Annuities are ‘Yellen’ for a rate hike

The stock-market gurus seem to have already priced in the Fed’s anticipated rate hike this week, but the annuity industry has its fingers and toes crossed with the hope of higher interest rates creating more sales through better contractual guarantees.

Everything is political

The interest-rate argument and decision is the ultimate political football. Senior citizens and retirees are clamoring for higher rates and reminisce about Jimmy Carter CDs they used to buy at their local bank. Most politicians see it only as a barometer for votes.

With over 90 million Americans now out of the workforce, and the economy limping along, there is really no valid argument, in my opinion, for rates to rise. However, I will be the first one to cheer if the Fed goes against current statistics.

As we all know by now with rates, nothing is a done deal. In a recent column by Ben White at Politico, he pointed out that Hillary Clinton backers aren’t thrilled with a possible rate hike because they think it will somehow hurt her chances for the presidency. Go figure.

Lifetime income = mortality + interest rates

Even though different annuity types contractually solve for specific goals like legacy and principal protection, the majority of annuity strategies revolve around lifetime income. Sadly, most people are unaware that annuities are the only product on the planet that will pay regardless of how long you live. The trendy definition for this contractual solution is called solving for “longevity risk,” and should be the only benefit proposition that annuity industry promotes.

Regardless of the type of annuity, the lifetime income-stream guarantee is a combination of return of principal and interest. Even though life expectancy is the primary pricing mechanism, interest rates do play a secondary role. So if the Fed raises rates, then annuity contractual guarantees will improve.

How rising rates will affect specific annuity types

For multi-year guarantee annuities (MYGA), which are similar to a CD in function, if rates rise, the contractually guaranteed annual yields will increase as well. Single-premium immediate annuities (SPIA), which some would say are the best contractual solution for “income now,” will also have higher guaranteed payouts if rates increase.

For a deferred-income annuity (DIA), structured like an SPIA, but solving for “income later” needs, payouts will also be better with higher rates. Qualified-longevity annuity contracts (QLAC) — this is a DIA (aka: longevity annuity) — but for a traditional IRA or 401(k), will see help for payouts as well with a rate hike.

An Income Rider is an attached benefit that you can add to select variable and indexed annuities at the time of application to use for future income guarantees. Higher interest rates will raise the annual crediting percentages on income riders.

For a variable annuity (VA), guaranteed contractual minimums will increase along with attached income-rider guarantees.

Fixed-index annuity (FIA) — the overhyped indexed annuity product — will also benefit from an interest-rate increase with their guaranteed contractual minimum return and any attached income rider. Even though FIAs were designed for CD-level returns, their index option strategies could also be more preferable with a Fed rate hike. However, even with higher rates, you will still get CD (not stock market) type returns.

Timing strategies are futile

I typically advise against anyone trying to time interest rates when considering the purchase of annuities. However, I have made a one-time exception because the Fed has indicated a definite decision this week. For the throngs of people who have been trying to time rates for the past three years, this week’s decision might be your holiday gift.

With that being said, never forget that annuity companies have the big buildings for a reason. There are some really smart math geeks in those marble corridors that are pricing product guarantees to entice you into placing your money with them. They are constantly solving for and offering contracts to address the questions you are asking when it comes to interest rates, regardless if they are up or down.

There’s a fly in the mortality ointment

Even if rates rise, life expectancy tables are expected to change across the board on 2016 to reflect you living to an older age. That means annuity payments will be longer, and in turn, lower. Sorry to be such a downer, but this is a fact that you need to be aware of when considering an annuity purchase right now. In other words, interest rates aren’t the only item for consideration.

Carrier response is the big unknown

So if Janet Yellen’s Fed does raise rates this week, the big unknown is the reaction time of annuity carriers to adjust their contractual guarantees. It’s a competitive annuity world that is trying to attract your transfer of risk money, so one carrier change will definitely trigger their competitors to follow.

It will be interesting to see what happens with the Fed’s decision. The interest-rate ball is in your court, Ms. Yellen. Let’s hope it’s an easy layup for you.

Originally published by 12.15.15 –