Response: Avoiding Risk May Be Costly!
December 31, 2009 by Dave Patterson and Erin Preston
PDF for Setting It Straight with CFPs
ORIGINAL ARTICLE CAN BE FOUND AT: Avoiding Risk May Be Costly
David and Erin,
I am an independent market research analyst who specializes exclusively in the indexed annuity (IA) and indexed life markets. I have tracked the companies, products, marketing, and sales of these products for over a decade. I used to provide similar services for fixed and variable products, but I believe so strongly in the value proposition of indexed products that I started my own company focusing on IAs exclusively. I do not endorse any company or financial product, and millions look to us for accurate, unbiased information on the insurance market. In fact, we are the firm that regulators look to, and work with, when needing assistance with these products.
I recently had the occasion to read your blog, “Avoiding Risk May Be Costly!” I understand that you are not fans of fixed and indexed annuities, and you have every right to biased against them if you so desire. However, you owe it to your readers and to the millions of Americans who have been misled by unscrupulous advisors to report accurate information. While reading your blog, I noticed an alarming number of inaccuracies and false information. I am reaching out to assist you in light of these errors.
First, indexed annuities have not been referred to as “equity indexed annuities” since the late 1990’s. The insurance industry has been careful to enforce a standard of referring to the products as merely “indexed annuities” or “fixed indexed annuities,” so as not to confuse consumers. This industry wants to make a clear distinction between these fixed insurance products and equity investments. It is the safety and guarantees of these products which appeal to consumers, particularly during times of market downturns and volatility. Your help in avoiding any such confusion is so greatly appreciated.
Most importantly, indexed annuities are NOT investments. They are insurance products, similar to fixed annuities, term life, universal life and whole life. Stocks, bonds, mutual funds, and variable annuities are investments. Insurance products are regulated by the 50 state insurance commissioners of the United States. Investments are regulated by the Securities and Exchange Commission (SEC). Insurance products do not put the client’s money at risk, they are “safe money products” which preserve principal. Investments, by contrast, can put a client’s money at risk and are therefore appropriately classified as “risk money products.” Investments do not preserve principal.
You say that indexed annuities are “complex products.” You and I both know that complexity is relative. Some would say that fixed annuities are complex. However, if someone can understand that they have the ability to deposit their money with an insurance company, defer taxes on the monies until they begin taking income, receive 10% withdrawals of the account value annually without being subject to penalties, and have the ability to pass on the full account value to their beneficiaries upon death- then they can understand nearly every indexed annuity sold today. As far as the indexed interest crediting is concerned, 95.2% of indexed annuities offered today have crediting methods based on the simple formula of (A – B)/B. My grandmother didn’t even attend college, and she fully understands indexed annuities. Furthermore, one can compare every indexed annuity against another with the touch of a button at my website, www.annuityspecs.com.
Insurance agents who sell these products have an insurance license, obtain regular continuing education, and go through intense product training. The disclosures that are provided to the consumers of these products are also very straight-forward and clearly communicated. It is not rocket science, folks. If a client is looking for a guaranteed return of principal, minimum guaranteed interest, and the potential for greater interest than fixed annuities can provide- they are probably a good candidate for an indexed annuity. If they are more concerned about the return OF their money, than the return ON their money- they are probably a good candidate for an indexed annuity.
I hate to be the first to point it out to you, but New York Life sells a considerable amount of variable annuities. When the stock market tanks, sales of variable annuities drop and sales of fixed and indexed annuities rise. This is because people are looking for products that provide principal protection while they are freshly reminded of their investment losses. For this reason, variable annuities directly compete with indexed annuities and THAT my friend, is why New York Life does not sell indexed annuities. Companies like New York Life, which do not sell indexed annuities, are consistently losing sales to them. This comparison is like saying that McDonalds stockholders don’t like the food at Burger King.
The article that you refer to in The Wall Street Journal, “How Well Do You Know…Indexed Annuities” was even more inaccurate than your blog. I am attaching my correction on that article, which was sent to Leslie Schism at WSJ. Your referring your readers to such an inaccurate article is disingenuous. This article had very little FACTS about indexed annuities. I hope that you will alter your blog reference in light of the information I have provided you.
Indexed annuities must limit the upside crediting potential, in order for the insurance company to be able to pay for the guarantees. Indexed annuities are only intended to provide 1% – 2% greater interest crediting than traditional fixed rate instruments. Although some years an indexed annuity (IA) may receive double-digit gains, others it will receive zero. Over the life of the contract, the IA product should outpace today’s fixed annuity rates by 1% – 2%. Therefore, all indexed gains must be limited through the use of a cap, participation rate, or spread. All three of these pricing levers serve the same purpose, in that they limit the potential indexed interest credited to the policy. Although an indexed annuity may use more than one of these levers, it is uncommon.
The average surrender charge on indexed annuities as of 2Q2009 was ten years. The average first-year penalty is 10.61%. In addition, the majority of these longer-term products are offered with a premium bonus, which provides an immediate boost to the annuitant’s cash value. Longer surrender charges are necessary to appropriately price for such an incentive. Furthermore, indexed annuities are some of the most flexible, liquid products available today. All indexed annuity consumers are given access to 10% of their annuity’s value, annually, without being subject to surrender penalties (some even allow as much as 20% to be taken annually). In addition, 9 out of 10 indexed annuities provide a waiver of the surrender charges, should the annuitant need access to their money in events such as nursing home confinement, terminal illness, disability, and even unemployment. Couple this with the fact these products pay the full account value to the beneficiary upon death, and I think you would have difficulty inferring that these products are illiquid.
It is misleading to say that “many of the products allow insurers to change the contract rules after purchase.” What on earth does this mean? What rules? While it is true that an indexed annuity usually provides the option to change the rates on the annuity in years two plus, this is NO DIFFERENT than how an insurance company can reduce the rates on a fixed annuity, or increase the mortality and expense charges on a variable annuity. Insurance companies must price these products appropriately, and that means building-in the ability to reduce rates, should the volatility of the markets require it. However, just because the insurance company has the ability to change these rates, does not mean that they DO. In addition, an insurance company can never adjust these rates in the middle of the crediting term; they must wait until the policy anniversary to do so, and they must inform the annuity owner of their actions.
I am constantly amused how people continue to site the fact that indexed annuity crediting calculations exclude dividends as a weakness of the product. In fact, a little education about the basic concept of an indexed annuity would go a long way with this concept.
1. An indexed annuity is an insurance product, not an investment
2. The annuity owner is never directly invested in stocks, or a stock index, when they purchase an indexed annuity
3. The insurance company holds the money that backs their indexed annuities in their general accounts, not a separate pass-though account (like a variable annuity)
4. Because the client is never directly invested in the index, they cannot gain from the dividends on the index
5. The insurance company’s general account assets cannot gain from the dividends on the index for the same reason
Hope that is helpful to you. Indexed annuities are not intended to compete with securities or the index itself. These are “safe money products” which provide a preservation of principal and a guarantee. They are intended to be compared against other safe money instruments such as fixed annuities and CDs. Indexed annuities are only intended to provide 1% – 2% greater interest crediting than these traditional fixed rate products. Although some years an IA may receive double-digit gains, others it will receive zero. Over the life of the contract, the index annuity should outpace today’s fixed annuity rates by 1% – 2%. To compare this product to any equity investment is ignorant.
You talk about the minimum guarantees on indexed annuities as if they weren’t an asset to the products. A little education is incredibly helpful in understanding why “some contracts guarantee the minimum return only on a portion of the amount.” The Minimum Guaranteed Surrender Value (MGSV) on indexed annuities is not appropriately compared to the guaranteed annual return of a fixed annuity or CD. An indexed annuity MGSV provides a guaranteed minimum value, in the event the client cash surrender the contract or if the index does not perform favorably over the duration of the annuity contract. A fixed annuity guarantee, by contrast, credits a minimum amount of interest every single year. A guarantee this rich is costly for an insurance company to purchase. Insurance companies offering indexed annuities must be able to afford the index linked interest on the contract, in addition to the guarantee. For that reason, the minimum guarantees on indexed annuities are slightly lower than those provided on fixed annuities. By contrast, indexed annuities provide slightly higher interest crediting potential than fixed annuities. In fact, the average indexed annuity would receive a return of premiums paid, plus nearly 18% interest at the end of the contract. I’m certain that millions of Americans today feel that having a guaranteed return of 118% would be a welcome alternative to their recent market losses.
The average street level commission on indexed annuities as of 2Q2009 was 6.46%. This commission is paid a single time, and yet the agent is expected to service the contract for life. Compare this to the generous, consistent commissions that are paid to brokers selling mutual funds, and I think you’ll agree that indexed annuity commissions are quite reasonable. So, technically, you are correct that “typical commission” on these products falls in the 6% – 10% range, as opposed to a 4% – 5% range, etc. You are setting-up your readers here, and it would have been more genuine of you to present this data in a different fashion. There are less than eight annuities in this market that pay a commission of 10% or greater, yet you twist this information in order to imply that indexed annuities offer exorbitant commissions.
Lastly, but perhaps most importantly, why would ANYONE ever advise someone who is risk averse enough to seek out an indexed annuity that alternatively they should invest in “mutual funds, index funds and exchange-traded funds (ETFs)?” This is not only ignorant, but it is reckless. The consumer risk profile for someone purchasing securities such as stocks and bonds is someone looking for “risk money places”- where they can have the potential to earn 20% at the cost of having a chance of losing 20%. The consumer risk profile for someone purchasing insurance products like fixed and indexed annuities is someone looking for a “safe money place”- where they can have a guaranteed preservation of principal plus limited interest. I’m certain your clients would GREATLY appreciate you understanding the difference.
You are right- the devil IS in the details, or in the LACK of them. Please get the FACTS next time David and Erin. Your credibility comes into question when you do financial planning, and provide such inaccurate information on financial services products.
P.S. I just received an email from a indexed annuity customer who was extremely pleased with his purchase because his annuity had a gain of 56% over a 7-year period, while his no-load mutual fund declined in value by 40%.
Sheryl J. Moore
President and CEO
LifeSpecs.com
AnnuitySpecs.com
Advantage Group Associates, Inc.
(515) 262-2623 office
(515) 313-5799 cell
(515) 266-4689 fax
