Response: Are Equity-Indexed Annuities Right For You?
June 7, 2010 by Sheryl J. Moore
ORIGINAL ARTICLE CAN BE FOUND AT: Are Equity-Indexed Annuities Right for You?
Dear Ms. Yuille,
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 am contacting you, as the author of an article that was published at Investopedia.com; it was entitled, “Are Equity-Indexed Annuities Right For You?” This article had numerous inaccurate and misleading statements about indexed annuities in it. I am contacting you in response to these inaccuracies to ensure that you and your readers have accurate, unbiased information on these products in the future.
First, indexed annuities are NOT investments, they are insurance products. Accordingly, the people who purchase indexed annuities are not referred to as “investors,” but as purchasers, consumers, etc. Investors purchase investment products such as stocks, bonds, and mutual funds. Investments are “risk money places” where the consumer may lose part of the original principal in addition to all gains as a result of market downturn. An indexed annuity is a “safe money place” where the client’s principal is always protected from market losses.
Second, it is inaccurate to state that an indexed annuity purchaser “may take on more risk compared to fixed or variable annuities.” The only risk an indexed annuity purchaser takes on is getting back less than their original principal if they completely cash surrender the annuity while surrender charges still apply. All annuities are subject to this risk. However, an individual who purchases a variable annuity takes on MUCH more risk than the person purchasing an indexed annuity. Variable annuity purchasers can lose all of their gain and principal, should the market decline. Indexed annuity purchasers cannot lose any principal as a result of market downturn, they are protected by an annual floor of (no less than) 0% interest as well as a minimum guaranteed surrender value.
Third, indexed annuities not only benefit seniors, but all who purchase them. As a young saver, I am proud to say that I own several indexed annuities as opposed to a 401(k). I sleep soundly every night, regardless of the market’s performance, knowing that I will be able to retire on my own time, with a standard of living that is comfortable.
Fourth, although several top-selling indexed annuities in the 1990s had complicated crediting methods which gave the products a reputation of complexity, the products being marketed today are very simple. 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 pass on the full account value to their beneficiaries upon death- then they can understand nearly every indexed annuity sold today.
Fifth, indexed annuities do not have fees. Perhaps you are thinking of variable annuities? There are some select indexed annuities that have optional benefits that carry annual fees, but indexed annuities do not have this pricing feature.
Sixth, all indexed annuities must limit the potential indexed interest that is credited to the contract in order for the insurance company to be able to pay for the guarantees on the annuity. 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.) Were the interest on an indexed annuity unlimited, there could be no minimum guarantee and that, Ms. Yuille is a variable annuity.
Seventh, although the Securities and Exchange Commission (SEC) would like for people to think that there are rampant sales abuses in the indexed annuity industry, the data does not support their insinuations. I have researched annuity complaints for the past several years, in order to evaluate such claims. Based on the NAIC’s Closed Complaints Database, complaints for indexed annuities are as follows:
▪ 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!
Eighth, although indexed annuities were identified as one of the products used in senior investment fraud in the national senior summit, so were certificates of deposit and more than a dozen other products (see attached). It is important to note that indexed annuities are just a tool in the financial professional’s toolbox. Would you outlaw hammers because a serial murderer used them to plummet their victims? I would think it would be rather difficult to build a house without a hammer…in the same manner, it is not good to damn indexed annuities because you heard a story about someone behaving badly while suggesting an indexed annuity.
Ninth, although the SEC’s Rule 151A would provide the “protections afforded by the securities law,” these protections are not necessarily better than the protections provided by state insurance divisions. For example, the SEC is the organization that let Bernard Madoff swindle $50 billion from American’s retirement nest eggs. Clear warning signs of Madoff’s fraud began to emerge as much as a decade before he was caught, and yet SEC did nothing. This is the same organization that many suggest regulate indexed insurance products? These people need to rethink their inclinations. Indexed annuities are regulated by the 50 state insurance divisions of the United States. These insurance commissioners regulate indexed annuities with rigorous standard non-forfeiture laws, advertising guidelines, suitability regulations, and other rules. The states hold the authority to take sanctions against insurance agents including, but not limited to, license revocation, penalties and fines. An interesting comparison of state and federal regulation exists relative to annuity complaints specifically. If I need to make a complaint on an indexed annuity, the state insurance division has to respond to me within ten days; and I incur no cost in my efforts to resolve the problem. Compare this with the exhaustive complaint process on the securities side; delays, lawyers, and a lot of my money spent. Yes, SEC regulation is different, but it most definitely is not better than insurance regulation.
Tenth, indexed annuities are not intended to compete with securities (such as variable annuities) 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, as equity investments do not have the guarantees and insurance benefits that indexed annuities provide.
Eleventh, all indexed gains must be limited through the use of a cap, participation rate, or spread on an indexed annuity. 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.
Twelfth, the typical methods for calculating indexed interest on indexed annuities are NOT annual reset, point-to-point and high watermark. It appears that this information has been taken verbatim out of the Annuity Consumer’s Buyer’s Guide which is more than a decade old. I recently rewrote this guide for the benefit of the National Association of Insurance Commissioners (NAIC) and it will be released shortly. For many years now, the typical crediting methods on these products have been annual point-to-point, monthly point-to-point, monthly averaging and fixed. These indexing methods can all be calculated by using a simple (A- B)/B algebraic formula with the exception of the fixed method, which performs just like a fixed annuity.
Thirteenth, it is disingenuous for FINRA to allude that insurance companies selling indexed annuities are not financially stable. So far, 251 banks have failed since the stock market collapse in March of 2008. It is also interesting to note that the Federal Deposit Insurance Corporation (FDIC) fund has recently been in danger. Interestingly, state guaranty fund associations (which insure the safety of insurance purchaser’s values) are not experiencing the same difficulties. In addition, NOT A SINGLE INDEXED ANNUITY PURCHASER HAS LOST A PENNY AS A RESULT OF THE MARKET DECLINES, BANK FAILURES, OR GENERAL WEAKENING OF THE ECONOMY.
Fourteenth, all annuities have surrender charges; Financial Industry Regulatory Authority (FINRA) would have you and your readers believe that indexed annuities have exorbitant surrender charges and are illiquid products, when this is not the case. 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 50% 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!
If more people understood what surrender charges do for the purchaser, they would appreciate them more. 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.
Fifteenth, “huge commissions” are not a problem in this business. There is no indexed annuity that pays a commission of 13%. The average street level commission in the indexed annuity market as of 1Q2010 was 6.34%. Although there are seven products that pay a double-digit commission in this market, sales for these seven products accounted for only 2% of first quarter, 2010 sales.
Sixteenth, indexed annuities ARE indeed regulated. They are regulated by the 50 state insurance commissioners.
Seventeenth, the perception that indexed annuities are “complicated” stems from on an old practice of developing new crediting methods and ways of calculating potential indexed gains. This is a practice that is no longer used; in fact there have been no new crediting methods developed in the indexed annuity market for over three years. As I previously mentioned, 96.4% of indexed annuities offered today have crediting methods based on the simple formula of (A – B)/B.
These are not complicated products. They are merely fixed annuities with a different way of crediting interest. Truly, 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. My grandmother didn’t even attend college, and she understands indexed annuities.
The bottom line is that indexed annuities offer many benefits that you readers may be interested in, including (but not limited to):
1. 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.
2. All indexed annuities return the premiums paid plus interest at the end of the annuity.
3. Ability to defer taxes: you are not taxed on annuity, until you start withdrawing income.
4. Reduce tax burden: accumulate your retirement funds now at a [35%] tax bracket, and take income at retirement within a [15%] tax bracket.
5. 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.”)
6. Provide a death benefit to heirs: all fixed and indexed annuities pay the full account value to your beneficiaries upon death.
7. 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.
8. 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.
9. Guaranteed lifetime income: an annuity is the ONLY product that can guarantee income that one cannot outlive.
I would truly appreciate it if you would consider pulling this article from your website or correcting the inaccurate information. Should you need any assistance in regards to indexed annuities in the future, please do not hesitate to contact us. It is our mission to ensure that these products are properly communicated in the media. Any assistance you can offer in this endeavor is so very appreciated.
Sheryl J. Moore
President and CEO
Advantage Group Associates, Inc.
(515) 262-2623 office
(515) 313-5799 cell
(515) 266-4689 fax