Historical Returns Distort the Analysis of Annuities

If you use historical interest rates to analyze options-based annuities, you will mislead clients as to the benefits of those products.

Low interest rates present a challenge to all investors, retail and institutional alike. Certain financial products, such as fixed indexed annuities (FIAs) and registered index-linked annuities (RILAs), have lower caps because of lower interest rates.

There are a growing number of tools and a body of research that attempts to demonstrate the value of FIAs and RILAs (and other annuities) based on product specifications using pure historical returns.

But analyzing FIAs or RILAs using historical returns is misleading and unlikely to accurately portray the potential benefits of the strategies. For example, caps increase with interest rates. As such, cap rates would have been (and indeed, have been) significantly higher in higher-rate environments. An analysis that relies solely on current cap rates would ignore that fact.

Therefore, any analysis to determine the efficacy of FIAs and RILAs should reflect today’s challenging rate environment (i.e., assume lower returns, especially for fixed income).

It is essential that financial advisors and investment professionals understand this dynamic and don’t unintentionally mislead clients. Indeed, they must educate them about these considerations when other advisors and researchers rely on historical returns.