All posts by fidxix

By Scott Stolz, CFP, RICP

Older annuity contracts likely have more generous payout rates making them a valuable source of income for policyholders.

Older annuity contracts likely have more generous payout rates making them a valuable source of income for policyholders.

When advisors come across an old annuity contract, their first instinct, typically, is to replace it with a newer, more feature-rich, and possibly cheaper one. After all, newer is better, right? Not always.

Old annuity contracts have one very important advantage: They were designed with vastly different assumptions about mortality and interest rates. If the contract is old enough – 15 to 20 years old – these assumptions can be beneficial to the policyholder because the older the contract, the more potentially valuable it is.

For example, despite recent Federal Reserve interest rate policies, rates remain below where they were at the turn of the century. In May 2000, 10-year U.S. Treasury notes were yielding 6.51% compared with “just” 3.6% today.¹ This means that insurance companies were basing their annuitization rates for these contracts at that time on the assumption they could earn much more interest than contracts issued over the last 15 years. This, in turn, means that these contracts likely have much more generous payout rates than offered in the market today.²

Adding to the potential advantage is the fact that older policies are based on older mortality tables. Since life expectancy has increased over time, the older the mortality table that is used, the lower the assumed life expectancy, which in turn generally means a higher rate of annuity income.³

While insurance companies update their mortality tables over time, it can often be many years after the National Association of Insurance Commissioners (NAIC) establishes the latest tables. For example, the 2001 Commissioners Standard Ordinary (CSO) tables weren’t required to be used until 2009.⁴ This means that annuities issued prior to 2009 could have issued with mortality tables created in 1980.⁵

Stop and think about that for a second. Life expectancy in 1980 was just 73.7 years, compared with 76.1 years today.^6,7 But more importantly, think about interest rates in 1980. U.S. 10-year Treasury notes hit 12.86% in March of 1980, before peaking at over 15.5% just 18 months later.¹

The point is that the older the annuity contract, the greater the amount of income the policyholder can likely receive by doing something that very few policyholders actually do – annuitize the contract. Financial professionals should consider contacting the insurance company and asking for an annuitization quote for clients with annuities contracts that are at least 15 years old. I expect you will be surprised at how much income that annuity can generate.

But are there a lot of contracts that old? Haven’t most of them been either cashed out or moved to a newer contract? You’d be surprised at just how many there are. After filtering through the 1 million+ annuities sitting in SIMON from iCapital’s Annuities Platform for contracts issued prior to February of 2008, there were over 240,000, or just under 25%, that are at least 15 years old. Almost 10% are 20 years old or older.

I don’t know about you, but I would have never guessed that there were that many old policies. But, if I stopped to think about it, I shouldn’t have been surprised. A lot of annuities are funded with money the policyholder never really needs; therefore, they just leave the money in the contract to avoid the taxes. They simply don’t realize how valuable the policy could be as a retirement income generation tool. I would suggest you educate them.

Scott is a Managing Director on the Annuities Solutions team. He previously was Head of Insurance Solutions at SIMON Markets LLC, a financial technology company acquired by iCapital in August 2022. Previously, Scott served as the President at Raymond James Insurance Group, where he leveraged his 40 years in the annuities industry to manage the due diligence, sales, and operational functions for annuities and life insurance distribution. A frequent speaker and panelist on any topic related to annuities, Scott has also authored two books on annuities: Unlocking the Annuity Mystery: Practical Advice for Every Advisor (2020) and Rest-Easy Retirement (2023). He received both his MBA and BSBA in Finance from Washington University in St. Louis and holds his CFP and RICP certifications.

Published on iCapital

By Scott Stolz, CFP, RICP

When I began to urge advisors to consider incorporating fixed indexed annuities into their practice back in 2006, I highlighted the importance of keeping the story simple. Specifically, I stressed the need to be able to answer the question: “How did the insurance company calculate the interest they credited to my policy?” To answer this question, I offered a simple solution – stick with one-year cap strategies on the S&P 500 (SPX). Why needlessly complicate things?

Increasingly, advisors are exploring other options within the indexed annuity space. According to Wink’s Sales and Market Report, in the third quarter of 2022, only 44% of fixed indexed annuity sales were in a cap rate strategy tied to the S&P 500 Index.¹ In other words, more than half of all sales were tied to indices other than the S&P 500.

In addition, the Life Insurance Marketing and Research Association (LIMRA) noted in its 2021 Fixed Indexed Annuity Sales and Assets report that only 16% of total sales were allocated solely to a cap rate strategy, while participation rate strategies captured 39%. Another 22% of total sales were allocated to a combination of participation and cap rate strategies.²

Obviously, there are a lot of advisors today who are not following my 2006 guidance. Is it time for me to follow their lead? Let’s take a look at a sample of fixed indexed annuities on the market and see.

Using SIMON from iCapital’s Annuities Platform, we can view the hypothetical performance metrics across one-year indexed terms between April 18, 1957 and March 10, 2023. The best return in any of those one-year indexed terms would have been 11%, or the cap. Since a fixed indexed annuity without a fee cannot have a negative return, the worst return would have been 0%. The average return across all of the observed one-year indexed terms would have been 6.64%. It is also worth noting that 72.31% of the observed one-year indexed terms would have resulted in a positive return, while 27.69% would have resulted in a 0% return.

Since its inception in 1957, the S&P 500 has an average annual return of 10.67%.³ If an indexed annuity policyholder had a 11% cap rate on the S&P 500 for every possible one-year period, the average return over time would have been 6.64%. In a world where protection is a primary goal for many investors, it’s easy to understand the attraction of an expected 6.64% return with full protection of principal. No one should be surprised, therefore, that LIMRA reported that indexed annuity sales hit record levels in the third quarter of last year, and then broke that record in the fourth quarter.⁴

Despite these expected results, I have to admit that it’s time for me to join those advisors who have already moved beyond the simple one-year point-to-point strategies on the S&P 500. My message today is if you have not considered some volatility-controlled indices, the time to do so is now. The rapid increase in interest rates over the course of 2022 has led to a corresponding increase in the general accounts of insurance companies, enabling them allocate more funds to the “options budget” of the indexed annuity and offer more attractive rates across the board.⁵

Volatility-controlled indices also have another important advantage. Since these indices are designed to manage volatility within the index, hedging is much less costly than hedging the S&P 500, according to Barclays’ Index Pricing Model.⁶ In other words, the insurance company can buy more options with less money, given the lower cost of the options. To better understand this concept, compare the cost of buying options on a relatively stable stock, like IBM, compared with a highly volatile stock, such as Tesla – as volatility increases, the prices of options tend to rise.

Participation rates on these indices have become very competitive relative to cap rates. As an example, consider an indexed annuity from Forethought Life Insurance Company, a Global Atlantic Company. It offers a 195% participation rate on a one-year point-to-point on the PIMCO Balanced Index (PIMBAL). While this particular index doesn’t have as much history as the S&P 500, we can observe returns that would have been generated by a 195% participation rate back to the beginning of the century. The results are in Exhibit 2 below.

Using SIMON from iCapital’s Annuities Platform, we can view the hypothetical performance metrics across one-year indexed terms between December 31, 2001 and March 10, 2023. The best return in any of those one-year indexed terms would have been 35.33%. Since a fixed indexed annuity without a fee cannot have a negative return, the worst return would have been 0%. The average return across all of the observed one-year indexed terms would have been 9.28%. It is also worth noting that 85.07% of the observed one-year indexed terms would have resulted in a positive return, while 14.93% would have resulted in a 0% return.

Historically, the current pricing on this strategy would have provided an average annual return of 9.28%, much higher than the 6.64% generated from the S&P 500 strategy with the 11% cap.⁷ In addition, this strategy would have provided significantly more positive one- year returns.

Some carriers now offer the option of paying an annual fee of 1.0–1.5% in order to add to the options budget and, therefore, increase the participation rate even further. For example, consider a fixed indexed annuity from Eagle Life Insurance Company offering 140% participation rate on a one-year point-to-point strategy on the Invesco Dynamic Growth Index (IIDGROW). In exchange for paying a 1.25% annual fee, the participation rate goes up to 220%. Advisors should keep in mind that this is a true fee, therefore, if the index does not increase in price by at least 1.25% during the year, the policyholder would get a negative return of up to … 1.25%. “Zero will no longer be your hero.”

How would these options stack up? Let’s review the data from SIMON from iCapital’s Annuities Platform.

In reviewing the performance metrics, we can observe that paying the annual 1.25% fee would have led to over a 4% greater annual average return per year. However, the trade-off is that in 12.5% of the observed one-year indexed terms, the policyholder would have suffered a 1.25% loss. Is it worth the trade-off? The answer will depend on the individual client’s investment objectives and risk profile. However, it is definitely worth considering.

SIMON from iCapital gives you the data you need to weigh the pros and cons of each option.

Regardless, of whether you stick with the simple S&P strategy or venture into one of the many volatility- controlled reference indices, the current interest rate environment provides an opportunity for investors to lock in attractive fixed indexed annuity rates while managing downside risk.

Scott is a Managing Director on the Annuities Solutions team. He previously was Head of Insurance Solutions at SIMON Markets LLC, a financial technology company acquired by iCapital in August 2022. Previously, Scott served as the President at Raymond James Insurance Group, where he leveraged his 40 years in the annuities industry to manage the due diligence, sales, and operational functions for annuities and life insurance distribution. A frequent speaker and panelist on any topic related to annuities, Scott has also authored two books on annuities: Unlocking the Annuity Mystery: Practical Advice for Every Advisor (2020) and Rest-Easy Retirement (2023). He received both his MBA and BSBA in Finance from Washington University in St. Louis and holds his CFP and RICP certifications.

Published on iCapital