When 2012 arrived, some in the financial services community opined that the era of historically low interest rates was beginning to wind down. But this promising rise didn’t last. In early 2012, interest rates suffered a disappointing retreat, which is particularly challenging for retirement savings options such as money market accounts and certificates of deposit (CDs), which are highly sensitive to interest rates.
Traditional fixed annuities also have struggled due to the continued low interest rates. In fact, total sales of fixed annuities dropped 10 percent in the first quarter, according to a report by LIMRA in April.
The major hurdle to sales of fixed annuities is the prospect of future rising interest rates. Now, more than ever, financial professionals and clients alike are finding it hard to envision rates going any lower. They share the sentiment that rates will rise in the coming year or so, which can make a range of long-term interest-rate-linked instruments, including fixed annuities, seem less attractive at today’s rates.
In response to these concerns, some insurers have introduced new features on their fixed indexed annuities to credit interest if rates rise. Some carriers have introduced interest-rate-based crediting strategies that use a point on a published “swap curve” as the benchmark rate, while another approach provides the fixed indexed annuity owner with credit based upon an increase, if any, in the three-month London Interbank Offered Rate (LIBOR). This index strategy credits interest if the three-month LIBOR rises from one annuity anniversary to the next.
Limits on interest crediting in fixed indexed annuities, such as caps, spreads and participation rates, also may be misunderstood, with clients thinking that such limits somehow boost profits for insurers. Generally, the insurance company purchases hedges to cover the cost of index credits that the annuity owner gets paid. In other words, an insurers’ hedging strategy typically means that they are not impacted by the actual performance of the respective index and don’t get a windfall depending on the actual market performance or interest rate movement.