Persistently low interest rates may have created a challenging environment for annuity carriers in recent years, but many clients remain deeply skeptical about the prospect of returning to the more volatile equity markets. Indexed variable annuities (IVAs), while developed to help insurance carriers manage risk more accurately, can represent the perfect solution for these market-shy clients.
IVAs—known to some as structured annuities—offer clients an investment alternative that can provide the stability and many of the product offerings associated with annuity products but also the potential for participation in any equity market gains. However, they also offer substantial downside protection to cushion against potential investment losses.
Indexed variable annuity basics
Although known by several different names and subject to a broad range of potential product features, an IVA is essentially an annuity product where investment returns are tied to the performance of one or more stock indexes (e.g., the S&P 500 or the Dow Jones). Unlike straight equity investing, however, the product itself offers a cushion against investment losses in exchange for a cap on the potential for investment gains.
The carrier may offer 10 percent, 15 percent or 20 percent (or more) buffers against investment losses, meaning that if the underlying investments generate a loss, the insurance carrier absorbs a set percentage of that loss before the client experiences any loss. As such, if the chosen index declines, for example, by 10 percent and the client has chosen a 15 percent buffer, the client's account value will decline only by the 5percent loss that exceeds the contract's downside protection.
However, as a trade-off for the downside protection afforded by these contracts, participation in the linked index's gains will be subject to a cap for a fixed term of years. Despite this, the term of years can be as short as a single year for some contracts, allowing the client a degree of flexibility that he might not otherwise find available in a fixed indexed annuity product. Further, some contracts provide for an upside cap that fluctuates annually — or, in some cases, as frequently as weekly or monthly.
Some insurance carriers even offer products that cover 100 percent of the downside risk of the investment, but these carriers also set the upside caps on these contracts at a lower percentage (in some cases, as low as 1.5 percent) that resets frequently (for example, every two weeks).
