Response: Indexed Annuities Cap Gains, Obscure Fees as Sellers Earn Trip to Disney
January 21, 2011 by Sheryl J. Moore
ORIGINAL ARTICLE CAN BE FOUND AT: Indexed Annuities Cap gains, Obscure Fees as Sellers Earn Trip to Disney
Good afternoon. As I am certain you have anticipated, I wanted to reach-out to you in regards to the article that you recently published with Bloomberg, “Indexed Annuities Cap Gains, Obscure Fees as Sellers Earn Trip to Disney.” I am happy that I could serve as a fact-checking resource to you on this piece since December, 2010. Gratefully, the mistakes that most reporters make in mis-reporting information on indexed annuities (regarding surrender charges, compensation, liquidity, etc.) were avoided in this piece because of your diligence in verifying the facts. Thank you so much for that, Peggy. Bloomberg’s readers are certainly deserving of the facts and I appreciate your pursuit of factual information.
What concerns me about this article, however, is the position you took with the piece. While it is not unique, it is disappointing; “Wall Street Journalism” on financial services products has to stop. Not all financial services products are securities, like the products sold on Wall Street. And while your biggest advertisers are the Wall Street firms, and not insurance companies, firms like Bloomberg need to realize that insurance products have value. While it is not in the best interests of your advertisers to promote insurance products, I would find it refreshing to see an article disclosing the benefits of these products to your readers. Indexed annuities are not “bad,” and I would like to clarify some additional concerns about your article:
1. Indexed annuities are not “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 referring to indexed annuities, as such.
2. Ms. Siswein was correct in her thinking that “if the market surge[d]” she could “make a lot.” On the high end of the spectrum, I have actual indexed annuity 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, 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. It is inconceivable that naysayers 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 3.33% 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. I was thrilled! You must remember- indexed annuities are primarily purchased by those more concerned with principal protection, not unlimited potential for gains.
3. Even IF Ms. Siswein’s insurance agent did not tell her about the caps and surrender charges on her annuity, all of the features of her annuity are clearly disclosed in the plain-language disclosures and contract that were left with her by the agent. When did we stop holding people responsible for the contracts that they sign and the purchase decisions that they make?
4. Ms. Siswein would not have had to pay ANY fees, had she kept her annuity until the surrender charges expired, as she had indicated she would when she purchased the contract. Much less, she could have withdrawn money from her annuity each year, without being subject to surrender penalties. AND she would have had surrender charges waived, had she been confined to a nursing home or died. This article makes it sound as if Ms. Siswein’s indexed annuity were illiquid; it was not.
5. Earning 3% a year on an indexed annuity is GREAT when the market is declining 50% in a single year. I think this is a valuable reminder.
6. Comparing a 3% return on an indexed annuity to a 6.3% return on the S&P 500 is inappropriate, as indexed annuities are not intended to perform favorably to the stock market. 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, much less via the S&P 500.
7. It is disingenuous to calculate the return AFTER surrender charges on an annuity, as an annuity is sold under the pretense that it will not be cashed-in while surrender charges still exist on the contract.
8. Just a heads up that dividends being excluded from the indexed calculation on indexed annuities is not a detriment. 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. This is a benefit to the indexed annuity purchaser, not a disadvantage. And while it is true that annuity purchasers will not “benefit” from dividends in an indexed annuity, they also won’t risk losing their money as a result of market volatility.
9. 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, Peggy. Thank you.
10. You say that indexed annuities “don’t decline in value if held to maturity.” Indexed annuities don’t decline in value as a result of market downturn EVER; even if they are not held until maturity. The only time a purchaser can get less money back than what they deposited in an indexed annuity is if they cash surrender their contract prior to the date they committed to.
11. Indexed annuities are not as complex as most perceive them to be. They are just fixed annuities with a different way of crediting interest. Furthermore, complexity is relative. Some would say that fixed annuities, which are the simplest retirement income product offered by insurance companies, 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, 98.4% 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 understands indexed annuities for goodness sake.
Note that the perceived complexity of indexed annuities stems from the historical practice of offering numerous, complex, unique crediting formulae on the products. Historically, there have been as many as 42 different ways of calculating indexed interest on these products. However, since hitting that high point in the year 2000, the number of unique crediting methods on indexed annuities has declined annually and sits at 12 today. Of these twelve different methods, nine use the calculation (A-B)/B to calculate the gain.
12. There is no such thing as an “embedded fee” on any indexed annuity, much less “hidden fees.” Indexed annuities have no explicit “fees,” like variable annuities do. The “cost” that the client pays on an indexed annuity is merely time; via a surrender charge. 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.
13. While it is true that insurance companies reserve the right to change the caps, participation rates, and asset fees on indexed annuities in years two plus, it does not mean that insurance companies do. I can name numerous 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.
14. I am just wondering how you feel that an incentive trip for salespeople in the insurance industry is any different than an incentive trip for people in the auto industry, pharmaceutical industry, or any other market?
15. It is interesting that Barbara Roper of the CFA claims that indexed annuities are “one of the most abusively sold products on the market today,” when the facts don’t back up her statements. In fact, the facts clarify that the indexed annuity market is much more “suitable” than many other markets. See data below from the National Association of Insurance Commissioner’s Closed Complaint Database on annuities:
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 indexed annuities declined annually for the past three years, but the average has declined consistently for the past four years. Conversely, variable annuity complaints (which are overseen by the Securities and Exchange Commission) have always been greater than the number of indexed annuity complaints, and have risen in recent 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 annually, per company, is quite reasonable and not indicative of “abusively sold products.”
16. While Kent Smetters is correct that most annuity purchasers don’t “convert the contracts into a lifetime stream of income at maturity,” he’s only telling half of the story. Most indexed annuities are converted into a lifetime stream of income BEFORE maturity; sometimes as early as year one of the contract.
17. I will tell you the same thing I told Lisa Gibbs at MONEY about William Richenstein; he has no basis for suggesting that indexed annuities don’t deliver attractive returns. Where is his research? Has he looked at any inforce policyholder annual statements? I highly doubt it. Not only do I own many indexed annuities, but I have collected policyholder annual statements over the past twelve years. Indexed annuities have consistently outperformed fixed annuities and certificates of deposit (CDs). Remember- I have actual policyholder annual statements on my desk, showing one-year gains on indexed annuities as high as 47.65% and I have owned numerous indexed annuities for more than a decade. Ultimately, Mr. Reichenstein’s assertion that indexed annuities “underperform” is based on faulty logic: they are not intended to perform favorably against securities products, which is what he is comparing them to.
18. It is not surprising to see that Carolyn Walder, a registered representative, replaced Ms. Siswein’s annuities. It is common practice for registered representatives to roll indexed annuities into securities products, so that they can earn commissions on them annually. In fairness, insurance agents also replace securities products with annuities when their client’s express concern about risk. There has been an ever-present quest to control the client’s assets in both the securities and insurance industries since the dawn of financial services. The bottom line is that both groups of financial advisors cannot play nice together in the same sandbox. In short, I would not assume that a product was unsuitable for someone, based on the words of someone who replaced that product with something they earned a commission on.
19. The suitability procedures that Jim Mumford described as being requirements for annuity sales in the state of Iowa are similar to those used in all states by all insurance companies.
20. It is a mystery to me what William Falck could be referring to when he states that “the interest may not” be guaranteed on indexed annuities, in reference to state guaranty fund association benefits. The guaranty fund covers the purchaser’s cash values and the indexed interest on an indexed annuity is included in that value.
21. MetLife and Prudential sell variable annuities, Peggy. When the stock market declines, sales of variable annuities drop overnight. Conversely, when the market declines, indexed annuity sales increase. I would hardly consider companies that compete against those selling indexed annuities to be a credible source of information on the products.
22. In addition, it is incorrect to state that MetLife doesn’t “offer indexed annuities.” MetLife DOES offer indexed annuities- via their broker dealer. Registered representatives appointed with MetLife Securities have the ability to sell indexed annuities that are underwritten by other insurance companies, but selected by MetLife. If Met has such a distaste for indexed annuities, why are they allowing their advisors to sell them?
In closing, I have a tendency to agree with Rick Stgeorge- I think that there SHOULD be “parades for indexed annuities!” Had I known about indexed annuities in my early years as a young saver, I personally wouldn’t have lost half of my retirement savings in a 401(k) when the dotcom bubble burst after the turn of the century. It makes me angry that more people don’t know about these products and that there is a lack of factual information about them available publicly. This is why I quit working in an insurance home office and started this company six years ago. These products are valuable and suitable for many people! There is just such a lack of factual, credible information about indexed annuities in the general media. It is my hope that organizations such as Bloomberg will realize the value of indexed annuities when companies like MetLife and Prudential offer them, and will then be singing the praises of indexed annuities.
Until then, I thank you for doing your best to present a balanced article with factual information. If I can ever serve as a resource to you in the future, please do not hesitate to contact me. Thank you, Peggy.
Sheryl J. Moore
President and CEO
Advantage Group Associates, Inc.
(515) 262-2623 office
(515) 313-5799 cell
(515) 266-4689 fax