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Fixed index annuities: Sales growing, products evolving

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Indexed annuities (IAs or fixed index annuities [FIAs]) continue to produce solid business results. LIMRA Secure Retirement Research reported that the products’ sales reached $48.2 billion in 2014, a 23 percent increase over 2013.

For the first time, FIAs accounted for more than a 50 percent market share for all annuity sales. The strong sales have continued into 2015, with a 3 percent sales increase marking eight consecutive quarters of higher sales.

FIAs are also gaining in other sales channels, according to the Insured Retirement Institute (IRI). In a July 20, 2015 press release, the IRI reported that FIAs made up 10 percent of total broker-dealer annuity sales in 2014 and half of broker-dealers expect that share to grow.

Understanding hybrids

Insurers are adopting new FIA designs as the market grows. Consulting actuary Simpa Baiye, FSA, CFA discusses the growing use of hybrid indices in an article titled, “Hybrid Indices in Fixed Index Annuities: The New Wave,” in the June, 2015 issue of the Society of Actuaries Product Matters! newsletter.

Advisors and investors are familiar with the mainstream equity market indexes, such as the S&P 500 or the Russell 2000, which are used to calculate FIAs’ crediting rates. Baiye refers to these as passive indexes, by which he explains that their weightings that are “generally driven by company market capitalization.” While these traditional indexes are still used by most FIAs, hybrid indexes are gaining market share and now account for almost a third of premium allocations.

Baiye points to two key differences between traditional and hybrid indexes. First, hybrids’ weights are driven by quantitative algorithms using “market signals such as realized volatility, short-term returns and price/earnings ratios in determining for­mulaic short-term weightings for each component of the hybrid index.”

The second differentiation is the use of volatility controls with the hybrids, also called volatility overlays. He explains that the overlays’ goal is to “stabilize returns on the under­lying index subcomponents over time. With this feature, weightings to underlying component indices can be shifted from or to a cash index, as often as daily, in order to attain a specific annual volatility target or stay under a specific volatility cap.”

The impact

Hybrid indexes create several benefits and drawbacks, Baiye notes. One benefit is that they can offer FIA buyers access to a tactical investment allocation in an index format. A second benefit is that hybrids’ goal of managing market volatility can lead to more stable returns versus the unmanaged indexes.

He writes: “More stable returns can, in turn, lead to better accumulation outcomes. Target volatility overlay mechanisms can also cheapen the cost of participating in the upside performance of underlying index components. In the current low-rate environment, this is an important attribute for both insurance carriers and policyholders.”

There are potential drawbacks, as well, including the possibility that some states’ regulations could cause difficulties in using hybrid-based illustrations. Another risk is that future evolutions of interest rates or market volatility could reduce the value of hybrid index returns.

Mr. Baiye’s article is available online.