As the leading wholesale broker-dealer for BGA, IMO, and FMO organizations, we are usually quick to hear about new distribution opportunities pertaining to registered products. Historically, that has been variable universal life and the occasional variable annuity available for third-party distribution. Over the past year, we have begun to see various types of registered annuities become available for distribution with select groups and carriers. If successful, we believe this may open up some new distribution opportunities for the third-party marketplace that we haven’t seen in quite a while.
You may have heard the terms structured annuity, buffer annuity, or hybrid annuity. When these terms are used I also hear cap rates which lead me down the path of an index annuity, or I hear investment risk which results in the conversation heading towards variable annuities.
So, what exactly are these products? Are they index annuities or variable annuities?
The answer is they can be either, depending solely on the investment design of each carrier’s product. In addition to the index options available in these contracts, some carriers have also included sub-account options. With the inclusion of sub-account options, rather than just index options, these contracts are technically considered variable annuities by the SEC even though a client may never use them in that manner. For the purposes of this article I am going to refer to these contracts as registered index annuities.
Registered index annuities got off to a slow start when they surfaced back in 2010, but grew in popularity over the last few years due to a low interest rate environment. The low interest rates called for lower caps on the traditional index annuity products and many investors went in search of something that would give them higher upside potential while continuing to protect against the downside. Registered index annuities were the perfect vehicle. It was an accumulation vehicle with downside protection at low to no cost. It was also a way of investing that they were already familiar with and there were only a few tweaks to the look of the product that they were comfortable investing in.
Today registered index annuities are the go-between product when a client wants better performance than what they can get with an index annuity, but aren’t ready to jump into full market participation without some downside protection. As with everything there is a trade-off, but it might not be as big as you would think.
Index annuities with 100 percent participation in the S&P index are averaging a cap rate of about six percent on an annual point-to-point. The one-year term rate on Brighthouse’s Shield product is currently at 11 percent. The Shield product also has a six-year term product available with a cap rate of 95 percent right now if you use the 10 percent downside protection option. This means you can grow your account by 95 percent over that six year term before the cap kicks in. Given these numbers and a $100,000 investment, the best case scenario over a six year time frame, the index annuity would reach an account value of $141,851.90. Using the six-year term Shield product there would be an account value of $195,000. The tradeoff for this upside potential is that you cannot guarantee that the client will not lose principal. However, you can illustrate using historical data that the likelihood is very low.
Using six year rolling periods from 01/02/1957 -12/29/2017 (660 observations) 94.2 percent of the time the S&P experienced losses of less than 10 percent. That means with the 10 percent buffer option on the Shield product the client would not have lost any principal 94.2 percent of the time. If you were to use the 15 percent buffer option (80 percent cap rate) that number would go to 97.9 percent and with the 25 percent buffer option (55 percent cap rate) 99.2 percent.
Historical data demonstrates that the risk associated with registered index annuities is minimal. Is it possible to lose money in a registered index annuity? Yes, but history tells us that the probability is low. If you are a financial advisor, talk to your fixed and index annuity clients and find out if they are comfortable with the possibility of loss, in exchange for more upside potential. If they are, registered index annuities might be the perfect match. If you are a third party distributor, contact the carriers you are working with to see if there are distribution opportunities that you are currently missing out on.
Source: Bloomberg, January 2018