How That Annuity Works: Security Benefit RateTrack

Insurers employ big teams of actuaries and investment managers to make complicated products look as simple as vanilla ice cream.

Security Benefit has one example: Its 1-year-old RateTrack Annuity contract, a fixed annuity with rates that can rise with the London Interbank Offered Rate.

(Related: Indexed Annuity Sales on Track to Reach $60 Billion)

The Topeka, Kansas-based company bills the product as an unusual kind of fixed, but floating-rate, annuity product. The product is a fixed annuity. It sounds like an indexed annuity, but with a crediting rate that happens to be linked to Libor, rather than the performance of a stock index.

So, how is the contract different from an indexed annuity with a Libor-linked crediting rate option?

The difference has more to do with the financial machinery inside the annuity than how it looks to the customer, according to Doug Wolff, president of Security Benefit's Security Benefit Life Insurance Company unit.

The current version of the contract is a fixed annuity that offers the purchaser the choice of a 5-year guarantee period or a 7-year guarantee period. Security Benefit Life agrees to pay a base rate throughout the guarantee period, along with an extra amount based on the 3-month Intercontinental Exchange Libor U.S. Dollar rate, or 3-month ICE Libor rate.

Today, for example, the purchaser of a RateTrack contract with a 5-year guarantee could get a guaranteed rate equal to 2.38%. That's the sum of the 1.2% base rate for the guarantee period and the 1.18% 3-month ICE Libor U.S. Dollar rate.

Security Benefit Life will adjust the total crediting rate to reflect changes in the Libor-linked amount at every contract anniversary.

If Libor fell to 0%, or below, the contract holder would get at least the guaranteed minimum interest rate established when the contract was issued.

If the 3-month Libor rate rose over 4%, the extra Libor-linked payment amount would be capped at 4 percentage points. If, for example, Libor jumped to 10%, the maximum crediting rate the holder of a RateTrack contract with a 5-year guarantee could get would be 5.2%.

To support an ordinary indexed annuity with a Libor-based crediting rate option, a life insurer would invest some of the assets in a variety of fixed-rate and floating-rate assets, and use some cash to buy options that mimic the performance of Libor, Wolff said.

The options would help the issuer cope with uncertainty about the future performance of Libor.

Because of the way the RateTrack annuity is structured, Security Benefit Life can simply announce the Libor-linked crediting amount at the beginning of the year, and then invest assets in loans and other instruments with returns linked directly to Libor, without buying Libor-linked options, Wolff said.

The crediting rate strategy means that the underlying assets themselves hedge Security Benefit Life against changes in Libor, Wolff said.

From the perspective of a customer, "it operates just like a fixed annuity," Wolff said. "But it works better for us as a company."

Because the RateTrack contract offers a guaranteed minimum crediting rate,

— Read Rydex Acquired by Security Benefit on ThinkAdvisor.