For the first time in years, interest rates may finally be rising—and financially savvy clients are, of course, beginning to look for ways to capitalize on this in their retirement income planning. Fortunately, annuity product innovation seems to be keeping up with client expectations, as several insurance carriers have introduced products that strive to take advantage of rising interest rates.
Clients who are just beginning to reassess the value of previously developed fixed annuity product plans in light of tentative rate increases may be interested to learn about several new product developments designed to maximize the value of rate increases—while also protecting the client’s future retirement income through the traditional annuity components of the product.
The Floating Rate Impact
When interest rates begin to rise, so can the risk of disintermediation—which is essentially the risk that clients will sell their annuity products prematurely in a rising interest rate environment in order to reallocate those funds to investments that seem more lucrative. Fortunately for clients, this is a risk that can motivate insurance carriers to develop products that also maximize the value of interest rate hikes.
Carriers have recently released types of fixed annuity products with interest crediting options that are tied to currently prevailing three-month LIBOR rates (which typically provide a benchmark for trends in interest rates generally). These products, also known as floating rate annuities, reset the interest crediting rate on the product on its anniversary date (over either a five or seven year period) to take advantage of interest rate movement.
Generally, the product credits the annuity with a base crediting rate, and then tacks on an additional interest credit based on LIBOR movement. Currently, a five-year product offers a 2% base rate, with an additional 0.63% LIBOR increase (for the first year). A seven-year guarantee-period option offers a base rate of 2.4%, with the additional 0.63 percent based on LIBOR.
The LIBOR portion of the interest rate crediting will be adjusted upward or downward, depending upon the actual performance of interest rates in future years—providing clients with an incentive to stick with a fixed annuity product even in a rising interest rate environment.
These products contain an overall cap on the level of earnings that can be realized through fluctuations in LIBOR, as well as a minimum guarantee.
Additional Product Developments
Other insurance carriers are offering product features to allow currently existing annuity contract holders to take advantage of rising interest rates—in the form of riders that can be attached to a base annuity product. One recently introduced rider offers clients a one-time increase in the contract’s credited interest rate based on the 10-year Treasury rate.
Other carriers have developed features designed to produce benefits from changing interest rates by regulating bond duration. For example, these products might peg performance to both an equity index and a bond index to control for market volatility.
The “duration” component of the feature provides that if interest rates rise, duration in the bond index will fall, and vice versa, in order to regulate the product’s interest rate exposure. These products provide for automatic adjustment of the interest rate exposure based on the underlying trends in the bond index.
Whether or not interest rates will continue to rise remains uncertain—for clients who are concerned about interest rate risk, however, interest-rate sensitive product features provide one more option for customizing an annuity product to the individual client’s needs, while also providing for future retirement income.
See these additional retirement planning articles by Professors Bloink and Byrnes:
Originally published on Tax Facts Online, the premier resource providing practical, actionable and affordable coverage of the taxation of insurance, employee benefits, small business and individuals.
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