Absorbing market volatility
Despite a 1,000+ point gain in the S&P 500® Index between March 2009 and August 2013,1 some investors seem hesitant to put money at market risk with nearly $8 trillion sitting in cash.2 As the 2013 Allianz Investor Market Perceptions Study shows, wealthy Americans are reluctant to risk their money in todayís volatile markets with approximately 80% of respondents saying they believe the market will continue to be volatile as they prepare for retirement, and nearly six in 10 (59%) noting market volatility as one of the top three economic concerns having an effect on their retirement outlook.
Part of this hesitation to invest also comes from a lack of available financial products that help meet their needs for asset accumulation and protection. Nearly a quarter (23%) of respondents said a lack of retirement products offering a balance of growth opportunity and loss protection was preventing them from investing idle cash today.
The insurance industry has been listening to these concerns and some insurers have responded with the index variable annuity (IVA) – a new breed of variable annuity that may be a fit for consumers who are willing to trade some potential gains from market growth in exchange for a level of protection from down markets.
IVAs offer a variety of investment and protection choices. Companies in the industry currently offer a level of protection from the first 10% to 30% of losses. Some IVAs also offer full principal protection, similar to fixed index annuities (FIAs). A popular investment choice in the IVA increases the amount of annual index return potential by declaring much higher limits (or caps) on the interest credit coming from the growth of an equity index allocation option, for partial protection against the first 10%-30% of losses. This is referred to as a buffer (described later in this article). While there is a level of protection from some downside risk, if the negative index return exceeds the buffer, there is risk of loss of principal. This is a fundamental shift for accumulation choices among variable annuities.
The variety of investment choices available on IVAs in the industry includes index allocation options and traditional variable investment options. Keep in mind that any investment in variable investment options does not provide any protection against loss of principal, and money that is allocated to the variable investment option could be lost. The index allocations available in IVAs do not directly participate in any stock, bond, or other investments. Clients are not buying any bonds, or shares of a stock index. The cap offered for new contracts which determines the return potential can generally vary as frequently as monthly and can experience significant highs and lows. Industry cap rates of IVA products have ranged from 3.50% to 16.00% annually with contractual minimums as low as 1.50% annually. Some product designs offer additional full market protection for the death benefit in exchange for an additional fee or a lower return potential. In addition, contracts are available with a variety of fee structures. Some products have an explicit annual fee and others apply a withdrawal charge if surrendered within the first five or six years of investment.
All of these options on IVAs allow clients to customize their contracts based on their individual accumulation objectives and risk tolerance, helping people to build a portion of their retirement income or savings. Because IVAs are meant to assist with asset accumulation and provide a level of protection, they also offer a possible solution for those seeking more return potential than they may get from bond funds.
1 S&P 500® Index, historical data.
2 JPMorgan, 2nd Quarter Market Insights, as of March 31, 2013.
Assumptions: All hypothetical historical examples shown throughout this document do not represent any specific IVA investment. They illustrate one example utilizing one constant declared cap and buffer rate with one index allocation choice. There are other factors to consider with each of the index allocation choices. These hypothetical examples show conceptually how the cap and buffer might work in different market index environments and assume no change in the declared cap. They do not predict or project the actual performance of an IVA. Although an external market index or indexes may affect your values, the index allocation choices do not directly participate in any stock or equity investments. An allocation to the index allocation choices is not a purchase of shares of any stock or index fund. These examples also do not reflect annual product fees and charges or withdrawals, nor do they consider taxes. If they had been reflected, results would have been lower.