Indexed products: You’ve seen one, you’ve seen them all, right? WRONG! Fixed Indexed Annuities (FIA) have been sold in the United States for over two decades. Sales of FIAs have skyrocketed in recent years as their popularity increased.
Consumers looking for an alternative to traditional savings vehicles and investments, as well as financial professionals’ eagerness to satisfy their clients’ need are driving forces behind the success of FIAs. Whether you like them or not, FIAs have become a sometimes controversial new-kid-on-the-block product line that demands attention.
You may think you know how index annuities work, and probably have formed a strong opinion as to whether they are good or bad. Your opinion may be based on fact, or hearsay. Nevertheless, as of the end of the 3rd quarter of 2015, there were 58 insurance carriers offering several hundred different indexed annuities according to Wink’s Sales & Market Report. Making general assumptions about this broad spectrum of offerings could mean bad news for your clients, and your practice!
It's About Balance
Indexed products are not created equal. While it is true that they all have the same components, the balancing act between the guarantees, expenses/profit, and hedging budget will have a lasting impact on the clients’ overall experience with the product. The integrity of the carrier’s management team and ownership may also contribute to a positive or negative experience.
Indexed annuity and indexed life insurers have to juggle with 3 main components that all indexed products are designed around; guarantees, expenses/profit, and the heavily-promoted, “upside potential without downside risk.” The ability to have a better-than-average opportunity to earn a better-than-average interest rate, while preserving all premiums paid and prior interest credited, is what makes indexed products so attractive. However, over promising on the opportunity, or setting irrational expectations on the additional interest to be earned has given indexed products a black eye.
Guarantees with Some Upside Potential
First of all, as an industry we should be promoting guarantees along with “SOME of the upside potential, and none of the downside risk.” Too often we hear these products promoted as if they have unlimited potential for growth. In reality, indexed products provide an opportunity to earn additional interest, linked to an index, without placing any principle or credited interest at risk. However, the potential is limited because there are guarantees involved, and they are expensive to provide. This is especially true in today’s low-yielding bond environment.
In an indexed product, all of the client’s money is held in the general account of the insurance carrier. The insurer then allocates most of the money towards purchasing long term high grade investments to back the guarantees of the contract. They keep a spread on these reliable investments in order to cover their operating expenses, (including sales commissions paid to the agent,) and to generate a profit. Lastly, the money that is left over, typically less than 5 pennies on a dollar, is allocated to hedging the gain of a specific index. This is typically done through the purchase of a European Style option.
Because the options that the carrier purchases cost more than what they have left over to spend, they are limited to the percentage of the option that may be purchased and retained. As a result, the “upside potential” that may be available to the policy holder is limited. Caps, margins, participation rates, or variations on crediting methods such as monthly and daily average methods may be implemented to reduce the cost of hedging the index gain.
The Allocation of Your Client's Money
All of the features of an individual FIA may be divided into one of the three components; guarantees, expenses/profits, and hedging budget. A premium bonus for example is a guarantee. An enhanced withdrawal privilege is a guarantee. Adding a guarantee will take away from the hedging budget and therefore reduce the crediting rates that will determine the customer’s opportunity for additional interest to be earned. A product with an increased commission will result in a similar situation. However, a product with a lower commission or fewer peripheral guarantees provides for more money to be allotted for purchasing a greater percentage of the hedge. This would result in more opportunity for additional interest to be earned by the client.
Ultimately, you want your clients to be successful so that they will give you repeat business and be open to sharing you with their friends, neighbors, family, etc. Creating the right expectations and then delivering on them is a great starting point. In order to set the right expectations, become knowledgeable about the general makeup of indexed products. Then, apply this knowledge to the products that you offer to your customer, looking past the marketing gimmicks and seeing the products’ true colors. This will lead to a more selective approach in determining what you offer to your valued clients.
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