So-called index policies have become an integral part of the life insurer’s product landscape. According to surveys, index policies are also very popular with customers. In this article you will find out how exactly an index policy works, which points you have to pay attention to and whether such a private pension insurance is really worthwhile and possibly something for you.
Overview of the article
Basic functionality of an index policy
Basically, how index policies work is explained very simply. As with a classic pension insurance (= with guaranteed interest), your contributions are only invested in the insurer’s cover pool (security assets).
Index participation or interest can be selected annually
As a customer, you can choose annually whether you want to participate in the development of the specified index (e.g. EUROSTOXX50, DAX, DowJones, etc.) or whether your money should earn interest at the respective interest rate of the insurer (secure interest rate).
No guaranteed minimum interest
In contrast to classic pension insurance, there is no minimum interest rate with the index policy with which your capital earns interest. The amount of the interest always depends on the interest on the cover pool of the respective insurer.
Higher return opportunities through index participation
However, if you as a customer choose to participate in the index, you can benefit from potentially higher returns on the capital markets.
How exactly does the index participation work?
If, as a customer, you have chosen to participate in the index, only your surplus participation will be used and thus invested in a “riskier” way.
Only surpluses are invested
The surpluses are determined from the return on the savings within one year and from the participation in the cost gains. As soon as the surpluses have been determined, they are invested in a stock index. However, shares in index funds are not bought (as would be the case with normal ETFs), but so-called options on the index are acquired.
Investing through options
With a fixed profit participation of, for example, four percent and a current savings balance of 10,000 euros, 400 euros are available for investing in the index. With these 400 euros, the insurer then buys an option on the corresponding index (mostly through a bank). This option business is like a bet on the price development of the index. If the insurer (= option buyer) assesses the course correctly, the option can generate a very good return – much higher than the return from the direct purchase of shares in the index. This “leverage effect” means that the return can be very high despite the use of relatively little capital.
The option represents a commitment to pay out a positive index development
The bank through which the option was purchased assures the insurer that a positive performance in the index will be paid out at the end of the index year.
Bankpartner assumes losses in the event of a negative index development
However, if the index develops negatively, the bank assumes the losses. And the insurer pays a risk premium for the bank partner taking on this risk of a possible negative index development. The so-called option price.
Limitation of performance through caps or quotas
The return on an index policy depends on how well the index has performed over individual months. At the top, however, there are limits, so-called “caps”, that are set. Thus, very high returns are quasi “cut off” and only counted up to the respective “cap”. Monthly losses, on the other hand, are fully taken into account when assessing the return.
The price of receiving your credit
In this way, it is possible for your capital to be maintained at all times and, for example, not to decrease due to a negative price development of the index. The price you pay here is to cap the return in good months (cap).
A balance is then always drawn at the end of an index year. All price gains are offset against the price losses. If there is a positive return, this will be credited to your contract.
Every credit on your capital is secured (lock-in effect).
Negative returns have no impact on your bankroll
However, if there is a negative return at the end of an index year, this is not “deducted” from your contract, but simply a “black zero” is set. In other words: your capital remains completely unchanged. It can’t go negative. In the worst case, your capital will remain at the previous year’s level.
The level of participation in the index is set anew every year
Every year the “cap” is set anew by the insurer. In many cases, the “cap” had to be lowered significantly due to the low interest rate environment. Because interest rates were too low, there were few surpluses.
Quotas instead of caps with some insurers
There are also insurers who use fixed quotas instead of “caps”. A fixed percentage of a positive index development is then always credited. This could be 65%, for example. Especially in very good years on the stock market, the customer benefits more from this variant than from the solution using a “cap”, since the return is not simply cut off. In less good or rather stable stock market years, on the other hand, the “cap” could be the better option, since the return is almost completely credited if it moves below the “cap”.
But you can see that neither one nor the other variant offers significantly better advantages.
For whom is an index policy the right product?
Index policies are fine for you if you have one high need for security have. The savings contributions flow entirely into the insurer’s security assets, which guarantees a very high level of security. That’s why she also plays With-profits and financial strength of the insurance company plays an enormously important role in your return prospects with an index policy. The annual option between the insurer’s cover pool and index participation enables you to generate a little more return than, for example, with a classic pension insurance. In order for this to be the case, however, you should regularly choose to participate in the index.
Unit-linked pension insurance as an alternative
If you don’t like the cap on the return at all and you also realize that you don’t really need many guarantees over a long investment horizon, then it’s a pure one unit-linked pension insurance with 100% participation in an index, fund, ETF, etc. probably the better solution for you. The costs will also be lower there.