Rates for Fixed Annuities
Fixed annuities have regained their prominence as a secure retirement vehicle that can see people through volatile markets and uncertain economic conditions. As such, there is a renewed interest in the rates for fixed annuities and how they are determined. When people move money towards safety and stability their focus turns towards the whole marketplace of fixed yield vehicles with an eye towards capturing the most competitive rates available.
How Rates are Determined
As a fixed yield investment, fixed annuity yields are often compared with yields offered in other safe savings instruments such as CDs, savings accounts and money market funds. Yields on fixed annuities, which are issued by life insurers, are determined much in the same way as banks determine the yield on CDs. There are three components that factor into the rate: the investment performance on the institutions portfolio, the current interest rate environment, and the length of time of the deposit.
A bank or life insurer is able to pay interest on deposits largely because they make money on the use of your money. Banks use deposits to fund loans while life insurers primarily invest deposits in their own general account to manage a return on investment. The better they perform, the more stable the yields they provide on deposited money. Stronger performance can also translate into more competitive yields, however, banks and insurers tend to take their cue from the current interest rate environment.
Current Interest Rate Environment
The fixed yield marketplace is vast and very competitive, so it is important for banks and insurers to be very sensitive to the movement of short and long term interest rates. If long term rates on bonds begin to rise, it can adversely affect the performance of loans and investment portfolios. In order to protect their portfolios from potential losses, they need to be as accurate as possible in predicting the direction of rates and make adjustments to yields and investments accordingly. This why you will see CD rates move up and down frequently. These rate movements, for both banks and insurers, are made with an eye towards the competition. If their portfolio performance has been good, they may be able to afford a higher rate to beat the competition.
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Length of Time
The length of time of deposit is also a big factor in that when bank or insurer knows that they will have a longer use of your money, they can afford to take a little more risk in order to achieve a better return on their portfolio. For a life insurer, this may mean investing in longer term, higher yielding bonds (insurers are restricted to investing in quality grade bonds). Banks might invest in larger capital projects that can yield more return. This is why a 5-year Jumbo CD offers a higher yield than a 1-year CD. Fixed annuities deposits are long term assets so insurers can invest for long term yields.
Fixed annuity rates, on average, tend to be a little higher than corresponding rates on CDS. This is because a bank’s loan portfolio is likely to be more interest rate sensitive than the bond portfolio of an insurer. Plus, by achieving the right mix of bonds that includes high yielding, long-term bonds, an insurer can achieve higher yields.
Different Rates for Different Annuities
Insurers determine yields differently depending on the type of fixed annuity and the way the accumulation account is structured. Most traditional fixed annuities offer a high current rate that is guaranteed for one year. After the first year, the rates are determined based on the three components discussed above. There is usually a minimum rate guarantee which offers protections against severe interest rate declines. Higher rates may also be available when larger lump sums are deposited.
Like banks, insurers also offer a fixed annuity that can secure an interest rate for a fixed period of time. Some even refer to it as a CD-type annuity. Fixed rate periods of 5 to 10 years can be selected for which the funds are guaranteed a fixed rate. These annuities require a lump sum deposit and larger deposits may also earn a higher rate of interest.
A more recent entrant in the fixed annuity field is the index-linked fixed annuity. The rate on this type of annuity is tied directly to a stock index. The insurer is not directly investing in stocks, rather it tracks a particular index of stocks and the return that is generated on the group of stocks. It then applies that return as a yield. If the index increases so too does the yield credited. Conversely, if the index decreases, the yield credited drops proportionately. There is an upper cap on yields as well as a lower cap. The upper cap limits the upside of yield increases while the lower cap protects you from severe market declines and ensures a minimum amount of growth on your funds.
Fixed annuity rates are as competitive as most other fixed yield investments with some types offering more attractive yields than others. Having a basic understanding of how rates for fixed annuities and their variations are determined will ensure that you select the right type that is most suitable for your situation.
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