What Causes Participation Rates for Index Annuities to Drop?
Index annuity rates, including renewal rates, are affected by bond yields and option hedging prices. For these products to qualify as fixed annuities, they must have a return element guaranteeing that at the end of the surrender period the annuity’s value will at least be equal to 90% of the original premium with interest compounded at 3.0% (some companies offer higher minimum returns than this requirement). To protect this minimum guarantee insurance companies invest in bonds and leave a portion of the funds to buy the options that provide excess interest. When bond yields fall, however, more dollars need to be invested in bonds in order to preserve the minimum guarantee. This, in turn, leaves less money to buy options.
In recent years, we have been in a declining interest rate environment. With the lower interest rates, more pennies of each dollar must be allocated to bonds. With fewer pennies to buy options, participation rates have to fall – unless option prices also decline. But rather than falling, option costs have actually increased. Option costs are affected by market volatility, which has accelerated and caused them to increase dramatically. Renewal rates have also been affected by declining bond yields, which leaves less money to purchase options. That combined with an increase in option prices has resulted in lower participation rates and/or cap rates.
Adapted from an article that appeared in the August 1999 issue of Newslinc, a marketing newslettter published by Lincoln Benefit Life Company.
Last Updated: 9/23/2012 10:05:00 PM