How do
you choose what is best for you?
To begin with, you
should understand the basic designs and features of
indexed annuities...
(see definitions below
of some "key" phrases and terms if need be)
Long
Term Point-to-Point
If, for example, the
last day of the Long Term Point-to-Point term falls at “Point
A”, below the initial start point, it is a
“loss”, and as such, would register a “zero” for the
index term. In such an event, the minimum guaranteed
value for the term would be paid. If, on the other hand,
the term ended at “Point B”, which is higher than
the initial start point, then a gain would be registered
for the index term. The Average End design, sometimes
referred to as the “Asian End” design, is a type of Long
Term Point-to-Point design.
This is possibly the most basic type of equity index
method
As the name implies,
there are only two days in this index calculation
method, the starting point and the ending point. For
example, if Point A (the starting point) is 500 on an
index and Point B (the ending point) is 550, then an
unadulterated or pure Point-to-Point method would
register a gain of 10 percent. The calculation is as
follows:
(550
- 500)/500=50/500=1/10=10%
That number would then
be multiplied by the participation rate to determine the
index gain for that period.
For
Example: .85 X 10%=8.5%
So far, two pure
Point-to-Point basic designs have emerged, the “Annual
Point-to-Point” and the “Long Term Point-to-Point”. In
the classic unadulterated version of the Long Term
Point-to-Point index method, the only days that count in
the index gain calculation are the first day (the issue
date) and the last day of the index term. Whatever the
market did in between is IRRELEVANT. Only
the first and last day of the entire index term count.
AVERAGE END
A significant variation
of the Long Term Point-to-Point design is the “AVERAGE
END”design. (The Average End is sometimes referred to as
the “Asian” End.) With the Average End, instead of
having one day at the end, there are a series of days,
usually weekly or monthly, to establish the end point
for determining gains. Thus, the odds of one bad down
day are somewhat diffused. In each case, the average
index level of the days in question is calculated to
come up with an ending point value.
Example: Average End
Like Long Term
Point-to-Point designs, if the average of the Average
End falls below the level of the initial start point, a
“zero” is registered, and “minimum” guaranteed values
would be paid. If the averaged ending point is “above
the line” of the initial start point, a gain is
registered.
Long
Term Point-to-Point
Here is a
picture of the typical Long Term Point-to-Point zones
for counting gains.
Educational
Illustration (Typical “Long Term Point-to-Point zones
for counting gains)
As this
illustration makes clear, it simply does not matter
where the market has been, except on the last day of the
index term, when the Long Term Point-to-Point method
“matures”.
This
illustration depicts both “Long Term Point-to-Point” and
“Average End” designs (where an ending average
substitutes for only one day - in each case the result
is the same - one final ending point). In this
illustration, only the third gain (Point A - above the
line of the initial start point) counts. It is the
difference between the starting point and the ending
point. (Of course, “Ending Point B” would be a loss,
resulting in a “zero”, which means payment of guaranteed
minimum values). The first gain and the second gain are
“excluded”. Also, you could make a case that the first
two of the three gains in this illustration are a
retracing of the final gain (looking back). One way or
another, both of the first two gains illustrated are
“Zone #3” gains. There are also two instances of “Zone
#2” gains, where gains occur below the initial start
point, but again, they do not count.
The Average
End Method is exactly the same as the Long Term
Point-to-Point method, except that the end point will be
an average of numbers taken over final weeks or months.
The design and the basic idea is highly similar
variation.
HIGH WATER
ANNIVERSARY MARK, LOOK-BACK
Another
index type is the “HIGH WATER ANNIVERSARY MARK,
LOOK-BACK” design. With this design, an Annual
Point-to-Point method is used to recognize and lock-in
the annual index values. At the end of the term or index
period, the highest anniversary value of a gain
is used to compute the total index return for the index
term.
Example: High
Water Anniversary Mark, Look-Back
Pick the
highest anniversary mark above the initial start
point (there is no annual reset of start point), and
that anniversary index value for that day is the index
value that is compared to the initial start point for
the purpose of determining gain for the full index term.
In other words, at the end of the term you “Look-Back”
to pick the highest anniversary. In the above example,
the end of year 5 is the highest (high water)
anniversary point above the initial start point.
Multiply the result of that fifth anniversary point by
the participation rate and a final index return is
derived.
There is a
common misconception relating to “High Water Mark”
designs, as they are often called. The misconception, is
that “High Water Mark” means that the highest point
during the year is selected. Although it is
theoretically possible to do this, a significantly lower
participation rate would be required than current
designs guarantee. That is why we refer to these designs
as “High Water Anniversary Mark” instead of “High Water
Mark”, so there is less possibility of misunderstanding
the actual method used, which, in fact, only counts days
on the policy anniversary.
HIGH WATER
ANNIVERSARY MARK, LOOK-BACK
Logically,
the odds of zone #1 gains occurring are about equal in
the traditional ups and downs of the market to the
combined zone #2 and zone #3 gains. Here is a picture of
the typical “HIGH WATER ANNIVERSARY - LOOK-BACK”
zones for counting gains.
Educational
Illustration (Typical "High Water Anniversary Mark,
Look-Back" zones for counting gains)
In this
classic example, the High Water Anniversary - Look-back
design potentially registers three gains during its full
term. However, only the highest of the three gains above
the initial start point (looking back) is the measure of
the full gain for the index term. Smaller retracing of
gains of the type shown (zone #3), and gains below the
initial start point (zone #2) do not count towards the
final index result in this design method. The “High
Water Anniversary - Look Back” design does not count
Zone #2 gains below the line of the initial start point,
or Zone #3 gains that retrace gains made in previous
years.
Typically,
in today’s interest rate environment (1997) High Water
Anniversary Mark, Look-Back designs have participation
rates well below one hundred percent. Two of the more
well known designs are currently at 70% and 75%,
respectively. As a generalization, it would be fair to
say that the High Water Anniversary Mark, Look-Back
design tends to be associated with participation rates
at the lower end of the participation rate spectrum.
Annual
Point-to-Point, with Annual Reset
This design
in all its variations, counts gains by the year,
recognizes those gains, and locks them in so that they
are not lost in market down-turns. All three zones of
gain are counted.
Example: Annual
Point-to-Point, with Annual Reset
Year 1 gain +
Year 2 gain + Year 4 gain + Year 5 gain + Year 7 gain=Total
Gain
Thus, you
can see, that Annual Point-to-Point designs of greater
than one year generally have an annual reset of the
starting point feature. Gains are registered below the
initial starting point, which can be about half of the
total possible gains. Also, all annual gains are added
or combined together for a term total, as opposed to
Long Term Point-to-Point, Average End, or High Water
Anniversary Mark, Look-Back designs, where ONLY ONE
point is derived from the index formula, and then a
number and an effective annual yield are calculated.
Annual
Point-to-Point with Annual Reset
Educational Illustration
(Typical Annual Point-to-Point, with
Reset, zone for counting gains)
As you can
see ALL UPWARD MOVEMENT, whether above or below the line
of the initial start point potentially counts
towards gains due to the presence of the annual reset.
When you consider gains below the line of the initial
start point, (“Zone #2”) as well as gains above the line
that retrace zone #1 gains above the line (“Zone #3”),
there is a MAJOR potential difference in zones of
counting gains. Also, these gains, as recognized in
each year, are combined into a final total
return, even if some of those gains are retracing
previous gains from previous years. For example, it is
not entirely improbable that gains between, for example,
500 and 550, could be recognized, locked-in, and
combined together two or even three times in one index
term. In summary, with Annual Resets, all three zones
are counted so that you get “correction protection” and
“recovery recognition”.
DEFINITIONS
As we begin describing
basic design types, here are a few practical working
definitions that will be used.
CAP: A "cap" is
a maximum percentage limitation on the earnings as
defined by the EIA index formula. There are a several
products, all with reset features, that have “cap” rates
between 12% and 15% annually. All “capped” EIAs we have
seen so far have the annual reset feature and the
“combine all the years’ gains” feature (versus one
anniversary mark or one point to determine the gain for
the entire index term).
PARTICIPATION RATE:
A percentage amount, which may be guaranteed either by
the year or for the policy index term, which is
multiplied times the percentage gain of the index
formula. For example, an index formula might yield an
annual gain figure of 10%, which is then multiplied by a
participation rate of either 80% or, in another EIA,
110%, to yield 8% and 11% respectively, in terms of the
calculation for that year.
STARTING POINT:
or “index starting point” is the index level on the
starting date or issue date of the EIA policy. It is the
base-line number from which gains or losses are measured
the first year, where there is an annual reset feature,
or for the term of the index if there is no annual reset
feature (eg. Annual Point-to-Point or High Water
Anniversary Mark, Look-Back designs).
ANNUAL RESET (of
starting point): The Annual Reset of starting point
feature is a reestablishment of the starting point for
gain calculations, annually. This is largely of
importance if the market goes down and closes on a year
below the initial start point. This annual reset feature
allows gains below the initial starting point to be
recognized and locked in for the customer, which does
not happen without a new lower start point. For example,
a policy is issued at an index level of 500, but the
year closes at an index level of 400. The following year
the index moves back to 490. With an annual reset, the
new annual start point was 400 (instead of 500) so gains
from the second year's move from 400 to 490 were
recognized. Without a reset, no gain occurs unless and
until the index passes the 500 mark, potentially at some
time in later years. For example, if there were no reset
feature, and the index moved from 490 at the end of year
two to 550 at the end of year three, then the gain from
500 to 550 would be recognized. However the gain from
490 to 500 during that same year would not be recognized
since it occurred below the line of the initial starting
point (at issue) of 500.
INDEX PERIOD or TERM:
This is the length of time during which the owner has
earnings linked to the index, and it is the time frame
for the final index gain calculation for the term of
that annuity contract. At the end of the term, various
options are offered, which differ by company.
RECOGNITION OF
EARNINGS: By the terms of the policy, a gain
calculation is completed and noted or recognized.
LOCK-IN OF EARNINGS:
By the terms of most contract designs, the gains are not
only "recognized", but they are guaranteed at that
level, that is, they are "locked-in". Locked-in earnings
cannot be lost by subsequent declines in the market
index.
ZONE FOR COUNTING
GAINS: There are three potential zones for counting
gains possible amongst the various designs:
- Zone #1. gains above
the initial starting point,
- Zone #2. gains below
the initial starting point, and
- Zone #3. gains
“retraced” over zone #1 gains of earlier years of that
index term, or gains excluded by definition.
“AUTOMATIC
ROLLOVER”: This is an end of term provision in some,
but not all EIAs. When this feature is present, the EIA
owner is limited to a relatively short period of time
(similar to a Certificate of Deposit) to decide whether
or not to recommit to the next term. Typically, this
window of time is 30 to 60 days. If no notification is
received by the Home Office, the default option is to
enter another equity index term, with newly declared
participation rates, caps (if applicable), etc. and new
surrender provisions. Normally, the new term is the same
as the first term.
One of the major areas
of confusion among agents is the calculation of various
values within the EIA design. Specifically, it is
important that you understand that various contractually
defined values such as:
- Full Index Value,
- Surrender value
during the term or at maturity,
- Minimum Guaranteed
Account Value,
- As well as values at
death, annuitization, nursing home or terminal illness
values etc.
All these items may be,
and usually are, calculated independently of each other.
For example, Minimum
Guaranteed Account Values are often calculated based on
90% of premium, plus 3% interest. Simultaneously, full
index values are based on 100% of premium plus potential
defined gains from the index formula. Both exist
simultaneously, but do not directly relate to each other
in this example. Your ability to specifically understand
EIA values depends on understanding this point.
Basic
Types of EIA Indexes
According to one
industry authority, over ninety (90) different designs
of EIAs have been identified, although many of these
design possibilities will never be incorporated into a
design that is filed and brought to market. Among the
basic design types already in existence, Long Term
Point-to-Point, High Water Anniversary Mark, Look-Back,
and Annual Point-to-Point with Annual Reset are the main
types. These types will be defined and explained in the
balance of this article.
click
here
for free quote
|