Why Renewal Rates Are the Secret to FIAs
Today's topic is a good one. How renewal rates are the secret sauce, the secret formula, the secret to fixed indexed annuities.
So let's do a little history lesson on fixed index annuities, the hottest selling product out there in annuity world. Indexed annuities were developed and introduced in 1995 as a CD type product. That's going to compete with CD returns. Indexed annuities are not securities, they are fixed annuities that are regulated at the state level in order to sell index annuities.
Now, indexed annuities are a fixed annuity and can be good or bad depending on what you’re looking for. One of the things about indexed annuities that's confusing to people is what's called the caps, and the spreads, and the participation rates. With indexed annuities, the accumulation value, the gains of the policy is typically calculated using call options. Call options, meaning in English, are betting on the markets to go north. When indexed annuities were first introduced, the S&P 500 was typically the industry that was used, the index that was used to calculate the gains. But here's the catch, with indexed annuities the dividends are never part of the return scenario.
In essence, you're taking a snapshot with indexed annuities from the contract anniversary date to next year's contract anniversary date, and then there's limitations, caps, spreads, participation rates, whatever on those gains, but that's not how it's sold now in the S&P index example. Historically, over 50% of the returns of the S&P index have been dividend based. However, with indexed annuities, dividends are not included. It's just a snapshot from where the S&P was on the contract anniversary date to the current moment.
Most indexed annuities are one year, that one year call option and the spreads, caps and participation rates. I.e. Limitations to the gains. Those can be changed annually at the carrier's discretion without talking to you and without talking to me, Stan the Annuity Man, America's Annuity Agent®. So I always tell people when you buy a 10 year indexed annuity and you're buying it for the gains, you're buying it for the accumulation value. In essence, you're buying a 10 year surrender charge product with a one-year guarantee that caps spread participation rate. Whatever it is on that index call option for that year, leads to the secret sauce, the secret formula, the secret to indexed annuities, and how to buy them properly or do your due diligence. It's all in the renewal rates and what the renewal rights are. That's when the annuity company gets to decide at their discretion what next year's option strategies are and what the caps and spreads and participation rates will be.
Now, that's where the rubber meets the road with indexed annuities. Some companies and carriers have a very good record of being very fair to their customers with renewal rates and either renewing at the same rate that you first got in or a higher rate. However, there are some companies out there that have what I call teaser rates. That first year is really high on the cap high. And then the next year it goes really low. And you're like, "Wait a minute, hold on. I based my decision on this 10 year indexed annuity on these rates that first year, and now second year, they're sticking it to me." Unfortunately it happens. A lot of times, it has to do with the current environment of buying the options, interest rates, etc.
I got a call the other day, a guy said, "Stan, I know that you're not a huge fan of the accumulation value. And you use indexed annuities primarily as a delivery system for income riders." And I said, "You're exactly right. We do that income rider guarantees for future income." He said, "But I want to buy one just for the accumulation value. And I want to make sure that the renewal rates, the company's going to be fair." Although we do know some carriers that have been fair or that have been historically fair on their renewal rates. That doesn’t mean that they are guaranteed.
You want it for what it will do, not what it might do® and the “will do®” are the contractual guarantees.
So there are some companies out there that are very fair on their caps and spreads and participation rates when they go to the renewal rates. This is because every single year with your indexed annuity, these options contract anniversary date, to contract anniversary date, and whatever those gains are, they lock in permanently.
In Your Favor
The hope is you're stair-stepping in locking in gains over time. So every year you're getting a little bit, then the next year, starting at that locked in gain amount. Okay. Sounds great right? It's a great chart to look at if it all works perfectly. The benefit of an indexed annuity is if you lock in this rate this year, then you lock it in this rate next year, then the market goes up from the toilet, you're still here and at that level. You don't go down because it's a fixed annuity and that gain has been locked in. I want to make sure that the renewal rate history is in your favor so that it can continually have the potential to lock in. Now, that goes a little bit against the grain about how I look at annuities.
You want it for what it will do, not what it might do and the “will do” are the contractual guarantees. If you go into an indexed annuity strategy just looking at accumulation value, you must understand that you’re buying it primarily for the principal protection, and also understand that you're going to get CD type returns. If one year is a little bit better, but over time and over the life of the policy blended returns will be CD type returns, then fantastic. Note that the renewal rates play a very, very big role with indexed annuities.
One more thing, never make a decision to buy an indexed annuity on some upfront bonus that's been offered by the annuity company. There's a hundred pennies on the dollar. They're not giving away free money. Nobody's waking up in the morning at the index annuity company going, "You know what I want to give away free money today and I'm going to have to do an upfront bonus." If you're buying an indexed annuity for accumulation value, buy it for the renewal rate history of the issuing carrier.
Never forget to live in the reality, not the dream with annuities and contractual guarantees! You can use our calculators, get all six of my books for free, and most importantly book a call with me so we can discuss what works best for your specific situation.