Insurers May Be in for More Misery (Update)

Ms. Gannon incorrectly characterizes the outcome of hedging strategies typically employed by issuers of indexed annuities. To clarify, hedging strategies with respect to indexed annuities do not "offset losses" for the company. Rather, hedging strategies, typically in the form of purchasing index call options, are utilized by companies to actually provide the funding for interest crediting in contracts with index strategy positions. Per the contract specifications, if the index is lower at the expiration of the strategy term than it was at the beginning, no interest credits are paid by the company to the insurance contracts.

However, unlike a variable annuity the contract holder does not experience any loss in value. If the index is higher at the expiration of the strategy term, index credits are paid to the insurance contract based upon the increase in the measuring index. In either case, the insurer has expended a predetermined amount for the option, and the cost of the option, not its value at any given point in time, determines the insurer's profit margin.

In order to fund the interest credits for the contracts, the company typically will purchase a call option. For example, if today the S&P 500 index is at 1000 the company would purchase a one-year call option on that index at a strike price of 1000. If the index closes at the end of that year at anything above 1000, the company would receive its return on the option, which in turn is credited to the insurance contract with the corresponding index crediting strategy. If the index closes below 1000, the call option will expire with no value and the insurance contract will not be credited with any interest earnings for that particular strategy that year but will not lose any value either.