I have been asked this question so many times by agents on this board; that I decided to write an intro about it.
So, how does a fixed index annuity work? A Fixed Index Annuity is not an investment in the stock market. Rather, it links your interest to a percentage of the growth of a major market index (not including dividends), typically the Standard and Poor 500 Index, Nasdaq, or Dow are the common indices that are used.
At the end of the year, a Fixed Index Annuity will credit you with all of the growth of the index up to a pre-determined limit. That ceiling might be an annual or a monthly cap, or a percentage of the growth of the index. In other words, if the annual cap were 9% and the index grew 12%, you would be credited with 9% interest for the year and that interest would be added to your annuity and would "lock in"; guaranteed never to be lost, providing that you stick with the terms of the contract.
Your principal is guaranteed against market risk from day one and your interest gains lock in each year on your contract anniversary and cannot be taken away in future market downturns. In other words, you can participate in a percentage of the upside of a major market index, but you are never exposed to any of the downside market risk!
At the end of the year, you will never lose money in the market, because a Fixed Index Annuity is not a stock market investment, but rather it is a fixed financial product backed up by an insurance company with interest gains linked to a percentage of a market index. They are not designed to "beat the market" but to give you a better than average opportunity for a better than average rate of credited interest on your money. As an IMO specializing in annuities; here are several questions that I get inundated with on a daily basis.
WHAT ARE SOME OF THE CONTRACT FEATURES?
Two features that have the greatest effect on the amount of additional interest that may be credited to an equity-indexed annuity are the indexing method and the participation rate. It is important to understand the features and how they work together. The following describes some other equity-indexed annuity features that affect the index-linked formula.
Indexing Method
The indexing method means the approach used to measure the amount of change, if any, in the index. Some of the most common indexing methods, which are explained more in detail later on, include annual reset (ratcheting), high-water mark and point-to-point.
Participation Rate
The participation rate decides how much of the increase in the index will be used to calculate index-linked interest. For example, if the calculated change in the index is 9% and the participation rate is 70%, the index-linked interest rate for your annuity will be 6.3% (9% x 70% = 6.3%). A company may set a different participation rate for newly issued annuities as often as each day. Therefore, the initial participation rate in your annuity will depend on when it is issued by the company. The company usually guarantees the participation rate for a specific period (from one year to the entire term). When that period is over, the company sets a new participation rate for the next period. Some annuities guarantee that the participation rate will never be set lower than a specified minimum or higher than a specified maximum.
Cap Rate or Cap
Some annuities may put an upper limit, or cap, on the index-linked interest rate. This is the maximum rate of interest the annuity will earn. In the example given above, if the contract has a 6% cap rate, 6%, and not 6.3%, would be credited. Not all annuities have a cap rate.
Floor on Equity Index-Linked Interest
The floor is the minimum index-linked interest rate you will earn. The most common floor is 0%. A 0% floor assures that even if the index decreases in value, the index-linked interest that you earn will be zero and not negative.
Averaging
In some annuities, the average of an index's value is used rather than the actual value of the index on a specified date. The index averaging may occur at the beginning, the end, or throughout the entire term of the annuity.
Margin/Spread/Administrative Fee
In some annuities, the index-linked interest rate is computed by subtracting a specific percentage from any calculated change in the index. This percentage, sometimes referred to as the "margin," "spread," or "administrative fee," might be instead of, or in addition to, a participation rate. For example, if the calculated change in the index is 10%, your annuity might specify that 2.25% will be subtracted from the rate to determine the interest rate credited. In this example, the rate would be 7.75% (10% - 2.25% = 7.75%). In this example, the company subtracts the percentage only if the change in the index produces a positive interest rate.
HOW DO THE COMMON INDEXING METHODS DIFFER?
Annual Reset
Index-linked interest, if any, is determined each year by comparing the index value at the end of the contract year with the index value at the start of the contract year. Interest is added to your annuity each year during the term.
High-Water Mark
The index-linked interest, if any, is decided by looking at the index value at various points during the term, usually the annual anniversaries of the date you bought the annuity. The interest is based on the difference between the highest index value and the index value at the start of the term. Interest is added to your annuity at the end of the term accordingly.
Point-to-Point
The index-linked interest, if any, is based on the difference between the index value at the end of the term and the index value at the start of the term. Interest is added to your annuity at the end of the term. WHAT IS THE IMPACT OF SOME OTHER PRODUCT FEATURES?
Cap on Interest Earned
While a cap limits the amount of interest you might earn each year, annuities with this feature may have other product features you want, such as annual interest crediting or the ability to take partial withdrawals. Also, annuities that have a cap may have a higher participation rate.
Averaging
Averaging at the beginning of a term protects you from buying your annuity at a high point, which would reduce the amount of interest you might earn. Averaging at the end of the term protects you against severe declines in the index and losing index-linked interest as a result. On the other hand, averaging may reduce the amount of index-linked interest you earn when the index rises either near the start or at the end of the term.
Participation Rate
The participation rate may vary greatly from one annuity to another and from time to time within a particular annuity. Therefore, it is important for you to know how your annuity's participation rate works with the indexing method. A high participation rate may be offset by other features, such as averaging, or a point-to-point indexing method. On the other hand, an insurance company may offset a lower participation rate by also offering a feature such as an annual reset indexing method.
These methods are also used in determining the rate of interest used in an EIUL (Equity Indexed Universal Life) policy. One of the major differences is that an EIUL has a COI (Cost of Insurance); that must be subtracted off the policy value, before any interest credits are added. If at any time you have any questions regarding the crediting methods or how a particular annuity works; please feel free to contact me. I hope this helps…………………..
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Good job explaining IAs. But just try to explain all or any part of that to a consumer. Add to it the different indexing strategies and the infamous MVA (market value adjustment).
That is why I like income riders with minimum growth guarantees. You can pretty much skip over the rest and talk about the guaranteed growth rather than the "if the market does this or the market does that" that nobody believes these days.
Insuranceexe, Great Post! I learned something from it. I know very little about Annuities, and I'm glad to have you sharing this info with the rest of us.
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Mark Rosenthal aka markingriffin
IMO/Ins Agent/Agent Trainer/Free Advice markcrosenthal@aol.comwww.realfastservice.com
Please visit mywebsite to learn more about me.
Email me for my Free Prospecting MP3 Tapes.
Good job explaining IAs. But just try to explain all or any part of that to a consumer. Add to it the different indexing strategies and the infamous MVA (market value adjustment).
That is why I like income riders with minimum growth guarantees. You can pretty much skip over the rest and talk about the guaranteed growth rather than the "if the market does this or the market does that" that nobody believes these days.
I could not agree with you more. Do you sell any MYGA's? I offer these to my clients when liquidity is more of a concern.
I am sure you would agree that an annuity with a MVA; that was sold between 2003-2007 has a nice positive MVA right now. I have found several people that have an 8% to the plus side; when replacing their annuities. It is also a good time to lock in a lower "indice reading", and try to capture more of the "upside" indice growth.
I am sure you would agree that an annuity with a MVA; that was sold between 2003-2007 has a nice positive MVA right now. I have found several people that have an 8% to the plus side; when replacing their annuities. It is also a good time to lock in a lower "indice reading", and try to capture more of the "upside" indice growth.
Yeah, the upside-down situation with the MVA is something I never thought I would see. the MVA was created to give the insurance company an edge, not the consumer. It is nice to see it working the other way.
As for income riders, basically you give up a half-point or so to have a guaranteed amount of growth added to your annuity investment each year. This guaranteed amount is available for lifetime income (this is not annuitization since you can turn it on and off). These aren't for every consumer, but for the situation where someone wants to let the annuity value accumulate and then take income down the road, you can predict to the penny what the consumer will get in income later. Many of these now have good death benefits as well, so that the beneficiaries get the higher value on the annuitant's death (if the annuitant did not take it all in income.)
As usual, there are bells and whistles and there are some "gothchas" as well. For example, Forethought has a product with a 35% bonus, but the percentage you can take out down the line in income is much smaller than most of the other companies. As a result, the product fits for someone younger who wants income almost immediately (at least one year out to get the bonus).
Aviva and Allianz have much better products for genuine growth and more honest returns when you take income. There are several others, but I am more familiar with the inner workings of these companies' products. For reasons expressed elsewhere, I would probably avoid Aviva right now if I had a choice (and I don't). Maybe North American will take Aviva's place for me as second place seller.
By the way, MVAs violate the nonforfeiture law unless they're in a separate account. Most states just haven't regulated them in 20+ years. NY has its own rule, & MO doesn't permit them in fixed annuities.
Allianz made the decision two years ago to just do away the damn things (MVAs).
Aviva has a 4 page "disclosure" on MVAs you have to go over with a client. It is a scary little piece of work. Glad I won't have to put up with it anymore. Here is one paragraph from the thing. this is followed by a signature for the client to say they "fully understand" the four pages of this sort of stuff:
The beginning 10-Year Constant Maturity Treasury
Series rate assigned to the premium and/or interest
Deducted from the Contract: A = 6.5%
The closing 10-Year Constant Maturity Treasury Series
Rate on the day before the surrender or withdrawal is
Processed by American Investors Life, plus .25%: B = 7.50% + .25% = 7.75%
Complete Contract months before withdrawal charge period expires: N = 144 – 84 = 60
Free Withdrawal amount: 10% x $50,000 = $5,000
Amount subject to MVA: $50,000 - $5,000 = $45,000
MVA Factor: 0.50 x (6.5% - 7.75%) x 60/12 = -.03125
Maximum Negative MVA (refer to MVA Endorsement for
Details of calculation): $12,500
Actual MVA: $45,000 x -.03125 = -$1,406.25
Withdrawal Charge: $45,000 x .06 = $2,700
Cash Surrender Value: $50,000 - $2,700 - $1,406.25 = $45,893.75
Thanks for that intro, insuranceexec! The danger with annuities, including equity indexed annuities, is that it isn’t a one-size-fits-all, risk-free investment vehicle. Consumers looking to purchase one must do their homework and get expert advice. It isn’t for everyone, however if it is a fit it can be a very powerful tool.
Thanks for that intro, insuranceexec! The danger with annuities, including equity indexed annuities, is that it isn’t a one-size-fits-all, risk-free investment vehicle. Consumers looking to purchase one must do their homework and get expert advice. It isn’t for everyone, however if it is a fit it can be a very powerful tool.
Thanks for that intro, insuranceexec! The danger with annuities, including equity indexed annuities, is that it isn’t a one-size-fits-all, risk-free investment vehicle. Consumers looking to purchase one must do their homework and get expert advice. It isn’t for everyone, however if it is a fit it can be a very powerful tool.
Rico
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SaveURRetirement.com
It comes down to suitability and product fitting for the clients needs.
Based on the market performance over the past decade, consumers (especially those who are retired) should really give these more consideration. What irks me is how much negative press and half truths surround these products. Of course, it is mainly perpetrated by those who sell the market.
If you look at the S&P 500 over the last ten years, Feb. 1999 to Feb. 2009, it averaged -5% per year for that period.
Someone investing $100,000 in Feb. 1999 would have about $61,000 left in Feb. 2009.
On the other hand, if they had just put their money into something that even got a lousy 4% compounded for that same period of time, they would have over $155,000 now.
When you put that on a graph, the first thing you notice is that THERE WAS NOT A SINGLE DAY THE MARKET DID BETTER THAN A STEADY 4% COMPOUNDED. Very powerful stuff to show folks why they might want to avoid being in the market.
How an Equity Indexed Annuity Works?
Linear Mode
