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Life Health > Annuities > Fixed Annuities

The Time to Buy a Fixed Indexed Annuity Is Now

By Sean A. Ruggiero

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What You Need to Know

  • Rates are up.
  • The regulations are strong.
  • If rates fall, that could also be good.

It is my obligation as a financial professional to offer clients the financial product and plan that best suits their unique situation.

In many instances that plan can include a fixed indexed annuity (FIA), and it’s important that all financial professionals know something about them.

Whether it is as a bond alternative, or a safe haven for an IRA, FIAs have grown in popularity.

They are a fantastic tool for those who seek protection of principle, upside gain potential, and the ability to generate guaranteed lifetime income.

So, why is now the best time to purchase an FIA?

To answer that, we need to understand a bit more about how FIAs are constructed.

What’s in an FIA?

The indexed part of fixed indexed annuities is referring to market indexes that represent the performance of the stock market.

To be clear, FIAs are not direct investments in the stock market.

No, insurance companies primarily purchase a derivative investment, known as a call option, tracking a certain index.

If the index goes up, the option is executed at the strike price and any gains from the option are credited to the FIA.

If the index goes down, the option is worthless, but the FIAs principle stays intact.

That said, where do insurance companies get the money to purchase these call options for their FIA products?

Risk Management

We must remember that FIAs protect the client’s principal.

An insurance company creates a hedging plan to manage its risk associated with an FIA.

An insurance company allocates client funds primarily into low-risk investments (this speaks to the safety and security of entrusting your money with an insurance company).

These low-risk investments generally provide a return, and that return provides the budget for the call options to be purchased.

These low-risk investments, such as U.S. Treasury bonds, are not only desired, but in many states required.

It’s the responsibility of the National Association of Insurance Commissioners to develop model rules and regulations for the industry, which generally must be approved by state legislatures.

The NAIC strengthened solvency regulation in the 1980s, through an accreditation program that requires state insurance departments to meet certain standards.

The accreditation program also established minimum capital requirements for insurers.

Monitoring of the financial health of insurance companies is also accomplished through detailed annual financial statements that insurers are required to file, as well as periodic examinations of insurers.

It’s a function of safety.

State regulators do not want to replicate what happened to one provider in the early 1980s, when insurance company investments were not regulated as closely.

As a result, certain companies poured more and more of their clients’ money into riskier investments in an attempt to gain a competitive edge.

When the market turned, these investments proved cancerous, and the company was sent into receivership because it was unable to keep up with its financial obligations.

Strict regulations at the state level help keep the reputation of annuities and client trust intact.

It’s a good thing.

So, if an insurance company’s budget for purchasing call options is largely limited to whatever its return on low-risk investments is, then the payout of such low-risk investments is critically linked to how an FIA will perform.

The Bond Market

Let’s dissect the U.S. Treasury bonds a bit more and start by comparing the U.S. Treasury yield curve from Sept.18, 2020, and Oct. 31, 2023. The yield is substantially higher now than it was just three years ago in 2020.

Focus on the 10-year Treasury bond. Why the 10-year?

When insurance companies contract a new annuity, they attempt to line up the investments with the surrender period as best as possible.

This helps ensure that they can offer the same participation rate, cap or spread that they offered when the contract was issued for the duration of the surrender period.

Contrary to some conspiracies I’ve heard, an insurance company does not want or intend to “bait and switch” participation rates for their clientele.

Although they reserve the right to change participation rates, caps and spreads each year, it’s something they’re desperate to avoid.

That’s why they look to get a guaranteed yield when they issue an annuity for the duration of the annuity’s surrender period, which is commonly 10 years.

Now, compare what a 10-year Treasury bond paid in 2020 at 0.70% and what it pays in 2023 at 4.88%.

This guaranteed yield is almost 700% higher in 2023.

This is a direct reflection of the Federal Reserve’s attempt to quell inflation by raising the overnight funding rate.

Therefore, this is an advantageous time to purchase an FIA because the insurance company has so much more yield in their budget to work with.

However, that’s only part of the story.

The Economic Environment

We would have to rewind nearly 20 years, back to 2007, if we wanted to find ourselves in an economic environment where an insurance company had the same budget they have now to purchase call options.

But there is one distinct difference between 2007 and today.

The yield curve was not inverted in 2007, which indicates there was no recession predicted, and certainly no warning that the stock market was going to crash in 2008.

The S&P 500 in October 2007 was at a high of 2,282.

Following the crash of 2008, it didn’t recover to that previous high until October 2013 — a span of six years! Yes, we are dealing with our own potential recession in 2023, but the inverted yield curve today suggests that we are probably not going to be caught off guard.

Any hit to the stock market is likely priced in already.

How severe will the recession be? Are we avoiding a recession?

We don’t know for sure, and there is no crystal ball, but I believe there is a very strong likelihood that we are not going to replicate what happened in 2008.

The one thing we can assume with a high degree of certainty is that the Fed most likely will want to start to cut rates in the presumably near future.

Based on guidance from Federal Reserve Chair Jerome Powell, many experts believe that the Fed will begin to cut rates in 2024, with more aggressive rate cuts in 2025.

As history has demonstrated, when rates come down, the stock market usually goes up.

If Rates Fall

Why is now the time to purchase an FIA?

Let’s summarize.

First, we could see a recession and potential market losses from where we are at the time of this writing.

With that in mind, protecting your wealth is paramount — and an FIA can help do just that.

Second, 10-year Treasury yields are the highest they have been in nearly 20 years, which is creating some of the highest participation rates and caps inside FIAs that we have ever seen.

Third, we are likely to see rates cut over the next six to 18 months, which will close this window on high yields and drive the stock market up.

So, purchasing an FIA now will likely result in very positive index returns within the first few years of your FIAs surrender period.

To have a little fun with it, let’s think about the S&P performance since 1995 (around the time the first FIA was created), and what a 60% par rate, with no fee, and no downside participation (which is obtainable from an A-rated company as I write this), would look like to someone who owned it.

When you eliminate the down years and participate in 60% of the up years, you average just over 9%.

Talk about jaw dropping.

Contrast that with the actual S&P price returns (with risk) of 11.52%, and it’s easy to see why this is such an attractive opportunity.

Do I believe that an FIA is always the best product for a client?

Absolutely not. Every client, advisor and agent will have to determine when and if an FIA is suitable as part of a well-diversified portfolio and financial plan.

But if your client is nearing retirement, in retirement, or simply looking to allocate a portion of wealth into a risk-free financial tool that can have great return potential and be converted into guaranteed lifetime income, then a fixed indexed annuity should be at the top of the client’s list — and the best time in history to purchase one might very well be now!

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Sean RuggieroSean A. Ruggiero, CEP, RICP, WMCP, NSSA, is an investment advisor representative, a licensed insurance producer and national director of annuity distribution at Integrity Marketing Group.

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