The Takeaways:
- Most insurance agents never care to ask why the CD-type annuities, otherwise known as Multi-Year Guaranteed Annuity (MYGA), can offer higher interest rates than bank CDs (Certificate of Deposit) do. Lucky for them, most annuity buyers have never asked this question.
- This is a totally legitimate question because money does not fall from the sky but must come from somewhere somehow.
- Some say CDs have a shorter life duration than MYGA annuity contracts. However, this may or may not be true because we do have one-year MYGAs in the market and they still have higher interest rates than one-year CDs.
- The first crucial fact: CDs are offered by banks, while annuities are offered by insurers.
- The second crucial fact: Banks and insurers are subject to different regulations. For the most part, banks face tighter regulations than insurers do.
- Therefore, insurers have the liberty to invest premiums in a variety of financial products: Bonds, stocks, mutual funds, real estate and even financial derivatives. On the other hand, banks make money mainly from interest spread, the difference between the interest rate they pay depositors and the one they charge for loans.
A Financial Fact Deserving Explanation
There is a hidden question that most insurance agents never care to find out what the answer is. It concerns the fact that one of the most popular annuity contracts, Multi-Year Guaranteed Annuities or MYGA, almost always offer higher interest rates than bank CDs (i.e., Certificate of Deposit in case you are not familiar with banking terms) do.
Insurance agents love to sell MYGAs because it is a CD-Type annuity, meaning to keep the premium for annuity like keeping the deposit for CD, but with (much) higher rates. Agents will not miss the opportunity to ask their clients the question of how much interest they get from CDs — all because they can brag about how high the rate is for MYGAs in comparison with CDs. They won’t bother to tell clients why they can offer a higher rate.
Most of the time they run into no problem because, guess what, most annuity buyers don’t care about why they get a higher rate of return, either. It’s human nature that people do not bother to ask questions about good news, they will do about bad ones.
But when something most agents won’t do, it helps make you unique if you can answer the question right. Suddenly your image improves a great deal, and you may even receive voluntary referrals by some admiring clients.
The Simple Answer for MYGA Magic
It does not need a rocket scientist to figure out the MYGA Magic: MYGA is offered by insurance companies (insurers), while CDs are offered by banks. Of course, this may or may not make much difference until we know the difference between their business models (i.e., how they make money as an industry) and industrial specific regulations.
Turns out that insurers have more regulatory freedom than banks do. For one thing, insurers can invest the premium in a variety of assets, including bonds, stocks, and real estate, even financial derivatives, to generate returns. Banks on the other hand are required to maintain a certain amount of reserve and are limited in the amount of money they can lend out. They make money primarily by lending out money to borrowers and use the interest rate spread (i.e., difference between the interest rate they pay on CDs and the interest rate they charge on loans) to gain profit.
Some say MYGA has longer time to mature than bank CDs, but this may or may not be true. We have some insurers offering one-year MYGA and still with higher interest rates than bank CDs.
Next time when an insured asks his /her agent how they can afford to pay so much better interest rates than banks, I hope the agent knows the right answer.