Index Variable Annuities (IVA) are annuity products where you invest your account into unique portfolio strategies with pre-determined return ranges. They are a hybrid of index annuities (IAs) and variable annuities (VAs) that try to get the best of both products.
IVAs are new to the insurance world but continue to grow in popularity.
The design elements of IVAs allow for the insurance company to design different structures to match the risk & return of the customer with the product. IVAs are similar to index variable universal life insurance (IVUL) products in account value designs.
What are index variable annuities and are they right for you?
What Is An Annuity?
An annuity is a scheduled series of payments to an individual. There are many examples of annuities in real-life, like structured settlements or a mega lotto win. But you can purchase an annuity directly from insurance companies as well.
When you purchase an annuity you are exchanging a lump sum payment today for a future stream of payments.
This future stream of payments can come with a slew of guarantees as well as tax-advantages and potential for increases in future payouts.
For example, if you purchase a $100k annuity that pays $10k a year for life with a guarantee to pay at least 10 payments, you would:
- Get at least your money back if you die within the first 10 years, or
- Get a positive and growing return for every year you live past year 10.
In short, annuities are the opposite end of a life insurance policy. Life insurance is there to protect you if you die too soon, whereas an annuity is there to protect you if you live too long.
What Is An Index Variable Annuity (IVA)?
An index variable annuity is a hybrid annuity that combines an index annuity (IA) and a variable annuity (VA). The return you receive in your account is based on the return of a fund (ie-S&P500). However, unlike an IA which is floored at a minimum return of 0%, an IVA can have a negative return, similar to a VA. However, since you are accepting some additional downside, you can receive much higher upside returns.
Index annuities have a minimum return that is at least 0% and a capped upside. The return you receive is based on the underlying fund. If you have a 1 year point-to-point S&P500 IA with a 0% floor and a 8% cap then:
- If the S&P return is negative, your return on your account is 0%
- If the S&P return is over 8%, then your return on your account is 8%
- If the S&P return is between 0% and 8%, then your account grows at the S&P return
Variable annuities let you invest directly in the underlying funds. Therefore your separate account will have a return in line with the S&P500 (or whatever asset you choose).
Index variable annuities keep the index feature, but allows for designing many different types of payouts. This allows the insurance company to design different risk & return levels that match customer’s preferences.
Two major carriers with prominent industry IVAs are Allianz and Prudential. And if you want to see how advisors consider IVAs for their clients, you can learn more here.
Index Variable Annuity Designs
There are 3 main types of designs that make up the IVA design: Buffers, Deductibles, and participation rates (par rates).
- Buffer – In a buffer design, the insurance company absorbs the first X% of losses for the customer. If the buffer is 10% and the S&P500 is down 15%, the customer only has a 5% loss.
- Deductible – In a deductible design, the customer absorbs the first X% of losses but has their losses capped. If the deductible is 10% and the S&P500 is down 15%, the customer only has a 10% loss.
- Participation Rate – Participation rate (par rate) determines a multiplier on the return of an underlying fund. An 80% participation rate means the account is credited 80% of the underlying fund while a 125% par rate means the customer gets 125% of the return.
These 3 designs can be combined into many different payout structures. For instance, having a deductible with a 125% par rate means you have a known capped loss and a leveraged upside. If the S&P has a big down year, your loss would be capped at the deductible. But if the S&P returns 10%, your account would be credited 12.5%.
The combinations allow for many different payout designs.
The insurance company is able to structure these different payouts by investing in bonds, options, and other derivatives. Therefore you are getting complex portfolio designs managed by professionals behind your annuity.
Index Variable Annuity (IVA) vs Index Annuity (IA)
Both IVAs and IAs credit your account value based on the returns of an underlying fund, often the S&P500. Your account value will grow based on how the fund performs. IAs were originally just 1 year point-to-point, meaning at the end of the 1 year period, you would get credited based on the return of the fund. However, they have expanded to longer periods that offer higher caps.
However, IAs are floored at a minimum return of at least 0%. Since the insurance company retains all the downside, there is a relatively low cap on the return you could receive.
IVAs allow for much higher upside potential, but the trade-off is that you can have negative returns on your account value.
Additionally, since the account can have a negative return, advisors need extra licensing to sell IVAs. This limits the market as not every annuity salesman has the ability to offer the product.
Index Variable Annuity (IVA) vs Variable Annuity (VA)
Both IVAs and VAs allow for a wider range or account value returns. In both products you can have a negative return if equity markets go down. By accepting the risk of a loss on your investment, you retain much more upside.
VAs allow for you to invest your separate account directly into the underlying equity fund. It is similar to buying funds in a brokerage account. You will receive the return the fund makes (after any of the guarantees on the product and fees).
IVAs don’t invest directly in funds. The insurance company buys bonds, options, and other derivatives to achieve various payout possibilities. This allows for less downside but much, or more, of the possible upside.
The Final Word – IVAs
Annuities are a product that protect customers from longevity risk. They turn a lump sum of money into a stream of cash flows and are very helpful for many retirees. Index variable annuities (IVAs) are a new type of annuity that allows for various payouts to the customer based on how an underlying fund performs.
If you want to have pre-determined ranges of returns on your product and annuities fit into your personal financial plan, you may want to look at IVAs. But not all advisors have the ability to sell an IVA, therefore you need to shop around till you find one who can.
Frequently Asked Questions (FAQs):
An index variable annuity (IVA) is a hybrid of an index annuity (IA) and variable annuity (VA). Like an IA, the returns on your account are dependent on the returns of an underlying fund. IVAs and IAs both have payout structures and the insurance company will credit your account accordingly. However, IAs are floored at a minimum of 0% and have relatively low caps. IVAs are able to have negative returns like a VA, but by accepting a negative return, you get higher upside potential. Unlike a VA, you don’t invest a separate account directly into the asset though.
An index variable annuity (IVA) is similar to an index annuity (IA) with the returns on your account dependent on the returns of an underlying fund. IVAs and IAs both have payout structures and the insurance company will credit your account accordingly. However, IAs are floored at a minimum of 0% and have relatively low caps. IVAs are able to have negative returns. But by accepting a negative return, you get higher upside potential.
An index variable annuity (IVA) is similar to variable annuities (VA) since you are able to have negative returns. But VAs have you investing your separate account directly into the underlying asset while IVAs have your return pegged to the return of the underlying asset. Additionally, IVAs can have payouts designs that cap losses and even have levered upside potential.
There are 3 main types of features that make up the IVA design: Buffers, Deductibles, and participation rates (par rates).
1) Buffer – In a buffer design, the insurance company absorbs the first X% of losses for the customer. If the buffer is 10% and the S&P500 is down 15%, the customer only has a 5% loss.
2) Deductible – In a deductible design, the customer absorbs the first X% of losses but has their losses capped. If the deductible is 10% and the S&P500 is down 15%, the customer only has a 10% loss.
3) Participation Rate – Participation rate (par rate) determines a multiplier on the return of an underlying fund. An 80% participation rate means the account is credited 80% of the underlying fund while a 125% par rate means the customer gets 125% of the return.
These 3 designs can be combined into many different payout structures. For instance, having a deductible with a 125% par rate means you have a known capped loss and a leveraged upside. If the S&P has a big down year, your loss would be capped at the deductible. But if the S&P returns 10%, your account would be credited 12.5%.
Both index variable universal life (IVUL) and index variable annuity (IVA) products have similar underlying account investment options. The account value returns are based on the return of an underlying fund, typically the S&P500. The products have combinations of buffers, deductibles, and participation rate features that can result in different risk and reward payoffs. The difference is that an IVUL is a life insurance product and the IVA is on an annuity, so the insurance wrappers around the account are different products.
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