Response: Equity-indexed annuities: Rip-off or bad rap?
March 24, 2010 by Sheryl J. Moore
ORIGINAL ARTICLE CAN BE FOUND AT: Equity-indexed annuities: Rip-off or bad rap?
Dear Pop Economics blogger,
Good afternoon. 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 that was published at http://www.popeconomics.com/2010/03/23/equity-indexed-annuities-rip-off-or-bad-rap/, “Equity-indexed annuities: Rip-off or bad rap?” Although I can appreciate the spirit of your blog, it was very inaccurate and quite biased. For this reason, I wanted to take the opportunity to contact you about the mistakes made in your blog. I know that your piece is commentary, but I am a big believer in journalistic integrity even with blogging. In the wake of the stock market collapse, it is so very important that Americans have access to reliable, credible, accurate information on retirement income products. These people who have lost as much as half of their retirement dollars in the market, are now in a position to delay their retirement, and are looking for help in terms of what to do with their money. You may not realize that you do these people a great disservice by disseminating information without fact-checking it prior to publication.
First of all, 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.
Second, you indicate that “ragging” on these products is a favorite pastime of:
- The media– whose motto is “sensationalism sells,” and would never print an article about the little old lady who is thrilled to have saved millions of her retirement dollars in an indexed annuity.
- Financial advisors– who sell products that compete against indexed and fixed annuities and stand to lose commissions if their clients buy these safe money products.
- State attorneys general– who have political aspirations and commit legalized blackmail against insurance companies on a regular basis. See my article at http://www.sheryljmoore.com/2010/01/ambulance-chasers-and-a-lack-of-responsibility/ for the truth about why lawyers have an interest in insurance products.
Third, you claim that “unscrupulous salesmen have pushed” indexed annuities onto seniors. Quite honestly, the data doesn’t support your claim. See data below from the National Association of Insurance Commissioner’s Closed Complaint Database:
TOTAL INDEXED ANNUITY COMPLAINTS FOR 2006: 187
TOTAL INDEXED ANNUITY COMPLAINTS FOR 2007: 235
TOTAL INDEXED ANNUITY COMPLAINTS FOR 2008: 220
TOTAL INDEXED ANNUITY COMPLAINTS FOR 2009: 148
Based on our research, this results in average annual complaints as follows:
AVERAGE INDEXED ANNUITY COMPLAINTS PER COMPANY 2006: 4.35
AVERAGE INDEXED ANNUITY COMPLAINTS PER COMPANY 2007: 4.12
AVERAGE INDEXED ANNUITY COMPLAINTS PER COMPANY 2008: 3.86
AVERAGE INDEXED ANNUITY COMPLAINTS PER COMPANY 2009: 3.29
So, not only have complaints on these products declined annually for the past three years, but the average has declined consistently for the past four years. Certainly, we do strive for 100% customer satisfaction in the insurance market, but I would contend that an average of only 3.29 complaints per company is quite reasonable and not indicative of seniors not understanding the “implications” of indexed annuities.
Fourth, I do not see how you allude that indexed annuities have brought on “ugliness.” These products are quite simple: they are just fixed annuities with a different way of crediting interest. Unfortunately, Wall Street would lose A LOT of money if more people purchased them. That translates to a lot of “haters” disseminating inaccurate information about the products.
Fifth, one cannot “invest” in an indexed annuity. An indexed annuity is an insurance product, not an investment. Other insurance products include fixed annuities, term insurance and whole life. Alternatively, investment products include variable annuities, stocks, mutual funds, and bonds. 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 all of a client’s money at risk and are therefore appropriately classified as “risk money products.” Investments do not preserve principal where insurance products do.
Sixth, an indexed annuity is a contract issued by an insurance company that has a minimum guarantee where crediting of any excess interest is determined by the performance of an external index, such as the Standard and Poor’s 500® index. An indexed annuity is considered a moderate risk/moderate return annuity product. To clarify, you will not lose money in an indexed annuity as a result of market fluctuations. It sounds like it would help you to have a basic understanding on how indexed annuities are priced. These products have to be profitable to three parties:
- The consumer– via fair rates
- The agent– via fair commissions
- The insurance company– via a fair spread
Seventh, you think that the limiting of interest on indexed annuities is a detriment when it is not. To ensure that you properly understand how indexed annuities are intended to work, I would like to provide a brief overview. Indexed annuities are a “safe money place,” which protect the purchaser’s original payment. These products should be compared against other safe money places. They are regulated by the 50 state insurance commissioners of the United States. Products like stocks, bonds, mutual funds, and variable annuities are “risk money places,” where the client is subjected to both the highs and the lows of the market. These products are regulated by the Securities and Exchange Commission (SEC) because they are investments. It is inappropriate to compare any safe money place, such as an indexed annuity, to risk money places and it is most certainly not appropriate to compare safe money places to the market index itself. Indexed annuities are not intended to perform comparably to stocks, bonds, or the S&P 500 because they provide a minimum guarantee where investments do not. Indexed annuities are priced to return about 1% – 2% greater interest than traditional fixed annuities are crediting. In exchange for this greater potential, the indexed annuity has a slightly lesser minimum guarantee. So, if fixed annuities are earning 5% today, indexed annuities sold today should earn 6% – 7% over the life of the contract. Some years, the indexed annuity may return a double-digit gain and other years it may return zero interest. However, what is most likely to happen is something in between. All indexed interest on these annuities is limited through the use of a cap, participation rate, or spread. Were the indexed interest NOT limited, the insurer could not afford to offer a minimum guarantee on the product, and THAT is a variable annuity- not an indexed annuity. On the other hand, the client is guaranteed to never receive less than zero interest (a proposition that millions of Americans are wishing they had during that period of 03/08 to 03/09) and will receive a return of no less than 117% worst-case scenario on the average indexed annuity.
Eighth, although it is not unheard of for an indexed annuity to use more than one pricing lever for their rates (participation rate, cap, or spread), it is extremely atypical. Generally, insurance companies simplify the crediting calculations of these products by only utilizing one “moving part.”
Ninth, you allude that indexed annuities are complex because there is more than one way to “calculate the return.” Complexity is relative to your audience. 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, 97.6% of indexed annuities offered today have crediting methods based on the simple formula of (A – B)/B.
Tenth, all annuities have surrender charges. The surrender charge on a fixed, indexed, or variable annuity is a promise by the consumer not to withdraw 100% of their monies prior to the end of the surrender charge period. This allows the insurance company to make an informed decision on which conservative investments to use to make a return on the clients’ premium (i.e. 7-year grade “A” bonds for a seven-year surrender charge annuity or 10-year grade “A” bonds for a ten-year surrender charge annuity). Investing the consumer’s premium payment in appropriate investments allows the insurance company to be able to pay a competitive interest rate to the consumer on their annuity each year. In turn, it also protects the insurance company from a “run on the money” and allows them to maintain their ratings and financial strength. I personally appreciate the value of the surrender charge on an annuity and if more consumers understood them, they would too.
In addition, there are indexed annuities with surrender charges as short as three years and EVERY indexed annuity permits penalty-free withdrawals of 10% of the annuity’s value annually. Some even allow as much as 20% of the annuity’s value to be withdrawn in a single year. 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 that you’ll see that consumers have tremendous access to their cash value when they purchase indexed annuities. These are some of the most liquid retirement income products available today!
Eleventh, the average street level commission for indexed annuities as of 4Q2009 was 6.47%. This is a far cry from being a “high commission,” especially when you consider the fact that products such as mutual funds pay consistent, generous commissions. Indexed annuities’ commissions are paid one time at point-of-sale only, yet the agent is expected to service the contract for life.
Twelfth, you would be best-off using CREDIBLE sources for indexed annuity information. Dateline NBC did not interview ONE insurance regulator, one insurance company offering indexed annuities, or anyone on the defense of these products in their “expose.” Interestingly however, they did interview securities regulators and attorney generals with political aspirations on their segment. Interesting that a “credible” newsmagazine would source someone who would have job security by the products being regulated as securities, or someone who is on the fast-track to a political coup.
Thirteenth, it never ceases to amaze me how people think that the dividends of the index being excluding from the crediting calculation of IAs is a bad thing. Mr. Pop Economics- the insurance company never receives the benefit of the dividends on the index on an indexed annuity, because the client is never directly invested in the index. The insurance company invests the indexed annuity client’s premium payment in the general account, which protects them from declines in the index. The premiums are never invested in a pass-through account, which would provide the benefit of the dividends, but also expose the client to risk should the market decline. For this reason, the dividends cannot be passed on to the consumer. So you see, the insurance company cannot pass on the dividends if they do not have them to begin with.
Fourteenth, indexed annuities are not intended to perform against index funds. These products compete with fixed annuities and certificates of deposit (CDs). It is disingenuous to compare “safe money” products to “risk money” products such as index funds. Indexed annuities are strategically designed to address the needs of risk-averse Americans who want the safety and guaranteed return of principal that an indexed annuity offers, all while being able to outpace the interest rates of traditional fixed money instruments such as CDs.
Fifteenth, while it is true that insurance companies reserve the right to change the caps, participation rates, and asset fees in years two plus on indexed annuities, it does not mean that insurance companies do. I can name plenty of companies that have never reduced their renewal rates on their indexed annuities. However, this provision is no different than that of a fixed annuity, where the insurance company has the discretion to change the credited rates in years two plus. Not to mention the fact that variable annuities have the ability to increase fees if necessary in years two plus. All fixed and indexed annuities are subject to minimum rates, as approved by the state insurance divisions that approve the products for sale in their respective states. Insurance companies are smart to protect themselves by filing products that have the ability to change rates annually, in the event of a volatile market. I personally feel much more confident that the companies offering these products today will be able to make good on their claims-paying ability, considering such flexibility in the event of unforeseen circumstances.
Sixteenth, nobody should put 100% of their retirement savings in a single product. However, indexed annuities are not a bad product and they are the right product for millions of Americans like myself. I am just not willing to risk losing my principal for the proposition of potential double-digit gains. Indexed annuities provide many benefits including (but not limited to):
- No indexed annuity purchaser has lost a single dollar as a result of the market’s declines. Can you say the same for variable annuities? Stocks? Bonds? Mutual funds? NO.
- All indexed annuities return the premiums paid plus interest at the end of the annuity.
- Ability to defer taxes: you are not taxed on annuity, until you start withdrawing income.
- Reduce tax burden: accumulate your retirement funds now at a [35%] tax bracket, and take income at retirement within a [15%] tax bracket.
- Accumulate retirement income: annuities allow you to accumulate additional interest, above the premium you pay in. Plus, you accumulate interest on your interest, and interest on the money you would have paid in taxes. (Frequently referred to as “triple compounding.”)
- Provide a death benefit to heirs: all fixed and indexed annuities pay the full account value to your beneficiaries upon death.
- Access money when you need it: fixed annuities allow annual penalty-free withdrawals of the account value, typically at 10% of the annuity’s value (although some indexed annuities permit as much as 20% of the value to be taken without penalty). In addition, 9 out of 10 fixed and indexed annuities permit access to the annuity’s value without penalty, in the event of triggers such as nursing home confinement, terminal illness, disability, and even unemployment.
- Get a boost on your retirement: many fixed and indexed annuities provide an up-front premium bonus, which can provide an instant boost on your annuity’s value. This can increase the annuity’s value in addition to helping with the accumulation on the contract.
- Guaranteed lifetime income: an annuity is the ONLY product that can guarantee income that one cannot outlive.
Seventeenth, it is irresponsible for you to suggest that indexed annuities are “not quite the right fit for anybody.” They are right for me, they are right for many of my friends, many of my colleagues, and many of my neighbors. In fact, they are probably right for anyone looking to save for their retirement, wanting to preserve their principal from market risk, and looking to outpace traditional fixed money instruments by 1% – 2%.
Should you have a need for reliable, accurate information about indexed annuities in the future, please do not hesitate to contact us. Thank you sincerely.
P.S. Ask us about our new TOTALLY FREE website, www.IndexedAnnuityNerd.com!
Sheryl J. Moore
President and CEO
Advantage Group Associates, Inc.
(515) 262-2623 office
(515) 313-5799 cell
(515) 266-4689 fax