Maybe you are considering investment in fixed annuities to accumulate for the next few year and then to supply a lifetime income thereafter. Before your final decision you need to check out the renewal rate history of the company offering the annuity. Two otherwise identical deferred fixed annuities that offer the same terms can vary in the renewal rates over time. This can happen because of the following issues.
Fixed annuities are under the jurisdiction of the state's department of insurance. This is unlike the regulations on variable annuities which are securities and thus federally regulated. These state regulations restrict the annuity company's options for investment to ensure that it can meet its fixed annuity obligations. The regulations covering investment for fixed annuities ensures that the company offering the product invests most of the money backing the fixed annuities in bonds.
Note that two fixed annuities can appear identical on the face: the same initial rate, the same surrender charge, the same surrender charges, the same withdrawal features and the same additional benefits. the big difference may be in how each insurance company invest the money that backs the fixed annuities.
When researching potential investments in deferred fixed annuities you might come across two companies that offer the same attractive terms. Both contracts will has the same initial interest rate, identical minimum guarantee rates, the same surrender charge, and lastly identical withdrawal features(fixed annuities). However, once the initial rate period has expired, each company will be free to set a renewal rate at its own investment discretion. You need to understand the factors a company will consider before setting the new rate.
The earnings that an annuity company obtains from its bond portfolio depend on the quality of the bonds and their average maturity. Both these factors are related to risk and, therefore, affect the yield.
In most cases, the better the bond quality, the lower the risk of default. However, the low risk bonds also yield lower interest. Yet another factor that impacts risk is time. Bonds with a longer maturity period usually yield more than bonds with short maturity periods. One can obtain information on the quality and duration of the bond portfolio held by the insurance company by asking for it. The same is true for fixed annuities. We have found that the reports from Vital Signs (a report that your annuity agent should be able to provide you) has a very good disclosure of the insurance company bond portfolio as to rating and maturity.
Companies with portfolios carrying higher risk obtain higher yields as long as the risk they take pays off. They can afford to pay more on overheads, offer better returns on annuities, or keep the greater profits. The choice rests with the company.
For instance, we can consider two annuity companies with bond portfolios that have different average maturities but offering the same fixed annuities regarding all other features. We can hypothetically assume that both yield 4% and other things are equal.
The table below illustrates that annuity company A, which owns bonds with longer maturity, will be trapped if interest rates go up and can only offer a 4% renewal rate. However, if interest rates fall, it can easily maintain the 4% payout on its fixed annuities. Company B, which has short maturity bonds, must necessarily buy to replenish its portfolio. The new rate it offers will reflect the prevailing interest rates at the time of renewal. This can either be beneficial or not depending on the direction in which interest rates move.
A few annuity companies might offer a high 'teaser' initial rate, termed bonus rates, and recoup associated losses by offering significantly lower renewal rates. By reviewing the renewal rate history of companies you will be able to pick the company offering the greatest return on your investment. You can obtain the needed information by asking for it.
Leave a Reply