The Basics

Annuity Rates

Fixed Annuities have an interest rate that is declared annually by the insurance company. Multi-Year Guaranteed Annuities are like traditional Fixed Annuities in that their interest rate is also declared by the insurance company. However, Multi-Year Guaranteed Annuities’ interest rates are guaranteed for longer than a one-year period. Guarantee periods on these annuities may range anywhere from two to ten years.

Most Indexed Annuities today offer some form of fixed bucket strategy. This would be a premium allocation option that receives credited interest in a manner like that of a traditional Fixed Annuity. A declared rate is set for the fixed strategy, and the annuity purchaser receives that rate if the annuity is held for the strategy term (usually one year). Most Variable Annuities also offer a fixed bucket for clients desiring a more conservative allocation mix. However, the line between Fixed, Indexed, and Variable is drawn when it comes to differentiating how the non-guaranteed rates are credited on these products.

Remember that with a Fixed Annuity, the insurance company declares a stated credited rate for the non-guaranteed, current interest rate. A Variable Annuity is very different in that the insurance company does not limit the potential gains of the product; the client is investing directly in the market. Therefore, a Variable Annuity purchaser may realize a gain of 18.00% if the fund they invested in grows that much over a one-year period. With an Indexed Annuity, the insurance company purchases options based on an external index’s performance, and the annuity purchaser receives non-guaranteed, current interest that is limited in growth (based on the option price).

Like the handful of crediting methods that can be confusing on some Indexed Annuity products, the pricing levers that are used to determine the actual rate credited can perplex others. There are three simple pricing levers that are used when calculating potential interest on Indexed products:

Participation Rate—the percentage of positive index movement in the external index that will be used in the crediting calculation on an indexed product. (Note that a product with a Participation Rate may also be subject to a Cap and/or Spread.)

Cap—the maximum interest rate that will be used in the crediting calculation on an indexed product. (Note that a product with a Cap may also be subject to a Participation Rate and/or Spread.)

Asset Fee/Spread—a deduction that comes off of the positive index growth at the end of the index term in the crediting calculation on an indexed product. (Note that a product with a Spread may also be subject to a Participation Rate and/or Cap.)

Now that all of the disclaimers are aside, it can simply be said that most indexed strategies that have 100% Participation utilize a Cap as the pricing lever. In turn, most indexed strategies that have less than 100% Participation utilize the Participation Rate as the pricing lever. There are also trends among indexed crediting methods; averaging strategies tend not to have Caps more often than others, and utilize Spreads more frequently. Annual point-to-point methods generally utilize the Participation Rate or a Cap to limit potential indexed gains.

It is really quite simple when you break it down. For example, on an Indexed Annuity over a one-year term where the S&P 500^® has experienced an increase of 20%:

A Participation Rate of 55% would afford the client potential indexed crediting of 11% (20% x 55% = 11%)
A Cap of 8% would pass on potential gains of 8% to the client (20% limited by an 8% cap)
A Spread of 3.00% would leave the client with 17% interest credited (20% - 3% = 17%)

Typically, an Indexed Annuity utilizes only one pricing lever on each strategy. This means that when the insurance company changes the annuity’s rates, or the contract comes upon the policy renewal, only the one pricing lever will be adjusted upward or downward. However, an insurance company may reserve the right to adjust more than one pricing lever in the event of declining rates. This does not necessarily mean that they alter more than one pricing lever by practice. Generally, the less “moving parts,” the easier the product is to convey to both the salesperson and the purchaser. For that purpose, insurance companies try to limit the number of variables needed to describe each crediting method. It is important to note that there are a handful of products that use a moving part that is unique specifically to that product. These are just other pricing levers where potential interest crediting has been limited.

Indexed Annuities are also like Fixed Annuities in that they have minimum guarantees to protect the purchaser from a downturn in current credited rates or Caps, etc. Fixed and Multi-Year Guaranteed Annuities generally offer a minimum guaranteed floor of 1.00% or more. Indexed Annuities offer a guaranteed floor of no less than 0.00%. In addition, Indexed Annuities have a secondary guarantee that is payable in the event of death, surrender, or if the external index does not perform. This secondary guarantee is referred to as a Minimum Guaranteed Surrender Value (MGSV); it credits a rate of interest between 1% and 3% on a percentage of the premiums paid in to the annuity.

MGSVs can be stated in two methods: as Account Value guarantees, which must deduct the surrender charges from the calculation, or as Surrender Value guarantees, which are net of the surrender charges on the contract. An Indexed Annuity with a first-year surrender charge of 10%, and an Account Value guarantee of 100% @ 3% may be equivalent to the Surrender Value guarantee of a second product with an MGSV of 90% @ 3%. (100% - 10% surrender charge = 90%).

When Indexed Annuities first emerged in 1997, their MGSVs were often based on 90% of premium, credited at 3% interest; i.e. 90% @ 3%. However, when market conditions began declining and insurance companies weren’t able to offer indexed products with these guarantees, we saw MGSVs drop as low as 65% @ 3% for first-year premiums. It is important to note that annuity MGSVs most adhere to state Standard Non-Forfeiture Laws (SNFL), which are enforced by the state insurance departments. Today, more than three quarters of Indexed Annuity products have MGSVs that are based on 87.5% of premiums, and credited interest is based on the 5-year Constant Maturity Treasury rate (a rate between 1 – 3%). Today, annuity MGSVs cannot be less than 87.5% of premiums paid, credited at 1% interest.

Another very important rate to consider when evaluating which product to purchase, whether Fixed or Indexed, is the renewal rates. These are the new interest crediting rates, Caps, Participation Rates, etc. that are declared at the end of the interest crediting term (typically one year). So many products today are copied off of another popular insurance company’s product. If you want to evaluate the annuity beyond the contractual features, and the service and integrity of the insurance company; renewal rates should be taken into consideration. That being said, renewal rates are one of the most difficult pieces of information to get your hands on. A scant number of insurance companies feel that their renewal rates are an integral part of their sales story, and actually publish marketing pieces publishing these rates. This gives the potential annuity purchaser an idea of what the insurance company may do to the future rates on the product that they purchase, based on past renewal rate histories.

If you do not have access to renewal rates, it may be helpful to research Fixed and Multi-Year Guaranteed Annuities’ minimum guarantees and an Indexed Annuity’s minimum Participation Rates and Caps, as well as their maximum Spreads. These can be an indicator of just how low the insurance company could reduce the rates on the product after it is purchased. Note however, that due to policy filing efficiencies, many insurance companies opt for unusually low rate guarantees, Participation Rates and Caps, and rather high Spreads. (This avoids the cost of potentially re-filing the product in the event that market conditions decline, forcing the insurer to dramatically lower rates.) Often, salespeople are surprised when they see the maximums and minimums on the pricing levers for Indexed Annuities in particular. From a marketing standpoint, it is important to remember that the insurance companies would most likely discontinue selling the product(s) before rates were ever reduced to these minimums/maximums.