Indexed annuities have become an established member of most financial advisors’ repertoire in recent years, gaining in popularity as clients seek out low-risk ways to participate in rebounding equity markets. Despite this, several years of relatively stable market performance has reduced the appeal of these products, which typically cap the client’s ability to realize the full extent of any gains.
Because of this, carriers have developed new twists on the uncapped index crediting method in order to allow for greater market participation while also tailoring volatility in the underlying equities. While these uncapped crediting strategies may be an attractive option to some clients, others may be in for an unpleasant surprise down the road—making it important that they understand the fine print before jumping in.
Innovations in Index Crediting
Index crediting is essentially the way that market gains are credited to a client’s indexed annuity value—the annuity itself is tied to a market index (or indexes), the performance of which governs the performance of the annuity. Many indexed annuities are subject to a cap in order to reduce the insurance carrier’s risk—for example, if the market gains 10% and the product cap is 5%, the client’s account will be credited with a 5% gain (absent other product features).
Uncapped crediting removes the cap. Recently, carriers have begun experimenting with a tailored approach to the underlying securities that govern the annuity’s performance. Some have begun combining this tailored basket of equities with an uncapped index crediting strategy in order to maximize the indexed annuity’s performance.
Using this strategy, the carrier will adjust the annuity’s exposure to the underlying mix of securities in order to reach a stable target volatility level—often on a daily basis to ensure consistency. Interest is credited using a traditional crediting method (i.e., the beginning index value is compared to the ending value, and the difference provides the basis for the amount credited), though some carriers credit these accounts less frequently than is typically the case (every two years rather than monthly or annually).
Theoretically, because the underlying basket of equities is chosen in order to reduce the risk of large swings in value, the consistent performance over a longer period of time should lead to larger interest values being credited to the client’s account.
The Fine Print
As most advisors are well aware, uncapped does not mean unlimited. While indexed annuity carriers that offer an uncapped crediting strategy do not impose a hard cap on the client’s participation in market gains, contracts providing for uncapped crediting continue to limit the client’s participation using participation rates, spreads and fees.