Breaking Down Different Types Of Crediting Methods | 7 Figure Annuity Sales Podcast | Ep. 264

All right, well, welcome back to this week's Seven Figure Annuity Sales podcast. I am Caleb North. Chad is not here this week. He's actually taking an extended vacation. We needed another podcast episode, so I get to record one by myself today. I'm actually super excited for the content that I'm going to be going over. It's something that I'm pretty passionate about and actually really enjoy diving into, specifically indexes and index crediting methods. And realistically, what's the best crediting method strategy and what types of markets do other crediting methods perform best in? So I've actually taken the liberty of crunching numbers, looking at the S&P 500 from 2000 all the way through the end of 2022, looking at the annual returns of the S&P 500 index. And then I've actually applied.

Rates that are available right now in annuity products, indexed annuity products, cap participation rates, performance triggers, monthly sum with a monthly cap and a monthly average with an annual cap. And I've applied these rates again that are available in existing products right now for each one of these strategies. And I've looked at numbers and I've looked at environments, return environments, market environments, in which these particular strategies have best performed in. And I want to just kind of share the info with you guys today that I found and hopefully have some kind of impact on the way that you all choose to allocate funds in the future. And it's not to sit here and say that, you know, there's not an argument for volatility control indexes with really high participation rates. I think there are. I think there's definitely an argument for that. But when you can look at factual historical data and returns of an index and you can apply rates from multiple different strategies, it, to me, it just makes a nice little comparison rather than comparing very various indexes themselves that have different asset classes and different triggers of rotation, rebalancing, all that kind of stuff, different volatility targets, all that kind of stuff. So we're looking at one index, the S P500, and we're applying five different crediting methods to it and examining which ones are best. And it's kind of. It's kind of a mixed bag. And it's an interesting picture if you look at just purely the annualized return. Okay, and this is a good way to think of the annualized return is it's not the average return of every year. It's the effective compounded rate of return over a period of time. And if you look at.

The S&P 500 from 2000 to 2022. So that's a 23 year stint. The annualized return of the index itself is 4.33%.

I've looked at the annualized return of.

Indexed products and indexing rates and crediting methods and every single one of the five that I'm looking at today and going over today beats that annualized return. Now it's important to remember we are in a particularly high rate environment.

We are seeing caps pars as high as we've seen them in a very long time. Spreads that are so low they're basically non existent right now, which is great. So a rate environment is really, really great. And, and so it's a little bit of an inflated picture when we take current rates and we back cast them over the last 10 years and particularly over the last 23 years. But for the sake of consistency, that's what we're gonna do. So the annualized return of The S&P 500 over the last 23 years is 4.33%. If you have a 10% cap with a 100% participation rate. So in other words, it's literally just a cap. It's 10% cap over that same time period has a 5.77% annualized return. A 50% participation rate in the S&P 500 has a 5.28% annualized return. An 8% performance trigger over that period has a 5.15% annualized return.

A monthly sum strategy with a 3% monthly cap has a 5.27% annualized return. And a monthly average strategy with a 12% annual cap has a 4.45% annualized return. All five of those annualized returns beat the annualized return of the actual S&P 500 over that period. The why is it doing that? When your upside is limited, it's because the downside is non existent. So when we're dealing with these indexed products that have a 0% floor and you take away the opportunity for loss exposure to the downside, even when the upside is limited, you create an environment in which the annualized return can actually be greater than the market itself. Now if we only look at bring the balance to the, to the equation here. If we only look at the last 10 years, which has been one of the greatest 10 year periods in market history, the actual index returns of the S P500 beat every one of the strategies. So it's realistically over the long term with very favorable rates that these strategies outperform. The annualized return of the actual index itself over the short term. And again, the last 10 years being one of the greatest periods of market returns in history. The market, The S&P 500 itself truly does beat the indexed strategies, albeit not by much. Over the last 10 years, you're the same rates, 10% cap, 6.85% annualized return, your 50% par is 7.04% annualized return, your 8% performance trigger, 5.5% annualized return. Your monthly cap with 3% monthly monthly cap is 7.59 and then your monthly average with a 12% annual cap is 5.86. So still really, really great returns over the last 10 years. Even with those, assuming we'd had those rates and again, the rates weren't existent and realistically these rates are probably not going to hold in most products for the next decade. And realistically, the next decade is probably not going to be as great as it was in the last decade as far as the actual returns of the market go.

So we're looking at these numbers, looking at them being a little bit higher, but I do want to want to look at it. If you look at just the well roundedness and the overall performance, you look at the number of years that any one of these five strategies had the highest return amongst the others.

The cap wins. Beats all of them actually pretty well. I mean six years of the last 23 years, the 10% cap would have had the highest, the highest annual return of those five strategies.

You look at the last 23 years, it would have had 11 years of double digit returns and it would only had 8 years of 0,0% returns compared to.

The participation rate. And the performance trigger only had the high return two of the last 23 years.

And they both had 80 years as well. Then you have the monthly sum with monthly cap was the highest returning strategy four of the last 23 years, but it had 100 years. And then you have your monthly average with cap. This one's kind of interesting. It had only three of the last 23 years where it was the highest, but it had the fewest number of zero years. In fact, there's a couple of years there, 2000 and 2015.

Where every other strategy returned zero percent because.

The point to point, the annual point to point period there was negative. The monthly average actually returned a positive credit, which is kind of a uniqueness to that strategy. And I'm actually going to go over here in just a few minutes when that strategy tends to perform best relative to the other Indexes. But all of this to say if you look at the numbers, just the sheer metrics, in any given year, you're more likely to.

Have the highest, highest crediting rate coming from a really high cap than you are from a par, a performance trigger, a monthly cap or a monthly average. That doesn't mean that that should be all that's allocated to. In fact, we talk a lot about diversifying allocation strategies and creating an allocation mix. And you know, diversification for me is one of those things that in an annuity it has a different purpose than the typical sense of the word diversification. So when we talk about diversification and finance and investment, you're referring to diversification as a risk mitigation tool or measure. It's designed to help offset some of the risk incurred by placing the majority of assets into one basket. Well, in an annuity, an indexed annuity that has a 0% floor, there isn't the risk of the downside exposure. Your risk is you credit zero, which I would argue isn't necessarily risk. It's just an inconvenience and it's a bummer to credit zero. But if that is 10% higher than what you would have done in a risk based strategy, well then you're doing pretty good. Zero is your hero, as they say. Right?

But because that's what we're trying to mitigate in indexed annuities, I would make an argument that a better, diverse, better diversification approach is actually by diversifying the crediting methods than by diversifying the index itself. And I believe that this kind of report that I put together, this.

Just examination that I did of the S&P 500, where we're looking at one index and we're looking at five different crediting methods, goes to show that if you were to create a mix of these index indexing methods, these crediting methods, you could create a scenario in which you technically don't ever have the highest return in any given year, but you also never have the lowest return in a given, any given year. Just think about it. There is going to be one particular strategy in every product in every year. There's going to be one strategy that has the highest credit and there's going to be one strategy that has the lowest credit. Okay? That's the nature of it. If you create a mix, you not only prevent your ability from having the highest, but you also prevent it from being the lowest. So you create a more middle grounded approach. What's cool about the allocation mix is that you do create an opportunity and when we look at this, the impact of the monthly average with cap, which had positive returns two years where everything else was zero, you created a scenario where your potential for zero years is significantly reduced as well, which is kind of a cool thing of diversifying the allocation mix.

So if you're going to pick one, a really high cap is hard to beat. In fact, looking at these rates, I can tell you that a 10% cap. I know of 62 different products and strategies on the market right now that have a 10% cap or higher on the S&P 500 annual, point to point with no fee, 50% participation. I know 41 different strategies, products out there with a 50% participation rate or higher on an annual point to point S&P 500 strategy with no fee, then you start looking at some of these more.

Less common crediting methods. Your performance trigger. There's 11 strategies out there right now in different products that have an 8% performance trigger or higher. For those of you that don't know what a performance trigger is, is basically anytime the index that it's tied to returns anything positively over the crediting period, it credits the trigger rate. So if you have a strategy that has an 8% trigger rate and let's say it's the S&P 500 and it does 0.5% positive over that one year period, well, it's going to credit to the annuity 8%. So it's a really cool strategy to implore or to employ. When you're in a kind of a volatile market, you're not real sure, you know, it's not really a bull or a bear. You're kind of in this weird correctionary period. But it's not, it's just, there's a lot of fluctuation. I like the strategy in that type of environment gives you some really, really great crediting potential. If you get just a very measly.

You know, positive return. And if you happen to credit or the index happens to return over 8%, well then the 8% basically is a cap. And that's still a really pretty stinking good cap. So even if the index booms and you, you know, you get a index goes 30% over the course of the year, you still got an 8% cap, which is pretty, pretty stinking good. But that's performance trigger. And there are eight or, I'm sorry, 11 different strategies that I'm aware of on the market right now that have an 8% or higher performance trigger, annual point to point with no fee. When you look at the monthly sum with cap. There are 19 different strategies and products on the market right now that have a 3% monthly sum cap or monthly cap available and then the monthly average with a 12% annual cap. I know there's seven out there right now that I know of that have at least a 12% annual cap on a monthly average strategy or higher annual point to point with no fee. If you look at all these numbers in relation to the other rates that are available, the cap, the par rate, the performance trigger, the monthly sum, the monthly average that I used on this particular example gave you guys today, they all fall into about the 75th percentile of what's available. Meaning there are rates that are higher in every single one of these categories and there are rates, more rates that are lower in every single one of these credit methods. They all fall right into about the 75th percentile. So it's a pretty good comparison from strategy to strategy.

Like their, their relative impact to the credit is pretty consistent with each other.

So I like the, I like the rates that we're looking at here. If I had to pick one that I was going to allocate everything to honestly probably go with the cap, just looking at the numbers, it's, you know, over the last 10 years it had 3, 3 years of being the highest return.

Had only 30 years, 6 years of double digit returns, like it takes the cake. Over the last 10 years and over the last 23 years in basically every metric that I looked at.

Second option that I would personally go with is the monthly sum with cap. If you can get a 3% monthly cap, think of this. In theory, what it's doing is it's taking the movement of monthly point to point and it's capping each month at three. Now if it goes negative over the course of a month, it's going to be the full negative and then they're going to sum all of that up. So theoretically, if you have a 12 month period where you hit a 3% cap every single month, theoretically you could have a 36% credit. What this means is that the upside potential of the monthly cap strategy, if you have a high cap, is really, really strong. And if you look at the metrics it had over the last 23 years, the second highest number of years of being the highest return. But it also, over the last 10 and over the last 23 years has been the strategy that had the most years of zero credit.

So you gotta bear in mind there's a lot of potential for zero and there's a Lot of potential for big fat double digit returns with these monthly caps. So I would use this strategy as in a mix, you know, 50% into annual cap, 50% into a monthly cap. Pretty good mix there. Or, you know, you toss in the participation rate or the performance trigger. If you, if you like that strategy in this type of environment, you can kind of start splitting it that way. The more strategies you split it between, the less likely you are for a 0% year, but simultaneously, and the less likely you are for the having the low credit of all the available strategies. Simultaneously you take out your chances of having the high credit. But when you look at the high versus.

The rest, again, the annual cap, having a 5.77% annualized return over the last 23 years is marginally better than the other strategies. So you create this allocation mix where now your, your average may be a little bit lower, your annualized return may be a little bit lower, but all your other metrics improve as a result of that mix. So let's talk about when these different strategies have performed best. This is kind of the meat of what I wanted to get into today, and I'm sorry it's going a little bit long. I have a tendency to, when I record podcasts myself, I have a tendency for these to be longer than when Chad and I are together. But bear with me, I hope it's valuable content to you all. When you look historically your, your cap rate, when you can have a high, a good double digit high cap, historically, it's going to be your best strategy. When you have.

When you have either really high single digit returns, actual returns in the index, or relatively close double digits. In other words, what the index actually does is not too far below and not too far above what that cap rate is. When you can get a good 10, 11, 12% annual cap on the S&P 500, most of the time, that's going to be a winning strategy.

That rate's not going to hold in these products forever. There's no way that it mathematically can. It's, it's, it's really high. But while we've got them, I recommend using them. When you talk about the par rates, the participation rates, 50% par is very generous in the S&P 500. When that's the best strategy is when you have more than double whatever the cap is, right? So if you have an 8% cap and you have a 50% par, well, you need 16% or more return in the index for the par rate to beat it. So when you look Historically, relative to the 10% cap, the par rate takes over and becomes your best highest crediting strategy when you have more than a 20% return in the index itself, which has been, you know, a handful of years over the last 23, but you can't necessarily call it common, more common in the last five. I mean literally two of the.

I guess it'd be five. Yeah, two of the five.

Years.

Over the last 23 years where the S&P 500 was over 20% credit happened in the last five years. So in other words, two fifths of the time frame that a 50% par rate would have beaten a 10% cap came in the last five years. A lot of economists would argue that those years could have been as a result of some extra work put in, pumped into the market. But that's when the participation rate wins the performance trigger. Pretty self explanatory. It's going to be your best crediting strategy when the actual returns of the index are really low, but still positive.

Your monthly sum with cap. This one's a little bit unique. So your monthly sum with a monthly cap is going to be your best strategy. When you have consistent good positive monthly returns over the course of the crediting period, you know, a year, let's call it annual, point to point over each one of those 12 months, you can have a pretty decent positive credit. Almost certainly your monthly sum with a monthly cap is going to be your best, your best crediting strategy. If you look historically the four years over the last 23 years where a 3% monthly cap actually created the highest credit of all the strategies we looked at today, they were four years and the only four years in which there were no more than two negative months. Any month that had three negative months, or I'm sorry, any year that had three negative months, the monthly sum with cap did not win the did not end up crediting the most return every single year that it was two or less negative months. The monthly sum with cap did have the highest crediting over the course of that year. So it's kind of a unique scenario there. It's great when you're hitting a really nice bull run. That monthly sum with cap can be really great. Somebody that allocated to a monthly sum with cap at, you know, the end of March, early April of 2020, right as the kind of we hit the trough of the COVID drop and then market started climbing back up over the course of the rest of that year. I mean there had to be some people that absolutely raked it in. Now granted, anybody that bought any kind of strategy, but any kind of annuity would put it into anything at that point. Probably did pretty stinking good. You know, going in at a low and watching that climb over the next year, but particularly with that monthly sum with CAP and then the monthly average, this one's kind of unique. The monthly average performs best when you have early in the crediting period. So if it's an annual point to point early in that year, you have really high jump in the price of the index. So if you can have.

You know, a good 5, 6, 7% month early on in that index, like increase in the price of that index and it will hold there even if it doesn't have a ton more up. If it can kind of hold at that really nice high, it's going to take the average price over the course of the year and then create the crediting, the credited rate based on the difference between that and the price that it started at. So you want to have a lot of months where the average or where the price of that index is particularly high relative to where it started. So if you can get some rapid acceleration early on in that strategy, you can do pretty stinking well there in the monthly average with cap. It's kind of similar to your monthly sum with cap and that it has pretty good, pretty good upside potential there for double digit returns, you know, in different years. But you also have the opportunity for some pretty low returns if you've got pretty stagnant years. So it's kind of one of those things that it can have some pretty significant variation between the low and the high. But also historically, of all the strategies we looked at, that monthly average with cap had the fewest number of 0 years relative to everything else, which is kind of cool. So those are the types of markets and environments where these different strategies perform best. Again, you know, not to make a case to only use S&P 500 index based strategies, I think there's a lot of validity to it.

You know, I think there's, there's still strong volatility control indexes out there with good participation rates that should definitely be included in the allocation mix. But to give you guys an idea of how you can use even the same index S&P 500 with different crediting methods and still create a bit of a diversified mix of allocation for your clients, I hope this, this helps navigate that. And if, you know, clients have ideas of what they think the market's going to do and if you're educated on where these different strategies tend to perform best, then you can help create a mix that is in alignment with what they think is going to happen. And not that we are trying to speculate anything, not that we're trying to advise on anything market related, but it's good to know and really try and make the best allocation that you can, not just treat it flippantly. So hope this helps you. If you have any questions, certainly feel free to reach out to me. I nerd out about this stuff, so hopefully we can have a conversation if you need to deep dive it a little bit more. Hope this helps you guys have a good one. As we always say, happy selling.

Sam.