Yield Curve & Annuity Rates

What Is the Yield Curve?

The yield curve measures the rates of return (the yield) across fixed-income instruments of different maturities. Most commonly used to monitor the range of yields on the US Treasury Securities market, the yield curve demonstrates the differences between two or more terms and can be plotted on a line.  

A line with a positive slope is a normal yield curve and is made up of rates that rise as the length of the maturity increases. A negative slope is considered an inverted yield curve, meaning the yields fall as maturities increase. This is abnormal and sometimes indicative of future economic weakness. 

While most commonly used to monitor US Treasury Bond rates, the same concept can be used for all fixed-income products with multiple length maturities, including other bonds, CDs and fixed-rate annuities such as multiple-year guaranteed annuities.  

In addition to its usefulness in quickly gauging the rates of return, the US Treasury Bond yield curve is also an important measure of economic health. This is beyond the scope of this article, but for more information, please visit the Federal Reserve Bank of New York.

How Yield Curve Impacts Annuity Interest Rates

The yield curve, typically measuring the range of yields on U.S. Treasury Securities from the three-month Treasury bills out to the 30-year Treasury bonds, impacts all other fixed-income instruments in the U.S. economy by generally setting a floor for rates of return. All other fixed-income securities contain more risk than the explicit guarantees of the U.S. government and will offer higher rates of return to compensate investors for that risk.

Unlike many other fixed-income investments, annuities are not marketable securities and cannot be resold to a third party. Annuities are two-party contracts between the owner and the insurance company, so while the yield curve informs the overall rates of return offered by the policies, it does not necessarily constrain the insurance companies from offering more attractive rates of returns or guaranteeing the yield on your policy.  

The most important way the yield curve impacts annuities and their respective rates of return is in projecting what an insurance company will likely earn on the money that guarantees their customers’ policies. Insurance companies primarily profit by earning more money from their investments than they pay out to annuity owners.

High interest rate environments mean insurance companies can expect to pass on higher rates of return to consumers. Alternatively, low interest rate environments mean that yields must be lower to accommodate the lower expected returns on the insurance company’s invested money.  

How Investors Should Use the Yield Curve

The yield curve is an important and useful economic indicator and should be used to inform how you invest in different market environments, whether you have a PhD in economics or not.  

In many cases, the movement of the yield curve is more important than the position at any given moment in time. A yield curve that is in the process of inverting (longer rates are moving below shorter rates) demonstrates that the bond market is more fearful of long-term loans out of concern for future economic conditions.  

For instance, if you think the economy will weaken in the future, making borrowers less likely to pay you back, are you more likely to loan your money for one year or five years?   Before making any investment decisions, it is vital to anchor your choices within your overall financial plan and the timeline until you need to access your money. There are a variety of strategies that can balance risk and return or close the gaps between your retirement income needs. Laddering fixed annuities is one strategy that is also popular with certificates of deposit and allows you to hedge changing interest rates without compromising access to all of your money. 

Frequently Asked Questions About Annuities & the Yield Curve