When will positive interest credits return on index annuities?
By Chris Conklin
Insurance Insight Group
Fixed indexed annuities offer the promise of interest credits linked to the increases of a market index, as well as protection from decreases in that market index.
A key part of the value of fixed indexed annuities is the protection element -- the fact that the annuity owner gets a zero interest credit, rather than a loss in value, for a period where the market index decreases. As a result, some industry sales trainers like to stress the value of that protection by saying "zero is your hero!" And, yes, zero is much better than a loss.
At the same time, though, a positive interest credit is better than zero, and annuity owners have been seeing zeros for quite some time now. So, when will positive interest credits return?
In-force fixed indexed annuities
To answer that question, let's take a look at the recent history of the Standard and Poor's 500 Index, the most common index used in calculating interest credits, and at one-year periods, the most common index measurement period.
The S&P 500 index rose every year from 2003 to 2007. As a result, most index annuities had positive interest credits on their policy anniversaries during that period.
The S&P 500 index ended 2007 at a level of 1,468.36. By the end of February 2009, it had dropped down to 735.09, about a 50 percent decline in just 14 months. As a result, most index annuities had zero interest credits on their policy anniversaries in 2008 and so far in 2009.
However, this year, the S&P 500 index rose about 25 percent from the end of February to the end of June, which at least offers the promise that, sometime soon, we should start to see positive interest credits once again. But when can we expect that to happen?
The answer depends on both where the S&P 500 index goes from here, and what kind of interest crediting method is being used.
Let's assume that the index stays at 919.32 -- its level at the end of June -- for the next 12 months. If so, the last time the index was below that level was the end of November 2008. Thus, fixed indexed annuities using a point-to-point crediting method could see positive interest credits starting in November. Monthly average and monthly cap crediting methods would need to overcome the lower index levels of some of the intervening months. Thus, the first positive index credit on a monthly average crediting method would be in January of next year, and the first positive index credit on a monthly cap crediting method would be in February.
If the S&P 500 exhibits 2 percent growth each month throughout the next year, that moves forward the first positive month by a month or two, to October for point-to-point, November for monthly average, and January for monthly cap.
If the S&P 500 falls 2 percent each month throughout the next year, very few index-linked credits will occur during the next year, with most of them occurring in February 2010, thanks to the dip the index took in February 2009.
What does this mean for you, the producer? For all your clients whose policy anniversaries occur over the next three months, expect to continue to explain the value of the protection offered by their fixed indexed annuities, because absent any extraordinary positive move in the index, your clients will be getting zero interest credits.
New sales of fixed indexed annuities
What should you recommend when you are making new sales of fixed indexed annuities?
Well, one thing we have learned over the past two years is that the index-linked interest crediting on a fixed indexed annuity can go through rather lengthy dry spells. As a result, many producers recommend that clients put at least some of their money in the fixed interest crediting method. In fact, it is not unusual to see an index annuity where all of the money is in the fixed interest crediting method, so that the client has essentially purchased a traditional fixed annuity with the option of moving some or all of the money to an index-linked option in future years.
Regarding the index-linked crediting methods, the reality is that no one can accurately predict the future movement of a stock market index. In fact, if you are not licensed to give investment advice, you should not be discussing your opinion about potential future index movements with your clients at all.
However, remember that the past performance of the index has nothing to do with the index-linked interest crediting on a new sale, or even on a new interest crediting period on an in-force policy, for that matter. So, just because we are in a lengthy dry spell where index-linked crediting methods have not credited interest, that doesn't mean that we'll still be in a dry spell one year from now when these policies come to their policy anniversaries.
When you come right down to it, whether we are in a period where fixed indexed annuities have been experiencing high interest credits or zero interest credits, their value proposition remains unchanged. Fixed indexed annuities offer the promise of interest credits linked to the increases of a market index, while offering protection from decreases in that market index. That means the interest credits have the potential to be quite high, but you have the assurance that they will never be negative. And that protection is a key element explaining why fixed indexed annuities are so popular.
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