Response: Considering an annuity? There’s always a catch
April 20, 2011 by Sheryl J. Moore
ORIGINAL ARTICLE CAN BE FOUND AT: Considering an annuity? There’s always a catch
I am an independent market research analyst who specializes exclusively in the indexed annuity 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 exclusively on indexed products. I do not endorse any company or financial product, and millions look to us for accurate, factual 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 advice column that you authored for The Chicago Sun-Times, “Considering an annuity? There’s always a catch.” Sadly, this is the second article with misinformation on annuities that I have had to bring to the attention of the Chicago Sun-Times over a two-week period (see also Malcolm Berko’s March 17 article). I am deeply concerned about many of the items in your response to your reader’s letter. Because of the misleading and inaccurate statements which were made in this piece, I wanted to reach-out to you and offer my services. It scares me to think that the readers of the Chicago Sun-Times may have difficulty obtaining the unbiased information they need, when searching for answers on annuities. An annuity not only provides a tax deferral benefit, but it is the only financial services product that can guarantee an income that the purchaser cannot outlive. Due to the not-too-distant collapse of the stock markets and our nation’s ever-extending mortality, Americans have never had a greater need for reliable and accurate information on this longevity insurance product. For this reason, I humbly offer the services of my market research firm to both you and the reputable news publication that published your piece.
First, you say that CD’s are “safe” and point-out that they are “insured.” Did you know that annuities are similarly insured by the State Guaranty Fund Association? For more information on this coverage, please go to www.nolhga.com.
Second, annuity purchasers are not “paying” for tax-deferral with annuities. The tax deferral is just one of many features offered by annuities. The primary benefit of an annuity is that it guarantees an income that the purchaser cannot outlive. This is a value proposition that cannot be offered by any other financial services product in the nation. That being said, if someone is looking for longevity insurance, an annuity may be a good solution for them, regardless of whether their funds are qualified or non-qualified. (There is a value to putting an IRA into an annuity, that being said.)
Third, your description of annuities concerned me. The negative manner in which you communicate the products would certainly deter all readers from exploring annuities as a viable option for their retirement income solutions, regardless of your brief personal endorsement. This is reckless given that Americans are living longer today than ever before, while saving less for their retirements. For those considering an annuity purchase, there are three questions that must be answered, when looking into what type of annuity is right for them:
1. What level of market risk am I willing to assume with the annuity?
a. If more concerned about a high minimum guarantee, regardless of the lower level of interest accumulation, consider a fixed annuity.
b. If willing to accept a lower minimum guarantee than a fixed annuity, but looking for potentially greater interest accumulation, consider an indexed annuity.
c. If willing to accept no minimum guarantee, and the possibility of unlimited loss in exchange for the possibility of unlimited interest accumulation, consider a variable annuity.
2. How soon will I be taking income?
a. If within the first year, consider an immediate annuity (offered in fixed, indexed, and variable types).
b. If it is further in the future, consider a deferred annuity (offered in fixed, indexed, and variable types).
3. How many premium payments will I be making?
a. If only a single payment, consider a single premium immediate annuity or a single premium deferred annuity.
b. If making more than one payment, consider a flexible premium deferred annuity.
Overall, it is important for consumers to understand that an annuity is merely a contract where an individual agrees to pay premiums to an insurance company and receives in exchange, a regular stream of income payments from the insurer- either now or at some time in the future. Annuities can be purchased with as little as a $1,000 lump sum premium, or $50 per month.
Fourth, not all annuities have a “catch,” much less “costs” the way that variable annuities do. Fixed and indexed annuities specifically have no explicit costs. The “cost” that the client pays on a fixed or 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.
Fifth, while you are quick to point-out that surrender charges “cover some of the cost” of the commission on annuities, Ms. Savage, you fail to mention that surrender charges also provide a greater potential for gains to the purchaser and offset the risk of offering a premium bonus on an annuity.
Sixth, not all annuities are “illiquid.” Indexed annuities in particular offer many options for liquidity, should the purchaser need access to their annuity’s value. In fact, 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, Ms. Savage. Please take note of how liquid these annuity products truly are in your future communications about annuities.
Seventh, your allusions to “fine print” on annuities cannot apply as a generalization to fixed and indexed annuities. These annuities are regulated as insurance (rather than securities) and given no opportunities to be communicated in “fine print.” The insurance commissioners that regulate these products not only require the full and proper disclosure of these products (at a minimum font-size, no less), but also require plain-language disclosures be provided to every prospective annuity purchaser. In fact, I’d venture to say that a consumer purchasing an indexed annuity today would have a far easier job with disclosure than the consumer purchasing a variable annuity (considering that the average indexed annuity contract fully-discloses the product features in an average 26.7 pages, but the average variable annuity prospectus exceeds 200 pages). Just some food for thought…
Eighth, I would be interested to know what type of product you are comparing annuity commissions to, as they are relatively modest compared to other financial services products. For example, the average commission paid on indexed annuities during 4Q2010 was a mere 6.37% (and even lower for annuities sold to older-aged purchasers). By comparison, securities products such as mutual funds, stocks, and bonds pay generous, consistent commissions each year. Also keep in mind that annuity commissions are paid one time, at point-of-sale only, and the agent services the contract for life. In light of this, I think you’ll agree that the commissions paid on annuities are quite fair and hardly “high,” as you would suggest.
Ninth, it appears that you misunderstand the fact that annuities are not intended to keep pace with the market’s performance. Even indexed annuities, which receive interest based on the performance of the market, are not intended to provide all of the stock market’s upside. 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. 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, and are therefore appropriately classified as “rick money places.” 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. The same can be said of fixed annuities. In fact, 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 the premiums paid plus interest at the end of the contract term. 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, Ms. Savage. I think that your readers, and more importantly your clients, would be better-served if you took note of this; you should remember that not every American is willing to tolerate market losses in exchange for the opportunity for unlimited gains.
As I mentioned, it is inappropriate to compare risk money places, such as investments, to safe money places, such as fixed and indexed annuities. If you would prefer a more appropriate comparison, it is most appropriate to compare fixed indexed annuities to instruments such as CDs. The average 1-year CD rate is currently 0.47% (according to bankrate.com) and the average fixed annuity rate is currently 3.50%. I would say that having the potential to earn as much as 10.20% or more annually on an indexed annuity, while deferring taxes and guaranteeing lifetime income, is a VERY attractive proposition as compared to CDs and even compared to fixed annuities. Bear in mind that the investments you compare fixed and indexed annuities to cannot provide tax deferral or an income that cannot be outlived either, Ms. Savage. You would benefit from understanding this important aspect in product positioning as well.
There has never been a product feature more miscommunicated than 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, Ms. Savage; 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 and are never included on the calculation of any indexed annuity. 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 while it is true that consumers will not ‘benefit’ from dividends in an indexed annuity, they also won’t risk losing their money as a result of market volatility either. It is a win-win that many risk-averse savers find appealing.
Also note that while you are quick to cite the increase in the S&P 500 index from dividends, you fail to account for the 0% floor on indexed annuities. You underestimate this annual reset feature, Ms. Savage. You shouldn’t.
And while certainly not priced to return market-like returns, you must also recognize that sometimes annuity purchasers have the opportunity for fantastic gains. Indexed annuities specifically have consistently outperformed fixed annuities and certificates of deposit (CDs); often providing amazing returns. I have actual policyholder annual statements on my desk, showing one-year indexed strategy gains as high as 47.65%. Ultimately, your belief that such annuities don’t perform is based on faulty logic: they are not intended to perform favorably against securities products, which is what you are comparing them to. Please be cognizant of this in your future comparisons of annuities.
Tenth, variable annuities are the only type of deferred annuity that have “funds,” much less “fees associated with the management of the funds.” This is not an attribute of fixed or indexed annuities.
Eleventh, variable annuities may use asset allocation models and fund restrictions to limit the “choice of investment transfers within the annuity,” but again- this is not a feature of fixed or indexed annuities.
Twelfth, it sounds like you have had the optional death and living benefit riders available on many annuities miscommunicated to you. Such riders actually do guarantee [X%] growth for a stated number of years, but the value that this guarantee is credited on is not available through a cash surrender of the annuity. This greater value is only available in the event of annuitization (on a Guaranteed Minimum Income Benefit rider, or GMIB), in the event of lifetime income via withdrawals (on a Guaranteed Lifetime Withdrawal Benefit rider, or GLWB), or in the event of death (on an Guaranteed Minimum Death Benefit rider, or GMDB). Keep in mind that these riders are most prominent on variable annuities, where they are offered in order to provide a principal protection element to a “risk money” product.
Thirteenth, as far as class action lawsuits are concerned, they are not exclusive to the annuity market and more likened to “legalized blackmail.” Do a quick Google search of “vanishing premiums on whole life” or “underfunded universal life” and you will see that class action lawsuits are actually quite common in the financial services industry. I believe you would most-benefit from reading the recent research I performed on more than 40 different class action lawsuits in the insurance industry (http://www.sheryljmoore.com/2010/01/ambulance-chasers-and-a-lack-of-responsibility/). It may surprise you to learn that this research revealed class action attorneys made as much as $6.4 million in each of these class action settlements when the “harmed” insurance purchasers averaged a return of premiums paid, accumulated at 4.15%. Am I the only person who thinks this sounds like someone creating a fire in order to get their next meal ticket? It is just a shame that the uninformed consumer is in a position to be negatively swayed as a result of this ambulance-chasing mentality.
Ultimately what is most disturbing to me. Ms. Savage, is that you fail to grasp that the individual purchasing an indexed annuity is likely too risk averse to make equities products a suitable investment purchase. Such recommendations are not only ignorant, but reckless. The consumer risk profile for someone purchasing securities such as stocks, bonds, and mutual funds is someone looking for “risk money places”- where they can have the potential to earn 20% at the cost of having a chance of losing 20%. The consumer risk profile for someone purchasing insurance products like fixed and indexed annuities is someone looking for a “safe money place”- where they can have a guaranteed preservation of principal plus limited interest crediting. Fixed and indexed annuity purchasers are more concerned with the return OF their money than the return ON their money. I’m certain your readers and your clients would GREATLY appreciate this difference be taken into consideration in your choice future of product solutions.
It would not surprise me if the Chicago Sun-Times’ editors were not aware of the fact that registered investment advisers, like yourself, often compete directly with insurance agents that sell fixed and indexed annuities. The general public is uninformed on advisers’ historic efforts to control 100% of the client’s assets, regardless of the fact that an insurance product may be most what is most appropriate in addressing the client’s financial needs. After all- why would an adviser refer the client to an insurance agent if that meant that he/she would lose the sale? Considering this conflict of interest alone, it appears inappropriate for you to purport to offer expert advice on any type of insurance product, including annuities Ms. Savage.
I hope that in the future, the reputable paper that published your column will take into consideration their readers’ urgent needs for credible and reliable information on financial services products. In pursuit of these efforts, I would happily offer my services to the Chicago Sun-Times as well as yourself. Anything that I can do to ensure that the facts are readily available to your clients and your readers is reasonable.
Thank you for your time.
Sheryl J. Moore
President and CEO
Advantage Group Associates, Inc.
(515) 262-2623 office
(515) 313-5799 cell
(515) 266-4689 fax