Are Indexed Insurance Companies at Risk in this Down Market?
November 25, 2008 by Sheryl J. Moore
Lately, I have noticed that several uninformed reporters specializing in the securities market are attempting to speculate on the financial stability of insurance carriers offering indexed life and indexed annuity products. Sadly, these individuals not only do not understand the investment strategies and hedging programs that are associated with indexed products, but they do not understand the products themselves. This has resulted in inaccurate, negative publicity during a time when consumers are 100% protected from declines in the market with their indexed insurance products.
This article is intended to set the record straight.
No. Insurance companies offering indexed products are not at risk because the market is diving, and they’re going to have to pay out on their minimum guarantees in the contract.
No. Insurance companies offering indexed products are not at risk because the market is diving, and they’re going to have to pay out a tremendous level of indexed interest a year from now, due to indexed strategies “capping out.”
Insurance companies offering indexed products are no more at risk than any other insurance company during this tumultuous market. Let me give a brief, general explanation of how insurance companies invest the monies used to offer an indexed annuity to address the issue.
Let’s assume that you are Insurance Company XYZ, and you want to offer your clients a 10-year indexed annuity with an annual point-to-point crediting method that uses a cap. This indexed annuity has a minimum guaranteed surrender value (MGSV) of 87.5% of premiums, credited at 3% interest; no premium bonus, a commission of 7% and first-year surrender charge of 10%. You have one dollar to use in your budget for the guarantees and index-linked interest.
So, you use 97 cents of the dollar, and invest in bonds. This assures that you are able to pay out the MGSVs on the annuities you issue, over each ten-year term. You have now covered your exposure to declining equity markets.
Next, you use the remaining three cents to purchase options, which provide the index-linked interest crediting on the indexed annuity products. You go to your option seller, and explain the above product specifications: product term, commission, minimum guarantee, etc. You then indicate that you want to use an annual point-to-point crediting method on the products, and you would like to use a cap to limit the potential indexed interest. The option seller tells you that with those specifications, he can afford to give you a 7% cap on the annual point-to-point method for your three cents.
If the index declines over a one-year period, the option expires and your clients receive zero indexed interest crediting. If the index goes up more than 7%, the difference is moot- you bought an option for a cap of 7%. Any increase in the index up to 7% is passed on to clients in the form of indexed interest crediting.
The beauty of indexed insurance products is that client’s monies are protected by a floor of 0%, should the market decline. However, they receive potentially greater interest crediting than traditional safe money alternatives (such as CDs or fixed annuities). This means that while the people who read the securities trade journals are getting ulcers over the nosediving account balances, the folks who purchase indexed products are sleeping soundly at night. Worst case scenario with an indexed product: 0% crediting. (I’d take that any day of the week, as opposed to losing some of my principal!)
The monies that back indexed insurance products are held in the insurer’s general account, as opposed to a separate account (like securities products). This is one of the main reasons that indexed life and indexed annuities are considered insurance, not investments. The insurance carrier bears the risk, rather than the consumer. However, the carrier also covers these risks, to ensure that they remain solvent. Truly, the guarantees on an insurance product are only as strong as the claims-paying ability of the insurance company offering it. However, no indexed annuity contractholder has lost a penny of their original premium due to an insurance company’s insolvency.
Obviously the insurance industry has seen numerous ratings actions on life insurance carriers as of late. This does not mean that the carriers are insolvent. Insurance companies are strictly regulated by state insurance divisions, which closely monitor these carriers to ensure their solvency, or their ability to pay claims. In addition, every carrier offering indexed annuities is required to become a member of a guaranty association, and contribute to a guaranty fund. This fund ensures that if a member company becomes insolvent, money needed to continue coverage or pay claims is obtained through assessments of other insurance companies offering the same types of insurance as the insolvent company. As it relates to guaranty fund coverage, every state provides at least $100,000 in withdrawal and guaranteed cash values for annuities in which the investment risk is not borne by the individual, according to Advantage Compendium’s SafeMoneyPlace.com.
In short, the market may seem very volatile right now, but there has never been a better time to purchase indexed life and indexed annuity products. It may be, perhaps, the soundest purchase you could make during an unstable market, such as what we are now experiencing.
Sheryl Moore is President and CEO of AnnuitySpecs.com and LifeSpecs.com, an indexed product resource in Des Moines. She has a decade of experience working with indexed products, and provides competitive intelligence, market research, product development, consulting services and insight to select financial services companies. She may be reached at sheryl.moore@annuityspecs.com.
