with respect to these guarantees, the very conservative client may be inclined to avoid the option altogether.
A hybrid annuity can also be used in conjunction with an annuity product that offers guaranteed benefits in order to provide a buffer against potential losses in other areas of the client’s portfolio. Because it is possible to structure the investment allocations so that the risk of loss is zero while still participating in market gains, this option can offer a higher return than traditional conservative products (such as a money market fund or CD).
Structured annuity products and IVAs may be best suited for clients who are seeking a slightly higher rate of return than a traditional indexed annuity would offer, if the client has a five-to-seven year investment time frame available. Further, because of the conservative nature of the products, they typically are less suitable for younger clients.
Although IVAs and structured annuities may be most appropriately used as a risk management component in the client’s overall portfolio, for many clients, the flexibility to manage their risk level — while still participating in market gains — may prove invaluable.
For previous coverage of differentiating annuity features in Advisor’s Journal, see GLWBs and LIBRs—Which Rider Fits?
For in-depth analysis of the various types of annuity products available, see Advisor’s Main Library: C—Types of Annuities.
Your questions and comments are always welcome. Please contact the Panel of Experts.