9 minute read
Capped And Uncapped Annuity Strategies: Weighing The Options
Each of these strategies provides accumulation potential while usually allowing for flexibility and reallocation opportunities.
By Doug Wolff
With the widespread availability of COVID-19 vaccines in the U.S., many investors are hopeful.
But even as savers nationwide continue to gain confidence amid the continuously fluctuating market, how are they addressing fast-moving market volatility? Some strategies have weathered these volatile markets and eased client anxieties of sudden or unsuspected losses.
In particular, fixed indexed annuities have offered many retirement savers stable tax-deferred opportunities with the potential for solid accumulation.
Many FIAs offer savers the ability to choose between capped and uncapped index strategies, with each providing accumulation potential while usually allowing for flexibility and reallocation opportunities on an annual or every other year basis.
Explain Capped Vs. Uncapped
With contracts flooring at zero percent, FIAs give clients solid protection from market loss, along with the potential for accumulation. But can clients be sure FIAs are a viable option for building their savings while maintaining a comfortable level of risk? Advisors must educate clients on the range of FIA options available and ways in which they can take advantage of them.
To guarantee principal in contracts, issuers design options on interest credits through a combination of a variety of account parameters including caps, participation rates and spreads. These parameters include uncapped and capped options. Allocating funds between both options is often a preferred strategy among many advisors and their clients.
A cap is essentially the maximum interest rate your client can earn during the particular index term, regardless of the change in the underlying index. For example, if the cap is 5% and the value of the chosen underlying index rises by 10% during the index term, the cap amount of 5% will be credited to your client’s contract. However, if the index rises only 2%, the contract would only be credited 2%, as that is lower than the cap.
Index crediting methodologies are established using what is commonly called a hedge budget. The hedge budget is set based on the amount the insurance company can earn on its investments less a net interest margin to cover expenses and profit. In this historically low interest rate environment, hedge budgets have been squeezed.
Uncapped strategies typically involve a volatility control mechanism with the target volatility set at a relatively low level (as compared with the volatility of a typical equity index). This lowers the cost of the derivative used to back the index credits and allows the insurance company
30%
20%
10%
0%
-10%
-20%
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S&P 500 Raw Index Return S&P 500 P2P Credit S&P Low Vol Raw Index Return S&P Low Vol P2P Credit
Annualized 20 YR
5.37%
3.30% 5.56%
4.54%
-30%
Depending on the underlying index, different cap strategies will deliver different outcomes. The above example shows returns for the S&P 500 Price Index with a 5% cap1 and the uncapped S&P 500 Low Volatility 5% Index with a 1.5% spread.2 In both cases, a point-to-point crediting strategy (interest is the ending value less the starting value) is used, and the raw index returns are included for comparison. While the raw indexes produced higher average annual returns over time, they also experienced much bigger swings (i.e., volatility). The uncapped index featured solid performance over time but trailed the capped index in some years. The capped index trailed the raw index performance but delivered much smoother returns. In down years, both strategies credited zero, as principal is guaranteed against market loss.
1The 5% cap on the S&P 500 Price Index is an example; the actual cap would depend on many factors, including interest rates, hedge budgets, implied or actual volatility, other product features and expenses, and more. The cap is the maximum amount credited to the account value in that year. 2The 1.50% spread on the S&P 500 Low Volatility 5% Index is an example; the actual spread on the S&P Low Volatility 5% Index would depend on many factors, including interest rates, hedge budgets, other product features and expenses, and more. Each year, the spread is subtracted from the index performance, resulting in the amount credited to the account value (subject to a minimum of zero).
to offer higher interest potential versus having a cap on the interest rate. It also tends to stabilize the cost of the derivative used, and can result in more consistent renewal parameters around index crediting from period to period. A drawback to uncapped strategies is that the volatility control mechanism itself can result in some limits to the index credits.
Capped strategies typically involve indirect exposure to a straight equity index (such as the S&P 500). There is usually less expense built into an index, but a cap is often needed in this low interest rate environment as the cost of the derivative to back the index credits would be too expensive without introducing the cap. This is because the volatility of straight equity indexes is usually higher than the volatility of those that have a built-in volatility-controlled mechanism (like the uncapped strategies).
How And When To Reallocate?
Having uncapped and capped contracts built into a client’s investment strategy gives both the financial professional and the client more options, and flexibility, when reallocating at the end of each FIA’s term.
Advisors often examine the capped amount of a crediting option versus the reduction of return from a participation rate or spread when working with clients to reallocate their contracts. Another consideration is the level of volatility being targeted in an uncapped, volatility-controlled index. Generally, the higher the volatility target, the more exposure to the equity portion of the index a policyholder can expect over time.
An analysis of what underlying indexes are available is another important factor. Advisors can explore various options that derive interest potential from indexes linked to equities, bonds and even commodities. Depending on what their economic outlook is, advisors can adjust client portfolios to match this view, providing even greater diversification potential.
Finally, your clients may also want to consider a guaranteed fixed return option for a portion of their assets. In this case, the interest earned is “capped” at the stated rate but is also guaranteed, usually for one contract year at a time. And in this low interest market, as noted earlier, the fixed return of an insurance contract will likely be considerably higher than what you may be able to find for your clients in other instruments, such as certificates of deposit.
Balancing a well-diversified portfolio that addresses client concerns, while distributing funds across varied allocations in uncapped and capped FIA strategies, can help them accumulate assets across a variety of market conditions.
It’s important to have multiple strategies as options that allow for flexibility in redistribution over time. In addition, it is important to help make sure your clients have a portion of their money in a position where they can still sleep soundly if a drop in the equity markets should occur.
Doug Wolff is president of Security Benefit Life. Doug may be contacted at doug.wolff@innfeedback.com.
Many Uncertainties Over Need For LTC
One of the most vexing concerns retirees face is whether they eventually will need long-term care. And one big unknown is just how many people will need help as they get older as well as how much help they will need.
MARRIAGE = LESS LIKELIHOOD OF NEEDING LTC
14% of single women.
13% of single men.
Source: Center for Retirement Research at Boston College
On one end of the scale, about 20% of today’s 65-year-olds will not need any long-term care during the rest of their lives, and another 20% will need only minimal support, according to the Center for Retirement Research at Boston College.
But on the other end of the scale, about 25% will need significant help for more than three years. Another 38% will fall somewhere in the middle, needing a moderate amount of care for one to three years.
So how do you know who is likely to need help in their later years? Those who remain healthy in their late 60s are the least likely to require assistance down the road, the study showed.
HSA BALANCES UP; CONTRIBUTIONS DOWN
Between 2019 and 2020, health savings account balances increased by $400, but average annual individual contributions fell 2%, and average annual distributions declined to an all-time low of $1,700. That’s the word from the Employee Benefit Research Institute.
EBRI researchers concluded the lower HSA contributions could be tied to employment concerns related to the COVID-19 pandemic, while the declines in distribution could be the result of fewer people seeking routine medical care during the pandemic.
AN UNVAXXED SPOUSE COULD COST WORKERS MONEY
The largest nonprofit health care system in Louisiana is hiking health insurance fees for anyone whose spouse or partner is unvaccinated against COVID-19. Ochsner
Health, which has 32,000 employees, announced it will add a $200 charge to its workers’ health insurance fees if they have an unvaccinated partner or spouse.
Ochsner’s employees are already required to be vaccinated unless approved for a religious or medical exemption. The spousal vaccination is not a mandate, president and CEO Warner Thomas said. Those who are unwilling to get the shot can pay the additional fee or leave the company health insurance plan. About 90% of Ochsner’s COVID-19 hospitalizations since December have been among unvaccinated patients.
Delta Airlines instituted a similar policy in August, adding a $200 increase in monthly premiums for all unvaccinated employees.
The percentage of individuals making contributions to their HSAs was flat between 2017 and 2020, at 50%. The percentage with employer contributions trended down over that time period, from 51% in 2017 to 44% in 2020.
Average annual individual contributions fell in 2020 after reaching an all-time high in 2019, going from $2,041 to $1,995.
AMERICANS STRUGGLE WITH HEALTH CARE LITERACY
The COVID-19 pandemic has led to more people paying close attention to health care, but many still lack the knowledge required to make informed choices about their health plan and care, according to a DirectPath report. Among the report’s findings: Almost one-third (31%) of employees know they have received an inaccurate medical bill in the past three years, yet 52% say they don’t know how to dispute or fix a medical bill.
QUOTABLE
The financial burden of paying for health care — sometimes referred to as ‘financial toxicity’ — is high for older adults in their 60s.
— John W. Scott, assistant professor of cardiac surgery at the University of Michigan
More than half (55%) of consumers don’t know that they can compare treatment or service costs before choosing where to get care, the report revealed.
The survey also showed that among those who have health insurance through their workplace, only 37% take advantage of the available employer resources to learn how to choose and use their health plans. Instead, many people turn to family (24%), friends (14%) or self-conducted online research (34%) to help inform their plan choices.
WORKERS SHOW GAPS IN HEALTH CARE LITERACY
57% of employees report they check if a provider is in network only when they plan to visit a new provider or facility, and 25% do so only when
their health plan changes.
Source: DirectPath
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