Are Hybrid Annuities too Complicated?

A common complaint leveled at hybrid annuities is that they are too complicated and have too many moving parts. The Annuity Guys®, Dick and Eric, discuss why many folks in the media and investment world like to hobby-horse this point while missing the real reasons why these financial products work so well as a foundational allocation in thousands of retirement portfolios. The secret is “the non-moving parts otherwise known as contractual **guarantees.” [continued below video]

 
Contractual Guarantees – absolute **guarantees, no-moving parts.

Hybrid/Fixed Index Annuities – allow for upside potential of specified moving parts in addition to absolute contractual **guarantees.

Income Rider – addendum to an annuity contract **guaranteeing a future lifetime income plus additional benefits in some income riders (this is a contractual **guarantee).

Features, Benefits, and Facts:

1. Annuity Owner Remains in majority control of the annuity’s cash account value during the surrender term and has 100% control after the surrender term.
2. Full account value of the cash account passes on to heirs with no surrender or penalty charge.
3. Guaranteed growth in deferral **guaranteeing a minimum future income. Example: Initial Premium $100,000 + 5% bonus **guaranteed growth of 7.2 percent deferred for ten years = $210,000 income account value producing a of $12,600 per year at age 70 with a single life payout.
4. Payout percentages from the income account are based on age and a single or joint income need. Example: age seventy single payout 6 percent or joint payout 5.5 percent
5. Fees for riders can be based on the cash or income account value and are charged to the cash account. Fees typically range from half of one percent (.5%) to one and a quarter percent (1.25%). This does not reduce the **guaranteed growth of the income account.
6. May have a death benefit allowing the income account if it is larger than the cash account to be distributed to heirs over a five-year period.
7. May have an increasing income as an inflation hedge.
8. May have a Long Term Care Benefit.

Index Strategy Moving Parts:

(Index examples: *S&P 500, *Dow Jones Industrial, *Trader Vic (Commodities), *Barclays Capital Aggregate US Bond, and literally any third-party index may be specified as a measure for crediting interest).

 
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Uncapped Index – the full percentage of earnings growth on an index to be applied as interest to the cash account value and income account value.

Cap – limits the percentage of earnings growth on an index to be applied as interest to the cash account value and income account value.

• Positive Example:  3% Cap *S&P index is up 10% for the year interest credited is 3%.
• Negative Example:  3 % Cap *S&P index is down 10% for the year interest credited is 0%.

Spread – a fee based on a percentage subtracted first, only when index earnings exist. Any earnings are applied as interest to the cash account value and income account value. If there are no earnings the spread is never applied.

• Positive Example: 3% Spread *S&P index is up 10% for the year interest credited is 7%.
• Negative Example:  3% Spread *S&P index is down 10% for the year interest credited is 0% the spread is no longer applicable.

Participation – allows a percentage of index growth to be applied as interest to the cash account value and income account value.

• Positive Example:  30% Participation *S&P index is up 10% for the year interest credited is 3%.
• Negative Example:  30% Participation *S&P index is down 10% for the year interest credited is 0%.

Average – allows the average index growth to be applied as interest to the cash account value and income account value over a specified period of time.

• Positive Example:  *S&P index is at 100 at the beginning of the year and it fluctuates up and down between 110 and 100 for the year with six months of the index being at 110 and six months at 100. The average annual interest credited is 5%.
• Formula:  (110+100+110+100+110+100+110+100+110+100+110+100)=1260/12=105-100 = 5%
• Negative Example: *S&P index is at 100 at the beginning of the year and it fluctuates up and down between 100 and 90 for the year with six months of the index being at 100 and six months at 90. The average annual interest credited is 0%.
• Formula:  (90+100+90+100+90+100+90+100+90+100+90+100)=1140/12=95-100 = -5%

Capped Monthly Sum or Average – allows for adding together each months index growth limited by a cap to the upside with no limit to the downside in any month being subtracted from the cumulative total. Cumulative earnings to be applied as interest to the cash account value and income account value over a specified period of time.

• Positive Example: *S&P index is up 12% for the year, however; six months were 0% earnings and six months were 2% earnings each. The monthly cap is 1%, the annual interest credited is 6%.
• Formula: (0% x 6 months = 0%)+( 1% x 6 months = 6%) = 6%
• Negative Example:  *S&P index is up 12% for the year, however; six months were negative 2% earnings and six months were 4% earnings each. The monthly cap is 1%. The annual interest credited is 0%.
• Formula: (-2% x 6 months = -12%) + ( 1% x 6 months = 6%) = -6%

Blend – combining a specified percentage of account value to an uncapped index for earnings growth with a specified percentage of account value based on a fixed interest portion. Then add all gains and any losses to determine the interest to be applied to the cash account value and income account value.

• Positive Example: *S&P index is up 10% for the year; 50% of the blend is an uncapped index and 50% of the blend is a fixed rate of 2%. The annual interest credited is 6%.
• Formula: (10% x 50% = 5%)+( 2% x 50%= 1%) = 6%
• Negative Example: *S&P index is down 10% for the year; 50% of the blend is an uncapped index and 50% of the blend is a fixed rate of 2%. The annual interest credited is 0%.
• Formula: (-10% x 50% = -5%)+( 2% x 50%= 1%) = -4%

 
Fees – are typically associated with optional riders. Fees are subtracted from cash value accounts not affecting income **guarantee accounts. Fees may reduce principal in years with no interest earnings. (some rider fees are specified as a spread and do not lower cash account value in years with no interest earnings).

Here are a few Index Strategies using various time periods and combinations of the components discussed above:

Annual Point-to-Point with a Cap

Annual Point-to-Point Average with a Spread

Annual Point-to-Point Monthly Average or Monthly Sum with a Cap

Annual Point-to-Point with a Participation Rate

Biennial Point-to-Point with a Biennial Cap

Quadrennial Point-to-Point with a Quadrennial Blend

Five Year Point to Point with an Uncapped Non-Correlated Commodity Index

Hybrid Annuity Case Studies

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*Disclosure: All examples are hypothetical for conceptual for educational purposes.The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The NASDAQ Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is not possible to invest directly in an index. TVI, TVI Index, Trader Vic Index, EAM Partners L.P., and EAM are trademarks of EAM Partners L.P. (“EAM”). The Trader Vic Index™ was created and is owned by EAM. EAM developed, maintains and is the sole party responsible for the methodology that is employed in connection with the Trader Vic Index™. The Barclays Capital U.S. Aggregate Bond Index is comprised of U.S. investment-grade, fixed-rate bond market securities, including government, government agency, corporate, and mortgage-backed securities. Barclays Capital and Barclays Capital U.S. Aggregate Bond Index are trademarks of Barclays Capital Inc. (Barclays Capital). NYSE Group, Inc. (NYSE:NYX) operates two securities exchanges: the New York Stock Exchange (the “NYSE”) and NYSE Arca (formerly known as the Archipelago Exchange, or ArcaEx, and the Pacific Exchange). NYSE Group is a leading provider of securities listing, trading and market data products and services. The New York Mercantile Exchange, Inc. (NYMEX) is the world’s largest physical commodity futures exchange and the preeminent trading forum for energy and precious metals, with trading conducted through two divisions – the NYMEX Division, home to the energy, platinum, and palladium markets, and the COMEX Division, on which all other metals trade. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information.

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