With the recent stock market volatility, many clients are looking for a safe haven with a realistic return.
Every month, the Genesis Group (the people who invented the FIA) prepares a back-test showing a true “range of reality” for equity indexed products.
This is not a “slice in time” comparison chosen to make a specific product look good. These results are based on issuing a hypothetical policy every business day for the last 30 years – approximately 7,800 iterations. Then, calculating the annualized rate of return for the policy purchased on the best and worst day over the last 30 years. They also illustrate the average of all these iterations.
One of the reasons we believe in the balanced allocation annuity (BAA) design is that the “engine” is significantly more efficient. If you throw away the best column as an aberration, a BAA policy purchased on the absolute worst day over the last 30 years outperformed the average of all the competition. The average for the BAA design is over 45 percent better for the client compared to traditional FIA designs! You may be asking yourself, “How can they do this?”
First, you need to understand the basic mathematics behind all FIA designs. The chart below is an over simplified illustration of what happens with every FIA. Once the company pulls its profit and funds to cover the contractual guarantees, the remainder (in this example, 1.5 percent) is what is left to buy the options on the index.
Insurance Company Portfolio Yield (6 percent) - Insurance Company Profit (2.00 percent) - Policy Guarantees (2.50 percent) = Money to Buy S & P Options (1.50 percent).
As interest rates increase or decrease, the funds allocated toward options will also increase or decrease.
The next thing to consider is option pricing. The two main factors that drive the cost of options are:
1) Term of the option (1-year, 2-year, 4-year, etc.). Traditionally, the shorter the term, the more expensive the option.
2) Volatility of the underlying security. The more volatile the index, the more expensive the option.
Traditional annual reset design products are based on 1-year options (the most expensive) in a volatile marketplace (the most expensive). That is why you are seeing significant reductions in caps and participation rates for these product designs.
In comparison, the new technology used in a BAA with a 2-year option strategy is more efficient. Based on recent studies by the Genesis Group, there is over a 25 percent price differential (efficiency) between one 2-year option and two concurrent 1-year options. And, since all BAAs are priced daily that means over the same 2-year term, there are 730 days you can get current account values instead of two. Again, the newer technology is much more efficient.