Trending
Earlier in the year, LIMRA reported that both fixed and fixed indexed annuity (FIA) sales hit record levels in 2023. Combined, these two types of annuities totaled $286.2 billion, or almost 75% of all annuity sales.1 More recently, LIMRA reported that the surge in these two annuity types remains unabated. Fixed annuity sales were $48 billion in the first quarter of 2024, up 16% over the previous year, while FIA sales set a record of $29.3 billion for the first quarter.2 Just ten years ago, the total sales in these two annuity types was 30% of the annuity market.3
As the baby boomers have marched into retirement, their desire to seek out investment options that provide downside protection has only grown. Combine this need with interest rates that are still near decade-long highs, and you have all the ingredients to push fixed and FIA sales to yet another record in 2024
But this also means that advisors have a choice to make. Do they keep it simple and minimize uncertainty by recommending a fixed annuity guaranteeing 5% annually for five years, or do they add a bit of both complexity and uncertainty and recommend an FIA with a 10% one-year cap rate strategy on the S&P 500? To answer this question, an advisor must better understand the trade-offs.
For the FIA, capturing all of the positive price changes of the S&P 500 over a one-year period up to the 10% cap certainly sounds like an attractive alternative to a 5% flat rate offered by the fixed annuity. But as you can see from Exhibit 1 below, the price of the S&P 500 drops on average one of every four 12-month periods. In those years, the client will earn 0% from the FIA. And in some years the market will be up, but by less than the 10% cap. So, what type of return can one expect from a 10% cap? Or put another way, how high of a cap would lead one to choose an FIA with a higher, but unknown return, over the known and certain 5% annual return provided by a fixed annuity?
Fortunately, if you have a history of all of the S&P 500 (SPX) oneyear returns, this becomes just a math problem. As an example, let’s view the hypothetical performance metrics across one-year indexed terms for an FIA with a 10% cap rate on SPX using iCapital’s platform for annuities
Using the iCapital platform for annuities, a user can view the hypothetical performance metrics across one-year indexed terms between December 31, 1964 and May 14, 2024. The best return in any of those one-year indexed terms would have been 10%, or the cap. Since a fixed indexed annuity without a fee cannot have a negative return, the worst return would have been 0%. The average return across all of the observed oneyear indexed terms would have been 6.28%. It is also worth noting that 73.8% of the observed one-year indexed terms would have resulted in a positive return, while 26.2% would have resulted in a 0% return. Of course, this information is only helpful if a particular product has a 10% cap. Scanning through the nearly 115 FIAs on the iCapital platform for annuities, a user can find one-year point-to-point strategies on SPX with cap rates as low as 5% and as high as 11% — and pretty much every rate in between.4
Let’s compare the average rate of return across one-year point-to-point strategies on SPX for cap rates from 5% to 11%. As shown in Exhibit 2, a cap rate of 8% or more is required to provide an average rate of return of more than the 5% that can be earned on a fixed annuity.
Considerations
The final question for an advisor becomes, how much of an expected return differential does an investor need to choose an FIA over the fixed annuity. Mostly, this will depend upon the risk profile of the investor. While both products provide 100% downside protection, the fixed annuity has the advantage of knowing the return will be a flat rate per year, regardless of market conditions. Some investors highly value this certainty. However, less conservative investors would likely be willing to accept some uncertainty for the opportunity to earn a higher return. Advisors should also factor in the following when evaluating an FIA:
1. The historical average return will most likely differ from the actual return.
2. The initial cap rate is not guaranteed in subsequent years. A reduction in the cap rate upon renewal can lead to significantly lower returns than modeled above.
3. Most FIAs have a surrender charge period of seven years or longer, which can be a longer holding period than a fixed annuity.
Summary
One can think of the return on a fixed annuity as the annuity world’s “risk-free” rate of return. Therefore, an advisor should consider an FIA over a fixed annuity only if the expected return is sufficiently above this rate to adequately compensate the investor for the added risk and uncertainty that comes with the FIA. But, choosing between these options becomes difficult, if not impossible, without the means to properly analyze the data. In the past, advisors had limited tools to properly analyze this trade-off. However, with the iCapital platform for annuities, advisors now have access to the tools and the data they need to assess the pros and cons of each option.
Related: Confessions of an Indexed Annuity Purist
1. LIMRA, Record-High 2023 Annuity Sales Driven by Extraordinary Growth in Independent Distribution, March 12, 2024.
2. LIMRA, U.S. Annuity Sales Surge to Strongest First Quarter Ever, April 25, 2024.
3. Saltzman Associates, Annuity for Banks, Regionals & Wires Roundtable, May 2024.
4. iCapital, as of May 29, 2024.
IMPORTANT INFORMATION
The material herein has been provided to you for informational purposes only by Institutional Capital Network, Inc. (“iCapital Network”) or one of its affiliates (iCapital Network together with its affiliates, “iCapital”). This material is the property of iCapital and may not be shared without the written permission of iCapital. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of iCapital.
This material is provided for informational purposes only and is not intended as, and may not be relied on in any manner as, legal, tax or investment advice, a recommendation, or as an offer or solicitation to buy or sell any security, financial product or instrument, or otherwise to participate in any particular trading strategy. This material does not intend to address the financial objectives, situation, or specific needs of any individual investor. You should consult your personal accounting, tax and legal advisors to understand the implications of any investment specific to your personal financial situation.
ANNUITIES ARE CONSIDERED COMPLEX PRODUCTS AND MAY NOT BE SUITABLE FOR ALL INVESTORS. The information is not intended as investment advice and is not a recommendation about managing or investing retirement savings. Actual annuity contracts may differ materially from the general overview provided. Prior to making any decision with respect to an annuity contract, purchasers must review, as applicable, the offering document, the disclosure document, and the buyer’s guide which contain detailed and additional information about the annuity. Any annuity contract is subject in its entirety is to the terms and conditions imposed by the carrier under the contract. Withdrawals or surrenders may be subject to surrender charges, and/or market value adjustments, which can reduce the owner’s contract value or the actual withdrawal amount received. Withdrawals and distributions of taxable amounts are subject to ordinary income tax and, if made prior to age 591⁄2, may be subject to an additional 10% federal income tax penalty. Annuities are not FDIC-insured. All references to guarantees arising under an annuity contract are subject to the financial strength and claims-paying ability of the carrier.
iCapital Markets LLC operates a platform that makes available financial products to financial professionals. In operating this platform, iCapital Markets LLC generally earns revenue based on the volume of transactions that take place in these products and would benefit by an increase in sales for these products.
The information contained herein is an opinion only, as of the date indicated, and should not be relied upon as the only important information available. Any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets is not necessarily indicative of the future or likely performance. The information contained herein is subject to change, incomplete, and may include information and/or data obtained from third party sources that iCapital believes, but does not guarantee, to be accurate. iCapital considers this third-party data reliable, but does not represent that it is accurate, complete and/or up to date, and it should not be relied on as such. iCapital makes no representation as to the accuracy or completeness of this material and accepts no liability for losses arising from the use of the material presented. No representation or warranty is made by iCapital as to the reasonableness or completeness of such forward-looking statements or to any other financial information contained herein.
Securities products and services are offered by iCapital Markets, an SEC-registered broker-dealer, member FINRA and SIPC, and an affiliate of iCapital, Inc. and Institutional Capital Network, Inc. These registrations and memberships in no way imply that the SEC, FINRA, or SIPC have endorsed any of the entities, products, or services discussed herein. Annuities and insurance services are provided by iCapital Annuities and Insurance Services LLC, an affiliate of iCapital, Inc. “iCapital” and “iCapital Network” are registered trademarks of Institutional Capital Network, Inc. Additional information is available upon request.
© 2024 Institutional Capital Network, Inc. All Rights Reserved. | 2024.06