Index Annuities - Looking Back to Look Forward

by Hersh Stern - Revised Wednesday, November 6, 2024

According to information compiled by Advantage Compendium for the period between 2007 and 2012, the average annualized index annuity return was 3.27%. How does this annual return compare to other investor portfolios over the same time period? Well, the answer depends entirely upon what asset classes, or types of investments, the investor had selected and held.

Over the past five years, investors have endured the mortgage bond crises, the stock market crash of 2008, an ongoing recession and a sluggish economic recovery. Despite this turbulent investment environment, the S&P 500 Index managed to return just slightly to its starting volume point. Indexed annuity products during this same time period produced annual returns ranging from 1.2% to 5.5%.

Moving forward, financial experts anticipate the market for indexed annuities to strengthen. As interest rates remain low, so should caps and index participation rates, ultimately providing an environment for investors to capitalize on future market gains. With this information in mind, which annuity crediting methods are going to be most advantageous to investors moving forward? Let’s take a brief look at each method and how they may impact the underlying investment capital.

Caps

Annuity products offering caps essentially limit the upside potential an investor may experience within the product. For example, an annuity product offering a 2% cap in a market environment where the annualized return ranges from 2.4% to 3.2% would receive a net return of 2%, even though the underlying index outperformed this rate. While this may initially seem disconcerting to the average investor, it should be noted that the returns received are often without market risk and typically greater than the comparative bank offered certificate of deposit (CD) returns. So, while some upside may be sacrificed, the investment at large is considered ‘more secure’ than investments subject to full market risk.

Monthly Cap

Annuity products utilizing a monthly cap crediting system consider gains and losses for each month throughout the year, often placing limits on gains but not losses, to produce a yearly sum number. Products utilizing this crediting method often experience greater market value swings than other cap crediting methods.

Uncapped

Annuities considered ‘uncapped’ often measure market periods that are greater in length; for example, three to five years. Due to these longer time frames, they often offer investors greater participation rates. Assuming the growth of the underlying index is positive over the time frame being measured; uncapped annuities often pose greater opportunity for growth.

Participation in Index Annuities will Increase

Despite pressure for decreased interest rates through 2015, many experts believe both caps and rates will experience a period of increase in the coming months. This welcome upswing - and subsequent annuity payout rates - may be a direct response to carriers anticipating a stronger future than once thought. Investors seeking options that preserve capital while offering some market upside will continue to be attracted to indexed annuity products. Should participation rates remain constant, indexed annuity products are still more favorable than comparable investment products such as CDs, which generally boast lower annual returns.

Ultimately, investors seeking portfolio growth should seek annuity products with strong participation rates or those that are ‘uncapped’.

Click here to see the Real World Index Annuity Returns report by Advantage Compendium.