Which Fixed Annuities Are Best For Renewal Rates?

Note: The Trust Me and Guaranteed Spread Portfolios may be based on a portfolio using a specific group of funds or an overall fund unique in each product.

Renewal rates for products using a specific group of funds will be based upon the money invested at a certain rate or during a certain period of time. Naturally, different groups of funds will have different renewal rates.

By contrast, an annuity with a product fund portfolio provides that all funds earn the same rate, regardless of when deposited. The rate will lag the market. During periods of falling rates, the renewal rates in these products may be higher than new money rates for multi-option portfolio annuities.

Conversely, new money rates rise much faster in the specific-group-of-funds annuities than product-fund annuities.

Agents and clients often ask me for an annuity where they can invest money at todays rates and if rates go up in the future, they will earn the rate offered on new money. (It is implied they are talking about an annuity using a specific-group-of-funds portfolio.) When I tell them there is no annuityor any other investmentthat works that way, they say, "Well, so-and-so said he had one that does." When I say that type would be financial suicide for the issuing company, they hang up on me.

Heres why that scenario is impossible for the specific-group-of-funds annuity:

When an insurer receives $1,000,000 in premium, it invests the money basically to match the duration of the penalty period. Simply stated, if its a 7-year contract, the money is invested for 7 years. Assuming the company earns 8% and credits 6% to the annuity, the company earns $80,000 in interest and credits $60,000 to the annuities.

Next year, rates go up and the insurer can now earn 9% and pay 7% on new money. But, it cannot credit the new 7% on old money, because the old $1,000,000 is still earning 8%. Therefore, the insurer only has $80,000 of old interest earnings to reinvest at the new rate of 9%. Theoretically, the old annuity should earn about 6.07% in year 2. Therefore, it is possible for renewal rates to increase, but it will happen very slowly.

Remember, if the policy uses a product fund portfolio, everyone in that particular annuity will earn the same rate.

So, which is the best type of annuity? It depends. I prefer CD-types because my clients know exactly what they will earn and thats easier to explain than "maybe" returns. Other professionals prefer portfolio rates of varying ilk.

Whatever the recommendation, remember this era has been the lowest rate environment in decades. Everyone knows rates will risebut not when or how high. So, the question of the day is: Lock in a high rate CD-type annuity or accept a lower rate portfolio annuity with the anticipation that rates will rise?

Danny Fisher, CLU, ChFC, is publisher of Fisher Annuity Index, Dallas. E-mail him at [email protected].

Reproduced from National Underwriter Edition, April 30, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.