How can an Indexed Annuity offer a Participation Rate above 100%?
When your money gets to the Insurance Company, they are going to make some purchases.
Fixed/Guaranteed product to stabilize the guarantee they make to you. Usually a bond or treasury, or both.
The fixed product produces a return that the Insurance Company can use to purchase an Option that is linked to the Index you have chosen.
The Option has a cost to it that can change on a day-by-day basis. The cost fluctuations are controlled by the Volatility of the Index. Volatility measures the amount of activity in the Index. If there is more activity, like all things we buy, the price will go up because the Index is in demand. The opposite is true if the activity is low.
Options can also be purchased at a higher Participation Rate. If the Participation Rate is higher, the cost of the Option is higher. If Volatility is very low, the Option can be purchased at a Participation Rate that is higher for the same cost as if the Volatility is higher and the Participation Rate is 100%.
What exactly is “Volatility Control”?
Volatility Control is when an Index movement is controlled by a mathematical equation that limits the movement up and down. This will slow down and lower the possibility of high returns, but it also lowers the cost of the Index. If the cost is lower, the rates the Insurance Company offers will be higher. So, the question becomes do you want potentially higher Index movement with lower Insurance Company rates, or lower movement with higher Insurance Company rates.
Why do my rates sometimes go down?
Each year an Indexed Annuity is recalculated and re-priced. The pricing is based on major factors and minor factors. The three major factors are Bonds, Treasuries and Volatility. The balance of the annuity is placed into Bonds and Treasuries. The interest from the Bonds and Treasuries are put into “Options” that are linked to the Index that is chosen. If the rates on the Bonds and Treasuries are down, then there is less money going into the Options and the Insurance Company will have to lower their rates. The Options have an upfront premium that has a fluctuating cost linked mostly to Volatility. Volatility measures the activity in the Option. If there is a high level of buying and selling of the Option, that means the demand for that Option is high. Just like anything we buy, if demand is high, the price goes up. If Volatility is up, the cost of the Option goes up and that means the Insurance Company rates have to be decreased.
Should I pay a fee to raise my Participation Rate?
The best way to answer this question is with an example of another financial product that has been around for over a century, a mortgage. It usually makes sense to “pay a point” and buy-down your mortgage interest rate. This is the same situation, but instead of buying down a rate, the rate is being bought-up. Typically, if an Indexed Annuity
How can I track my Indexed Annuities performance?
How can the Insurance Company guarantee I will not lose money?