The ins and outs of index solutions

by Leo Almazora05 Dec 2018

Over the past few years, index solutions have slowly been gaining favour among advisors whose clients seek accumulation potential while limiting risk. Aside from the variety of product types — fixed-index annuities, fixed index-linked universal life insurance, and so on — an exponential increase in the number of benchmarks has also led to a wider variety of options for financial professionals.

Because of the wider variety of options, there’s also been an increase in the complexity of the products. Aside from matching the client’s goals and specific situation, the products also have to be suited to the current economic environment.

“This evaluation requires an understanding of what an index tracks, how the index tracks it and how those factors impact the rates available on a product,” wrote InsuranceNewsNet Magazine contributor Eric Thomas.

Indexes can be differentiated based on whether they track equities, bonds, commodities, or a mixture thereof; they can also be divided further into specific geographies and market sectors. Aside from this, some indexes can also employ techniques like daily asset-allocation rebalancing to maintain a desired level of volatility and growth potential.

After determining what the index tracks, it’s important to determine how an index tracks changes in its constituent parts. There are two common methods: tracking changes to the index’s current price, and tracking changes in its future price.

Unlike “future price” indexes, “current price” indexes do not reflect fluctuations in short-term interest rates and do not include dividends. The inclusion of interest rates and dividends could have a major impact on the rates that will be available for a particular index. “Current price indexes” typically will have the largest change in new and renewal rates available on a contract, while “future price” indexes will typically see more stability on those rates.

“When evaluating the index offerings available on a given contract, you should know if there are options available in terms of ‘how’ the index will be tracked,” Thomas advised.

The interplay of “what” an index tracks and “how” it tracks them has a major impact on the performance, index volatility, and rate volatility changes a client can expect from year to year. Because of that, the different rates — participation rate, cap rate, spread, and so on — available on the index need to be understood. In other words, a 100% par option isn’t always the best choice and doesn’t always offer the greatest growth opportunity.

“A client who chooses the ‘future return’ version should typically expect to see the renewal par rates stay close to the original 100 percent year after year,” Thomas explained. “A client with the ‘price return’ index should typically expect to see the par change more frequently.”

Client priorities can vary from steady predictable credits and renewable rates, to maximizing potential credits while ensuring that “0” is the worst-case scenario. To accommodate that spectrum of preferences and brace for different economic scenarios, it’s often most prudent to consider a diversified approach.

 

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