Hit the Nail on the Hedge

In previous blogs, I’ve talked about the power of not losing money during down markets. We’ve all heard it a thousand times before, with fixed indexed annuities, “zero is your hero.”

Well, what if I told you we could do even better? We all also know about the hedging concept, where you place a small amount of your portfolio in an investment that will move contrary or “opposite” of the traditional equity markets. This is most commonly done by using bonds, as bonds tend to increase in value when the market crashes, because most investors think bonds are “safe.” The Great Recession proved that is not always true. So we go to fixed indexed annuities for safety in the down markets and to create guaranteed lifetime income. The other general rule of thumb is that if you want to get decent income out of a product there won’t be a lot of growth potential, and vice versa.

But now the game has changed. There is a new product that offers good income with the opportunity to increase along with good rates for growth. The crediting strategy I want to discuss in this blog post has been around for a while, but these are some of the best rates I’ve seen on this type of crediting strategy. This crediting strategy is referred to as the inverse performance trigger.

How it works is simple. If the S&P 500 performs 0% to -9.99%, the client receives a 2% credit. If the S&P 500 is down more than 10%, the client receives an 8% credit. Now, no one should put 100% of their money in this strategy, because in the last 10 years they would have received a return only three times. However, this product also has a participation rate strategy on the straight S&P 500. So what happens if you combine the two? A hedge on your hedge.

Let’s look at how this strategy would work in two different scenarios compared to another product with a 3.5% S&P 500 Annual PTP cap. With the first product in both scenarios we are starting with $100,000 initial investment and a 100% performance bonus on each year’s crediting rate. We will have an allocation with 75% in the participation rate (45% PR) and 25% in the inverse performance trigger (S&P 500 < 0% to -9.99% = 2% and S&P 500 < -10% = 8%). With the second product, let’s assume we start with $100,000 initial investment, with a 22% premium bonus to the Income Account Value and a 50% performance bonus on each year’s crediting rate. We will have a 100% allocation to the S&P 500 Annual PTP with a cap of 3.5%. Now I know the second product has crediting methods that have higher upside potential, but I wanted to compare apples to apples, and they do not have an uncapped strategy on the S&P 500.

The first scenario we will compare the two products in is the Great Depression. Some important notes to remember as you look at the hypothetical below: $100,000 invested on the first trading day of 1928 into the S&P 500 would have taken 25 years to get back to the initial $100,000 you invested.

Par Rate/Inverse Performance Trigger Allocation
Year S&P Return 45% PR Inverse Trigger $100k with a 75/25 split FIA Return IAV Credited Rate Inc. Acct. Value
1928 37.88% 17.05% 0.00% $112,784.50 12.78% 25.57% $115,980.63
1929 -11.91% 0.00% 8.00% $115,040.19 2.00% 4.00% $118,880.14
1930 -28.48% 0.00% 8.00% $117,340.99 2.00% 4.00% $121,852.14
1931 -47.07% 0.00% 8.00% $119,687.81 2.00% 4.00% $124,898.45
1932 -15.15% 0.00% 8.00% $122,081.57 2.00% 4.00% $128,020.91
1933 46.59% 20.97% 0.00% $141,277.83 15.72% 31.45% $153,183.62
1934 -5.94% 0.00% 2.00% $141,984.22 0.50% 1.00% $154,141.02
1935 41.37% 18.62% 0.00% $161,808.59 13.96% 27.92% $181,043.20
1936 27.92% 12.56% 0.00% $177,055.81 9.42% 18.85% $202,367.83
1937 -38.59% 0.00% 8.00% $180,596.93 2.00% 4.00% $207,427.02
1938 25.21% 11.34% 0.00% $195,962.79 8.51% 17.02% $229,487.86
1939 -5.45% 0.00% 2.00% $196,942.60 0.50% 1.00% $230,922.16
1940 -15.23% 0.00% 8.00% $200,881.46 2.00% 4.00% $236,695.21
1941 -17.86% 0.00% 8.00% $204,899.08 2.00% 4.00% $242,612.59
1942 12.43% 5.59% 0.00% $213,494.86 4.20% 8.39% $255,334.97
1943 19.45% 8.75% 0.00% $227,509.46 6.56% 13.13% $276,286.40
1944 13.80% 6.21% 0.00% $238,105.71 4.66% 9.32% $292,371.45
1945 30.72% 13.82% 0.00% $262,792.51 10.37% 20.74% $330,262.79
1946 -11.87% 0.00% 8.00% $268,048.36 2.00% 4.00% $338,519.36
1947 0.00% 0.00% 2.00% $269,388.61 0.50% 1.00% $340,635.10
1948 -0.65% 0.00% 2.00% $270,735.55 0.50% 1.00% $342,764.07
1949 10.26% 4.62% 0.00% $280,110.44 3.46% 6.93% $357,600.40
1950 21.78% 9.80% 0.00% $300,700.66 7.35% 14.70% $390,458.29
1951 16.46% 7.41% 0.00% $317,405.34 5.56% 11.11% $417,571.96
1952 11.78% 5.30% 0.00% $330,024.58 3.98% 7.95% $438,323.98

Some things to consider in this scenario: it takes 12 years to double your money; in those 12 years there were eight years where the S&P 500 had negative returns; and six of those eight years were double digit losses.

Now let’s look at how the other product with the 3.5% cap would have fared.

3.5% S&P 500 Annual PTP with Cap
Year S&P Return 3.5% Cap $100k with a 22% Bonus FIA Return IAV Credited Rate Inc. Acct. Value
1928 37.88% 3.50% $126,270.00 26.27% 5.25% $128,405.00
1929 -11.91% 0.00% $126,270.00 0.00% 0.00% $128,405.00
1930 -28.48% 0.00% $126,270.00 0.00% 0.00% $128,405.00
1931 -47.07% 0.00% $126,270.00 0.00% 0.00% $128,405.00
1932 -15.15% 0.00% $126,270.00 0.00% 0.00% $128,405.00
1933 46.59% 3.50% $130,689.45 3.50% 5.25% $133,460.95
1934 -5.94% 0.00% $130,689.45 0.00% 0.00% $133,460.95
1935 41.37% 3.50% $135,263.58 3.50% 5.25% $138,715.97
1936 27.92% 3.50% $139,997.81 3.50% 5.25% $144,177.91
1937 -38.59% 0.00% $139,997.81 0.00% 0.00% $144,177.91
1938 25.21% 3.50% $144,897.73 3.50% 5.25% $149,854.92
1939 -5.45% 0.00% $144,897.73 0.00% 0.00% $149,854.92
1940 -15.23% 0.00% $144,897.73 0.00% 0.00% $149,854.92
1941 -17.86% 0.00% $144,897.73 0.00% 0.00% $149,854.92
1942 12.43% 3.50% $149,969.15 3.50% 5.25% $155,755.46
1943 19.45% 3.50% $155,218.07 3.50% 5.25% $161,888.33
1944 13.80% 3.50% $160,650.70 3.50% 5.25% $168,262.68
1945 30.72% 3.50% $166,273.48 3.50% 5.25% $174,888.02
1946 -11.87% 0.00% $166,273.48 0.00% 0.00% $174,888.02
1947 0.00% 0.00% $166,273.48 0.00% 0.00% $174,888.02
1948 -0.65% 0.00% $166,273.48 0.00% 0.00% $174,888.02
1949 10.26% 3.50% $172,093.05 3.50% 5.25% $181,774.24
1950 21.78% 3.50% $178,116.31 3.50% 5.25% $188,931.60
1951 16.46% 3.50% $184,350.38 3.50% 5.25% $196,370.78
1952 11.78% 3.50% $190,802.64 3.50% 5.25% $204,102.88

As you can see, you end up with approximately $140,000 more in your account value using the par rate with inverse performance trigger than just a 3.5% annual PTP cap in the same timeframe. As far as your income account? Around $230,000 more in the first product.

Now let’s take a look at the second scenario, the Great Recession. In this scenario, we’ll look at an even 20 years. If someone invested $100,000 on the first trading day of 1999, you would only have $187,101.41 at the end of 2017. Compare that with the two hypothetical charts below.

Par Rate/Inverse Performance Trigger Allocation
Year S&P Return 45% PR Inverse Trigger $100k with a 75/25 split FIA Return IAV Credited Rate Inc. Acct. Value
1999 19.53% 8.79% 0.00% $106,591.38 6.59% 13.18% $113,182.75
2000 -10.15% 0.00% 8.00% $108,723.20 2.00% 4.00% $117,710.06
2001 -13.04% 0.00% 8.00% $110,897.67 2.00% 4.00% $122,418.46
2002 -23.37% 0.00% 8.00% $113,115.62 2.00% 4.00% $127,315.20
2003 26.38% 11.87% 0.00% $123,186.59 8.90% 17.81% $149,985.58
2004 8.99% 4.05% 0.00% $126,924.22 3.03% 6.07% $159,087.08
2005 3.00% 1.35% 0.00% $128,209.33 1.01% 2.03% $162,308.60
2006 13.62% 6.13% 0.00% $134,102.79 4.60% 9.19% $177,230.44
2007 3.53% 1.59% 0.00% $135,700.46 1.19% 2.38% $181,453.39
2008 -38.49% 0.00% 8.00% $138,414.47 2.00% 4.00% $188,711.53
2009 23.45% 10.55% 0.00% $149,369.11 7.91% 15.83% $218,582.21
2010 12.78% 5.75% 0.00% $155,811.77 4.31% 8.63% $237,438.20
2011 0.00% 0.00% 2.00% $156,590.83 0.50% 1.00% $239,812.58
2012 13.41% 6.03% 0.00% $163,677.93 4.53% 9.05% $261,519.82
2013 29.60% 13.32% 0.00% $180,029.36 9.99% 19.98% $313,771.48
2014 11.39% 5.13% 0.00% $186,949.91 3.84% 7.69% $337,895.01
2015 -0.73% 0.00% 2.00% $187,884.66 0.50% 1.00% $341,273.96
2016 9.54% 4.29% 0.00% $193,934.08 3.22% 6.44% $363,250.30
2017 19.42% 8.74% 0.00% $206,645.00 6.55% 13.11% $410,866.97

If we talk a look at the second product, illustrated in the hypothetical chart below, we see that the S&P 500 in the same time period would have outperformed the FIA. However, we do get the downside protection and the Income Account Value. That being said, the first product not only outperforms the second product but outperforms the S&P 500 by almost $25,000.

3.5% S&P 500 Annual PTP with Cap
Year S&P Return 3.5% Cap $100k Initial Investment FIA Return IAV Credited Rate Inc. Acct. Value
1999 19.53% 3.50% $103,500.00 3.50% 5.25% $128,405.00
2000 -10.15% 0.00% $103,500.00 0.00% 0.00% $128,405.00
2001 -13.04% 0.00% $103,500.00 0.00% 0.00% $128,405.00
2002 -23.37% 0.00% $103,500.00 0.00% 0.00% $128,405.00
2003 26.38% 3.50% $107,122.50 3.50% 5.25% $135,146.26
2004 8.99% 3.50% $110,871.79 3.50% 5.25% $142,241.44
2005 3.00% 3.00% $114,197.94 3.00% 4.50% $148,642.31
2006 13.62% 3.50% $118,194.87 3.50% 5.25% $156,446.03
2007 3.53% 3.50% $122,331.69 3.50% 5.25% $164,659.44
2008 -38.49% 0.00% $122,331.69 0.00% 0.00% $164,659.44
2009 23.45% 3.50% $126,613.30 3.50% 5.25% $173,304.06
2010 12.78% 3.50% $131,044.76 3.50% 5.25% $182,402.53
2011 0.00% 0.00% $131,044.76 0.00% 0.00% $182,402.53
2012 13.41% 3.50% $135,631.33 3.50% 5.25% $191,978.66
2013 29.60% 3.50% $140,378.43 3.50% 5.25% $202,057.54
2014 11.39% 3.50% $145,291.67 3.50% 5.25% $212,665.56
2015 -0.73% 0.00% $145,291.67 0.00% 0.00% $212,665.56
2016 9.54% 3.50% $150,376.88 3.50% 5.25% $223,830.50
2017 19.42% 3.50% $155,640.07 3.50% 5.25% $235,581.60

To summarize, I have included a table below with some of the highlights of each product. I want to be very clear here; I am not saying that one product is better or worse than the other. I am simply trying to provide insight into a strategy that is under-utilized and not talked about in our industry nearly enough.

Product #1 Product #2
Premium Bonus 0% 22% on IAV
Performance Bonus 100% 50%
Free Withdrawal Percentage 7% with Enhanced Liquidity after year 1 10% of Premium after year 1
IAV after Great Depression $438,323.98 $204,108.88
IAV after Great Recession $410,866.97 $235,581.60
Payout at Age 65 5% Level; 4% Increasing 5% Increasing
Enhanced Death Benefit No Yes
Multiplier for LTC Needs Yes, based on ADL’s No

Give our marketers a call so we can run your next case and determine which product is the best fit for your client’s scenario, or simply to find out what products I am referring to in this blog. As always, I encourage any feedback, comments, or questions on this or any blog post.

 

Thanks for reading,

Dustin Casebolt

Director of Advisor Development