One year ago the number of fixed annuities available with a surrender charge term of less than five years could be counted on one hand. Today there are over 40–and they are better than ever.
What’s the Deal?
As can be seen in Chart 1, the short-term market has become marketable and competitive for two reasons:
The yield curve is comprised of short and long bond rates. Typically, the longer the bond, the higher the interest rate. The Federal Reserve can influence very short rates, but longer duration bonds are only influenced by market conditions. Theoretically, if the Federal Reserve increases the Federal Funds rate, then this increase spreads through the entire bond market—but it takes time. The one-year will react quicker than the five-year, the five-year will react quicker than the 10-year, etc.
Since 2017, the “short” rate (three-year for this example) and the 10-year rate have both increased. This increase has allowed insurance carriers to offer more competitive products for all durations. However, the short rate increased over 1.25 percent while the 10-year only increased 0.49 percent. Currently, there is only a 0.16 percent difference in the three- and 10-year rates. This flattening of the yield curve has allowed short products to rightfully stake their claim in the market. Insurance carriers who are closely monitoring interest rate trends and have flexible product filings are well positioned to act quickly in this emerging market.
Why Does This Matter?
Short products have three advantages over their longer counterparts:
Clients prefer shorter product offerings if they can receive meaningful benefits. During the persistently low interest rate environment of 2009-2016, there wasn’t enough yield to pass on meaningful accumulation benefits for products shorter than five years. Fixed rates of one percent just aren’t that exciting to talk about–even if those rates are still better than what’s offered in bank CDs.
Short products afford clients the flexibility to react to life’s changes. A wedding of a child, an unexpected illness or a surprise trip commemorating a lifetime milestone can be planned for. Flexibility means the client maintains more control of the nest egg that he or she worked so hard to accumulate over the years.
2) Positioned well for rising interest rate environment
Interest rates have been at all-time lows and are now increasing. We don’t know how steeply or how quickly rates will increase, but they will go up. Why lock in historically low interest rates for a long period of time? Why not be positioned to quickly adapt as the market moves with the yield curve? Short products allow the client to earn competitive interest rates now while still maintaining the flexibility to pivot to competitive products as yields increase.
Insurance carriers price annuities based on what bonds can be purchased today. When the client buys an annuity, he or she locks in today’s interest rates because the carrier locks in current bond rates. As bond rates increase, rates offered by insurance carriers increase as well. Longer-duration (10+ years) interest rates tend to increase slower than short rates. When the Federal Reserve actively increases short rates, there is the possibility that a short-lived inverted yield curve may occur. This occurs when short rates are higher than long rates. Short products position the client to take advantage of this type of environment and position the agent as a trusted advisor. It’s a no-lose scenario. If rates rise, the client wins. If rates remain low, nothing has been lost by going short.
3) Credibility builder between insurance agent and client
Annual reviews build the agent-client relationship. Annual reviews that include good news and require new decisions cement the relationship. What better position for an agent than to inform the client that they earned an industry-leading guaranteed interest rate for two years. The surrender charge term is now over, the client’s funds are 100 percent liquid, and the client can now choose to earn a higher interest rate if he or she would like. This kind of discussion leads to a lifetime client.
Let’s consider a sample client who is 65 years old and would like to earn positive interest credits without risking any losses until her life expectancy of 85. What is a good 20-year product strategy in today’s rising interest rate environment? Should she go with two 10-year products or mix in some shorter products? This example assumes standard products, no premium bonuses and standard street commission percentages.
Interest Rates Stay Flat
Assume that interest rates do not change and the yield curve stays flat over the next 20 years. Whether the client purchases two 10-year products (Option 1) or a five-year, 10-year and another five-year (Option 2), there’s essentially no difference to the agent or client over this 20-year period. At the end of 10 years, the agent and client can decide if a different product strategy is appropriate. This is summarized in Table 1.
Interest Rates Increase
Assume that interest rates continue to increase over the next 20 years. Being positioned to capitalize on higher rates affords the client the opportunity to adapt and earn a higher effective interest rate for the 20 years. In this example, today’s five-year and 10-year annuity rates are assumed to be flat at 2 percent. Five years from now, interest rates increase, so Option 2 takes advantage of the increase by locking in three percent for 10 years. Option 1 has to wait until year 11 to lock in this rate increase. As can be seen in Table 2, the client could have earned an annual effective interest rate of 3.0 percent instead of 2.5 percent by mixing in some short products. At the end of five and 15 years, the agent and client can reevaluate the product strategy.
Product Features that Work Well in Increasing Rate Environment
Flexibility, flexibility, flexibility! Products with surrender charge periods or windows of five years or less are ideal in today’s flat interest rate environment. It’s no coincidence that very strong two to five year products are currently available. Many of these products automatically include free withdrawal and death benefit provisions. For longer products, the following features should be available for the client to react effectively to the changing rate environment:
Today’s short market is very competitive, and it’s not going anywhere. Insurance carriers that are on top of things will offer competitive short products because they see the value that can be brought to the agent and client. Unless interest rates decline, short products position the agent and client to react quickly and effectively in an increasing, flat or inverted yield curve environment. Based on today’s yield curve, short products should be considered when developing client accumulation strategies. The inclusion of short products allows the agent to provide a flexible and current strategy, cementing the value he or she brings to the client.
ASA, MAAA is director of product development at Equitable Life & Casualty Insurance Company. For the last 15 years, Freeburg has specialized in fixed and fixed indexed annuity product development. She enjoys working closely with insurance agents to ensure that products offered by insurance carriers are relevant to current agent and client needs. Freeburg can be reached by email at [email protected]