Over the past couple months, the news cycle has been blasting headlines about interest rate cuts. Well, the Fed reduced rates in late July—the first time in over a decade. And now they're hinting to another rate drop. We know a rate cut means insurance carriers will reduce fixed rates offered on annuities. But what happens when rates bounce back? And what do you need to know now so you and your clients can plan ahead and better leverage future opportunities?
Fixed-rate annuities, rider roll-up rates and fixed indexed annuities
For clients who currently own fixed-rate annuities, their rates aren't impacted when there's a rate change. The annuity value is determined by the initial premium and accumulated interest on funds not withdrawn. This is then compounded at an interest rate contractually guaranteed by the issuing company.
The more interest rate the company can earn on its investment portfolio, the higher the rates it can offer to policyholders for income rider roll-up rates and/or lifetime payout percentages. Keep in mind, however, that even in a rising interest rate environment, there is a lag for increased rates offered to policyholders. They generally realize smaller, incremental increases instead of dramatic changes.
Fixed indexed annuities are marketed as having the upside benefit of the stock market without the downside risk. But as you know, the returns are capped. So even when the market rises significantly, you’re probably only getting a fraction of the return. Also, unlike investing in a broad-based stock market index where 40% of the return over time typically comes from dividends, indexed annuities are based only on the price of the underlying index. Annuity clients don’t receive any of those dividends.
Rising interest rates and disintermediation risk
When interest rates begin to rise, so does the risk that clients will sell their existing annuities early on to reallocate those funds to investments that may perform better. In response to the threat of disintermediation risk, some carriers have created annuities with specific features to help clients realize some value from a higher interest rate environment.
One newer fixed annuity product ties interest crediting to current three-month LIBOR rates. Then it resets the crediting rate on the annuity anniversary date over a five- to seven-year period. This type of annuity typically has a base crediting rate and supplement credited interest based on the LIBOR rate. It also usually has a cap on earnings and a minimum guarantee.
Some carriers have developed riders that can be attached to a base annuity that offers a one-time increase to the credited interest rate based on the 10-year Treasury rate. Others companies offer annuities that track performance to an equity index and a bond index to alleviate market volatility.
To learn more about these types of products, call us at 866.866.7050. We can help you stay two steps ahead and plan now for different interest rate scenarios.