Indexed Annuities: Read the Fine Print

An article in CFA Institute outlines factors to consider before investing in indexed annuity products that promise a “minimum amount of interest plus potentially additional interest based on the price change of a financial index with complex indexing features, such as participation rates, interest rate caps, and spreads.”

The article reports that more than 50 “volatility-controlled” indexes are attracting investors hoping to take advantage of rising financial market indexes, but the complexities of these products should not be overlooked. It lists the following factors for investors to consider:

  • Design: Volatility controlled indexes, which track rules-based trading strategies, are designed to “de-risk during volatile periods, reducing hedging costs for insurance carriers. This way, these carriers can offer more sellable interest-crediting features, such as higher interest rate caps, along with volatility-controlled indexes.”
  • Fee structures for these indexes are not as straightforward as investors might expect, and “Performance is often calculated net of a servicing costs an on an excess return basis.”
  • Performance: Most volatility-controlled indexes are created with simulated performance track records, the article reports, adding, “so live and simulated returns may be conflated in annuity illustrations and marketing material.”
  • Selling approach: How volatility-controlled indexes are marketed could be confusing to investors, the article notes. “Though sometimes referred to as ‘market indexes’ in marketing materials, these indexes are not designed to track any market or segment of the market,” it explains, adding that some sellers link actual with back tested index returns and “might unintentionally mislead investors who fail to read the fine print.”