Response: A sure thing? Better to avoid those equity index annuities
November 26, 2010 by Sheryl J. Moore
ORIGINAL ARTICLE CAN BE FOUND AT: A sure thing? Better to avoid those equity index annuities
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.
I recently had the occasion to read an article that you wrote, which was published by The San Diego Union-Tribune, “A sure thing? Better to avoid those equity index annuities.” While your efforts to inform your readers are to be commended, your article had some grossly inaccurate information in it. Such misinformation reflects poorly not only on you, but also on The San Diego Union-Tribune. So that you will have access to accurate information on these products in the future, and so you and The Tribune can make an appropriate correction to this article, I am reaching-out to you as the foremost authority in the indexed annuity market.
First, I need for you to know that it is inappropriate to refer to indexed annuities as an “investment.” 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 referring to indexed annuities, as such.
Second, you have the value proposition of indexed annuities all wrong. It is inappropriate to say that when you own an indexed annuity you can “kick back and enjoy nearly all of the glorious gains of the stock market” and I have never heard of someone thinking that indexed annuities were a way to “strike it rich.” Indexed annuities are promoted as ‘allowing the purchaser to have LIMITED participation in the market’s upside, while avoiding the downside risks associated with the market.’ You see, all gains on indexed insurance products must be limited through the use of a participation rate, cap, or spread. Perhaps it would help if I first started with a brief overview of how indexed insurance products 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 product with unlimited gains.
Third, it is inappropriate to refer to indexed annuities as ‘equity-indexed annuities’ or ‘EIAs.’ Indexed annuities have not been called “equity-indexed annuities” or “EIAs” 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, Ms. O’Shaughnessy. Thank you.
You are correct, however, in that indexed annuity purchasers are never in the position to “lose any money” when “the stock market does it’s occasional imitation of a 20-car pileup.” NO INDEXED ANNUITY PURCHASER HAS EVER LOST A PENNY AS A RESULT OF MARKET DOWNTURN. It is this proposition, along with the ability to outpace traditional fixed rate instruments (such as fixed annuities and certificates of deposit), that has driven indexed annuities sales to record levels since the market collapse of 2008.
Fourth, where did you do your fact-checking for this article, Lynn? You say that insurance agents that sell indexed annuities are “rewarded with huge commissions.” That is simply untrue. The average commission paid on indexed annuities 3Q2010 was a mere 6.50% (and even lower for annuities sold to older-aged purchasers). Keep in mind that this commission is paid one time, at point of sale only, and the agent services the contract for life. By comparison, many securities products such as mutual funds pay generous, consistent commissions annually. In light of this, I think you’ll agree that the commissions paid on indexed annuities are hardly “huge.”
Fifth, do you find the formula (A-B)/B to be a “complicated formula?” This simple algebraic formula is used to calculate the indexed interest on 98% of the indexed annuities available today. 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 to give the appearance that one indexed annuity is better than another. 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. I would hardly call the aforementioned calculation a “complicated formula,” Lynn. Perhaps the changes in indexed annuities over the past decade have not been communicated to you?
Keeping in mind that indexed annuities’ gains are limited, and that they are not intended to perform comparably with securities products or the market itself, I believe you’d be impressed with what indexed annuities can offer today as opposed to other safe money products. Certificates of deposit (CDs) are paying a mere 0.54% interest today. Fixed annuities are averaging a paltry 3.14%. However, indexed annuities currently have the ability to credit 8.90% or more in a single year. Worst-case scenario zero interest, best case scenario outpacing fixed money instruments…I would take that any day. Wouldn’t you, Ms. O’Shaughnessy?
Sixth, it never ceases to amaze me how people like you can so misunderstand the concept of dividends being excluded from the crediting calculation of indexed annuities. You comment that dividends are excluded from the indexed calculation on indexed annuities as if it were a detriment; it is not. 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. By not directly investing in the index (which would pass-on the dividends), the insurance company is protecting the purchaser from losses. So, you see- this is a benefit to the indexed annuity purchaser, not a disadvantage. And yes, your readers will “kiss…goodbye” the dividends of the index, but they will also kiss goodbye the risk of losing money as a result of market volatility as well.
Seventh, while you are correct that indexed annuities do limit potential gains, you are wrong in that not all indexed annuities use a cap AND a participation rate to limit the indexed interest. Caps, participation rates, and spreads are just three different ways of doing the same thing: limiting the potential indexed interest on an indexed insurance product. Although an indexed annuity may use more than one of these levers, it is uncommon. What you need to understand, Lynn, is that the limiting of the interest on indexed annuities is not a detriment to the purchaser. This limitation of interest is necessary, in order to ensure the guarantees that are provided by the contract.
Eighth, I am absolutely appalled that you would suggest indexed annuities pay commissions in the “15 percent range.” YOU ARE CONTRIBUTING TO THE MISINFORMATION ON THESE PRODUCTS IN THE MEDIA, LYNN AND IT IS NOT OKAY. Do your fact checking! Indexed annuities pay commissions that average 6.50% today. These commissions range from 1.50% to 12.00%. There are exactly six indexed annuities that pay a double-digit commission. However, there are also nearly 30 indexed annuities that pay a commission of 4% or less. Please, double-check your information in the future before publishing it- for your readers’ sakes.
Ninth, indexed annuities do not have “onerous” surrender charges. Just because there is ONE product with a penalty as high as 20% in the first year (declining annually thereafter), does not mean that you can paint this entire industry with one broad brush. The average surrender charge on these products as of 3Q2010 was ten years and the first-year surrender penalty was just over 10% (even lower for older-aged annuity purchasers). However, surrender charges are available with surrender charges as short as three years and as low as 5% in the first-year. 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, Lynn. I ask you to please take note of how liquid the products truly are and don’t let them be promoted in a manner contrary to this in your articles. Thank you so much.
Tenth, I am curious to know why didn’t you publish any commentary from insurance agents that sell indexed annuities? You appear to have only requested comments from an investment advisor and a financial planners; individuals from groups that generally competes against insurance agents that sell indexed annuities. Investments advisors and financial planners generally sell investments, Ms. O’Shaughnessy. You need to speak with someone who actually sells indexed annuities to receive credible feedback on their value.
In the future, if you need contact information for insurance agents that sell indexed annuities, please do not hesitate to reach-out to me. I would be more than happy to provide you with a referral to an agent in your area of interest.
In addition, Mr. Glenn Daily is not educated on indexed annuities whatsoever. Indexed annuities have consistently outperformed fixed annuities and CDs. On the high end of the spectrum, I have actual policyholder annual statements on my desk, showing one-year gains on indexed annuities 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, I believe that you should consider a study that was recently done by Jack Marrion. Sure, the study has its flaws (i.e. small sample size), but this “Real World Returns” study is compelling. The study looked at actual returns of inforce indexed annuities and shows 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. I find it hard to believe that anyone would shun an average return of 5.79% following a period when the market declined nearly 50% in a single year. Keeping in mind that fixed annuities are currently averaging a mere 3.14% interest, I think that this return is respectable. Personally, one of my indexed annuities returned a gain of just over 7% this year, while my grandmother’s variable annuity had a loss. You must remember- indexed annuities are primarily purchased by those more concerned with principal protection, not unlimited potential for gains.
Mr. Daily further shows his ignorance of these products by suggesting stock mutual funds as an alternative to indexed annuities. Mutual funds cannot guarantee a return of principal and gains like indexed annuities can. RISK TOLERANCE is one of the primary pieces of information that investment advisors must collect on their clients during a suitability review. Shame on him for suggesting such a risk money product for those who are risk averse and looking for the guaranteed return of principal that indexed annuities offer.
Eleventh, with rates on CDs and fixed annuities below 4% right now, how do you suggest your readers outpace inflation? Sounds like an indexed annuity is the only retirement savings vehicle which can do this without the risks associated with securities. You would do well to keep that in mind.
Twelfth, it is preposterous for you to suggest that “there aren’t many professionals who can…crack the code” on indexed annuities. Anyone who has access to my website can easily compare every indexed annuity to any other on an apples-to-apples basis.
Thirteenth, you suggest that your readers “think long and hard about asking…someone else who lives off commissions” about advice on indexed annuities. That is interesting. Would you also suggest your readers use someone other than a real estate agent for information on buying a home? Someone other than a car salesman for information on purchasing an automobile? You fail to realize that earning a commission on the sale of a product does not necessarily create a conflict of interest. Do people know that these professionals are going to be paid a commission in exchange for the services rendered? YES. Does that mean that the salesperson is going to only look out for their best interests? NO. Sales jobs are built on relationships; the cornerstone of these relationships is repeat business and referrals. So, if the car salesperson sells me a crummy car (where they received a high commission), what is my likelihood to suggest that salesperson to my friends and neighbors? What is the likelihood that I’ll buy my next car from that same person? Not good in either scenario. I think you get the picture. Insurance agents NEED the client loyalty and referrals. Anyone who makes an inappropriate sale is obviously going to lose out on business, not to mention face potential fines, license revocation, and imprisonment. With that understanding, I think you can agree that agents are not in a position of “conflict” when suggesting indexed annuities to their clients that are risk-averse. You need to understand that fee-based advisors can be crooks just as well as any other person in a position of influence over consumers on their financial decisions.
You are correct in that your readers should not “invest in [something] they don’t understand.” This is one of the primary reasons that we have rigorous suitability review and training requirements in this industry. However, if your readers 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. In fact, indexed annuities have 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 the designated beneficiaries upon death.
- Access money when you need it: every indexed annuity allows annual penalty-free withdrawals of the account value at 10% of the annuity’s value; some even permit as much as 50% to be withdrawn in a single year. 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 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.
I would advise that if you and your readers truly want to the facts about indexed annuities, that they go to my website and not read your “reporting.” It appears that you do not know enough about these products to be writing about them. However, should you have a desire to write about these products in the future, I am more than happy to assist you in your understanding of these products or aid you in fact-checking. Please do not hesitate to contact us, should there be a need.
Sheryl J. Moore
President and CEO
(515) 262-2623 office
(515) 313-5799 cell