Then they determine how much they can pay the policyholder. That is the participation rate, which is a percentage of the index s return. Mich. Inadequate Hedging Safeco s equity-indexed annuity had great marketplace appeal. Once set, the margin was guaranteed for the full seven years. Stock market volatility caused the higher option prices and was particularly bad last fall.
Insurers buy the options to provide the link to the stock index they are tracking.
Shorter-duration options are more greatly affected by the option price swings and thus became much more expensive than options with longer durations. Interest rates also have a major bearing on the performance of equity-indexed annuities. Insurers use the bulk of investors money to buy bonds to provide the minimum-return guarantees. When long-term interest rates fall, insurers must use more of investors money to buy bonds and have less available to buy stock options. This combination of lower interest rates and higher option prices proved to be a double hit on insurers and equity-indexed annuities.