Envestnet Whitepapers

Annuities as an Asset Class for Fee-Based Advisors l 24 © Envestnet 2022 Contract Value Growth The underlying contract value of deferred annuity assets can grow (or shrink, with variable annuities) throughout the life of the contract. With variable annuities, the process is straightforward and comparable to how most will understand investing with brokerage accounts. VAs allow for the direct investment of premiums into subaccounts representing different asset classes and their investment performance less distributions and fees will determine the value of remaining assets over time. Variable annuity subaccounts are subject to capital losses. Since FIAs are fixed annuities, crediting interest is the technical term for the returns generated by their contract value. FIA premiums are added to the general account of the insurance company and credit interest to the owner based either on a fixed return or on the performance of a linked market index. FIAs offer index-linked interest, but they are not invested directly into the underlying index. There are no subaccounts. They simply pay interest to the owner using a formula linked to the index performance. With FIAs, the credited interest (or returns) can be structured more precisely in terms of controlling downside and upside exposures. FIAs protect principal in the sense that 0 percent interest is credited even if the underlying index declines significantly in value. To obtain this protection, FIA owners should expect to receive only a portion of any positive gains experienced by the index. Overall, FIAs may reduce the volatility of the underlying contract value relative to a variable annuity. For FIAs, insurance companies generally offer access to different index options as well as a fixed interest option. Contract owners can often combine these options in any way they choose and can change the allocations at the start of each new term. Common index choices include the S&P 500 for large capitalization US stocks, or the MSCI EAFE index that provides representation for international stocks. Only the price returns (capital gains or capital losses) matter with these indices as dividends are excluded from the returns when determining credited interest. This is because financial derivatives are used to link performance rather than owning the underlying assets, so dividends are not available. Almost countless crediting methods are used in practice and there is a trend to increase the complexity of the methods used. With the chosen index, interest crediting will generally be based on a formula that can include floors, caps, participation rates, and spreads. As an example, we will consider an annual reset one-year term point-to-point crediting method with a participation rate. Overall, FIAs may reduce the volatility of the underlying contract value relative to a variable annuity.

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