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  • Response: Surging Interest in Stock-Based Annuities

    October 21, 2010 by Sheryl J. Moore

    PDF for Setting it Straight with Bob Carlson

    ORIGINAL ARTICLE CAN BE FOUND AT: Surging Interest in Stock-Based Annuities

    Dear Mr. Carlson,

    I recently had the occasion to read an article that you authored for Investing Daily, “Surging Interest in Stock-Based Annuities.” While your efforts to provide an favorable article on indexed annuities is to be applauded, this article was quite inaccurate. Such misinformation reflects poorly on Investing Daily, so I am contacting you (as the expert in the indexed annuity market), to ensure that you can make appropriate corrections to this article and have a reliable source for fact-checking in the future.

    I am an independent market research analyst who specializes in the indexed annuity and 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 and IUL 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.

    The first item I would like to draw your attention to is regarding the use of the term “EIA” or “equity index annuity.” Indexed annuities have not been called “equity-indexed annuities” by those in the insurance industry 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. The interest potential of these products is limited, unlike equities investments. In addition, 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. Thank you.

    I would also like to bring your attention to the fact that whenever there is a “difficult market” or a decline in the equities markets, there is a corresponding increase in fixed AND indexed annuities. This is driven by the fact that consumers have a tendency to seek out products with guarantees when they have been recently reminded of the fact that they are subject to losing money. It may also interest you to know that sales of indexed annuities also increase when rates on fixed annuities and certificates of deposit are unattractive. These are the primary products that indexed annuities compete against for Americans’ retirement dollars.

    I am displeased that you have suggested that indexed annuities are not “safe.” Precisely what is it about these products that you find unsafe? Is it the guaranteed principal protection? Perhaps the promise of no less than zero percent interest credited, regardless of the performance of the market? Or is it the minimum guarantee, which promises no less than 117% return on the average indexed annuity, even if the market declined every year of the contract? In fact, the only way that the indexed annuity purchaser can receive less than what they put into an indexed annuity, is if they cash surrender the contract in the early years of the contract. Perhaps if you illuminate why you perceive indexed annuities to be not safe, I can provide you with additional clarification on the product’s mechanics, as it seems you misunderstand how this product works.

    I would like for you to know that it is inappropriate to refer to an indexed annuity purchaser as an “investor,” as it is to refer to indexed annuities as “investments.” Variable annuities are the only type of annuity that can be called an “investment,” as these products place the purchaser’s principal and gains at risk due to market volatility. Stocks, bonds, and mutual funds are also investments. The Securities and Exchange Commission (SEC) is responsible for the regulation of such investment products. Fixed and indexed annuities, by contrast, are insurance products- similar to term life, universal life and whole life. Insurance products are regulated by the 50 state insurance commissioners of the United States (collectively referred to as the National Association of Insurance Commissioners, or NAIC). Insurance products do not put the client’s money at risk, they are “safe money products” which preserve principal and gains. Investments, by contrast, can put a client’s money at risk and are therefore appropriately classified as “risk money products;” they do not preserve principal. The NAIC does not permit the use of the word “investment” when discussing indexed annuities, as such.

    I think that you should also know that it is not precisely accurate to say that indexed annuities offer the potential for higher returns “when a stock market index does well.” This is untrue for two reasons. First, some indexed annuities are based on the performance of bonds or commodities, not just stock market indices. Second, some indexed annuities credit interest when the index or benchmark does not do well (or declines).

    You say that it is “not unusual for ‘EIA’ investors to be unpleasantly surprised at the returns credited to the accounts.” I am interested to know where you did your fact-checking for that statement. I think it would help if you knew about the true gain potential for indexed annuities, and how they are intended to work. Because indexed annuities are a “safe money place,” they should be compared against other safe money places. Investment products such as stocks, bonds, mutual funds, and variable annuities subject the purchaser to both the highs and the lows of the market. 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. 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. In addition, no indexed annuity owner has ever lost a penny as a result of market downturn. This is a strong value proposition that cannot be offered by any securities products.

    Now, that being said, I have actual policyholder annual statements on my desk, showing one-year gains as high as 47.65%. Are indexed annuities intended to return this much on a consistent basis? No. However, sometimes purchasers do “hit a home run” with these products. For a more realistic review of general gains on these products, you should consider the study that was done by my former partner, Jack Marrion, as well as the CIO of Skyline Capital Management and a professor from the Wharton School of Business. This “Real World Returns” study looked at actual returns of indexed ; it illuminates that from 1997 to 2007, the five-year annualized returns for actual indexed annuities averaged 5.79%. Interestingly, this is precisely the expected return for products over this period.

    You fail to realize that while annuities are backed by the claims-paying ability of the insurer, the insurer is backed by the Guaranty Fund Association. And interestingly, very few insurance companies have gone insolvent since the market collapsed. In contrast however, 322 banks have failed since the market collapsed in 2008. I believe you may have to drop your almighty FDIC from its pedestal, Mr. Carlson. Please realize the context of such statements before making them; your negative persuasion toward the claims-paying abilities of annuity issuers portrays these products differently than reality. Your public, disparaging statements have the ability to inappropriately sway your readers.

    You do not appropriately understand the minimum guarantees on indexed annuities. They do not have a ‘guaranteed annualized return of 1% to 3%.” All indexed annuities guarantee zero percent interest annually. In addition to this guarantee, they all have a secondary guarantee that applies in the event of cash surrender or non-performance of the underlying index. This guarantee is credited on a portion of the premiums paid (typically 87.5%, but never less), and ranges from 1% to 3%. With this secondary guarantee, the client would receive 100% of their premiums back in year four of the contract.

    You also do not appropriately understand how the interest is calculated on indexed products. You say “Suppose the policy has been in force for a few years and has earned a 4% annualized return. The stock index has a negative return for the current year. You may receive a 0% return this year, because the prior years’ cumulative return exceeds the guaranteed minimum.” This is not true. All gains received on the contract are locked-in and can never be taken from the purchaser, once they have been credited. In addition, an indexed annuity will never receive less than 0% interest crediting, should the index decline. This has nothing to do with the minimum guarantee however. Gains are credited, regardless of the minimum guarantee. If you need additional explanation of how this guarantee works, please do not hesitate to contact me.

    Despite your statement, there is no such thing as an indexed annuity that offers “no guaranteed minimum return, but…only a return of your initial [premium].” Every indexed annuity guarantees no less than a zero percent return in negative years, in addition to a minimum guaranteed surrender value (as explained above), as well as a return of principal at the end of the term.

    The item that you refer to as a “return ceiling” is actually called a “cap” in the indexed insurance market. Just FYI.

    As the foremost “analyst” in the indexed insurance market, I can assure you that there are not “over 30 formulas used to credit income” to indexed annuities. There less than 20.

    There are very few indexed annuities that use more than one “moving part” (i.e. cap, participation rate, or spread) in their crediting formulae. For that reason, your illustration with the 75% participation rate and 8% cap is not representative of how indexed annuities work in general.

    You are wrong; most of the formulas used to calculate indexed interest on these products are very simple. In fact, if you can calculate the simple algebraic formula of (A-B)/B, you can calculate the indexed interest on any indexed annuity.

    The most common crediting methods are not as you cite (I realize you pulled this information from the NAIC Consumer’s Buyer’s Guide which is over a decade old. Fortunately, I have re-written this guide, and it will be released by the NAIC with updated information shortly.) Point-to-point and averaging methods are most common. However, annual reset is not a crediting method. It is merely an expression of how frequently interest is credited (annually). In addition, high water methods are only used on precisely five products. So, it would be incorrect to say that this method is common.

    It never ceases to amaze me how some people think that the dividends of the index being excluded from the crediting calculation of indexed annuities is a bad thing. Mr. Carlson- 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 purchaser’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! This being said, not ONE indexed annuity uses dividends in the crediting calculation.

    There is also not one indexed annuity that uses simple interest in the calculation of indexed interest on the contract. Please take note that your statement to the contrary is not correct.

    Indexed annuities do not have “expenses” or fees. Some indexed annuities offer optional benefits that have an annual fee, which can be offered in addition to the annuity. Such benefits are not mandatory, however, so it is disingenuous to suggest that indexed annuities have expenses, and/or fees. It is important to note that these optional benefit fees do not vary based on the indexed interest credited on the contract, as you suggest.

    Just so you know, the average commission paid on indexed annuities today is 6.34%. It is not typical to see commission as high as 9%, as you allude.

    There are not currently any bonuses in the indexed annuity market, which are only credited after the first year. All indexed annuities that have bonuses credit them in the first year (at the time the policy is issued), and some pay the bonus for several years thereafter as well. It is also inaccurate to say that bonuses are “offered by weaker insurers that need to bring in new investments.” The majority of indexed annuity sales have a bonus credited to the contract, whether it be a 1% bonus, or 10%. So, your statement would mean that most insurance companies selling indexed annuities are “weaker.” Not true, Mr. Carlson. The bonus bears no reflection on the financial stability of the issuing insurance company. It is merely a product feature that is offered on some of the most attractive products available today because consumer interest in bonuses has driven product development in this market. Bonuses are especially attractive for those who have recently lost money in an investment; it can be a good way to offset some of their previous losses. However, you are correct in that premium bonuses typically require longer/higher surrender charges. This is how you appropriately price for a bonus on an annuity contract.

    There is only one indexed annuity on the market today, which requires that the purchaser annuitize, in order to receive their full account value. In addition, 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. Plus, 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 that these products pay the full account value to the beneficiary upon death, and it is clear that these are some of the most liquid retirement income products available today. This is not the picture that you would paint of them. Please take note of how liquid the products truly are.

    You make the surrender charges on annuities sound bad, when in reality they work for the client. 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. For this reason, surrender charges are a benefit, not a detriment, to the purchaser.

    While it is true that indexed annuities will not perform as favorably as stocks when the market is up, they are not intended to. These are safe money products, which protect the purchaser from loss due to market volatility. You must remember that indexed annuities are for the risk-averse; people who are unwilling to try for 20% market gains at the risk of losing 50% or more.

    I apologize if this email comes-off as aggressive. The negative/inaccurate media in the indexed annuity market is overwhelming. I have taken it upon myself to set the record straight on these products, so that consumers (and agents) that read articles about indexed annuities will have access to accurate, factual information. I appreciate your efforts to provide a fair and accurate portrayal of these products. In order to ensure that you fully-succeed next time, I encourage you to reach out to my firm for fact-checking. We are always happy to help people like yourself to obtain the facts about indexed insurance products; particularly when you are communicating information about them in public domain.

    Thank you.

    Sheryl J. Moore

    President and CEO




    Advantage Group Associates, Inc.

    (515) 262-2623 office

    (515) 313-5799 cell

    (515) 266-4689 fax

    Originally Posted on October 21, 2010 by Sheryl J. Moore.

    Categories: Negative Media