Response: Equity index annuities can torture retirees' nest eggs
April 4, 2011 by Sheryl J. Moore
PDF for Setting it Straight with Malcolm Berko
ORIGINAL ARTICLE CAN BE FOUND AT: Equity index annuities can torture retirees’ nest eggs
Dear Mr. Berko,
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 advice column that you authored for Lake County News-Sun / The Chicago Sun-Times, “Equity index annuities can torture retirees’ nest eggs” I am deeply concerned about a couple of things in your reader’s letter and many of the items in your response to him. 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 your readers may have difficulty obtaining the information they need, when searching for answers on annuities. If the reader who sent you the letter needs additional assistance understanding what he purchased, or if you need help in the future with fact-checking, I humbly offer the services of my market research firm to you.
First, your reader P.B. from Fort Walton Beach was told about the following indexed annuities features that are absolutely true:
1. The indexed annuity will never lose money as a result of market downturn,
2. The indexed annuity offers the potential for gains based on the growth of the S&P 500,
3. The indexed annuity will pay his beneficiaries a death benefit of the premiums paid plus all gains,
4. The indexed annuity would allow monies to be withdrawn without penalty every year,
5. The indexed annuity salesman’s commission is paid directly by the insurance company, not the annuity purchaser.
I am not able to address the “guarantee of 4% per year” without knowing which indexed annuity was proposed to your reader and I do not know what their comment that “it’s triple-A rated” is in reference to.
That being said, I have some serious concerns about your irresponsible reply to P.B.
First, I would like you to know that it is inappropriate to refer to these products as “equity indexed annuities” or “EIAs.” 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.
In addition, it is disingenuous for your to state that indexed annuities “have more moving parts than a Swiss watch.” Indexed annuities are simpler than you perceive; they are just fixed annuities with a different way of crediting interest. Understanding a few key features can de-mystify the crediting of interest on these indexed insurance products:
1. Which index is being used to determine the potential gain credited to the policy? The indexed annuity purchaser can choose to have their interest linked to the performance of one or more of 17 different indices (S&P 500, NASDAQ-00, etc.). Although most companies offer only the choice of the S&P 500, there are a few companies that offer more than one index selection.
2. Which crediting method is being used to calculate the indexed interest on the policy? The annuity purchaser then has their choice of one of 11 crediting methods (calculations) for their gains. Again, most companies merely offer only a simple annual point-to-point crediting method, but several companies offer more choices.
3. Which pricing lever is being used to limit the potential indexed interest on the policy? There are three ways in which an insurance company may limit the interest credited to these products: use of a cap, participation rate, or spread (also referred to as a margin or asset fee). All three of these pricing levers are merely a way to limit the indexed interest on an indexed insurance product; they all do the same thing. Regardless of whether the interest is limited by a cap, participation rate, or spread- all indexed annuities are priced to return the same amount.
Ultimately, the index used, the crediting method utilized, and the choice of a cap or participation rate are irrelevant. All indexed annuities are priced to return 1% – 2% greater interest than traditional annuities are earning today, over the life of the policy (regardless of index, crediting method, and pricing lever). All of these different features (index, crediting method, pricing lever) merely give the marketing organizations that distribute these products an opportunity to promote why their product is “different” or “better” than their competitors’ products, to the agent. They do not actually make any one product better than another. Yes, some designs will perform better than others in some years. However, over the life of the contract, they will be about even keel.
I’d be interested to know where you obtained your statistic that “70 percent of complaints received by state securities regulators” are on indexed annuities. I searched all over the internet, through industry data sources, and on regulators websites, and was unable to find any statistic that was relatively similar. In fact, this inaccurate statistic has been more thrown around on the internet that viral Charlie Sheen videos. Why? Several years ago when the North American Securities Administrators Association (NASAA) decided to pursue securities regulation of indexed annuities, they began disseminating data with misleading statistics. Consider the attached presentation by Alabama Securities Commissioner, Joseph Borg. On slide three of this presentation, Mr. Borg states that “34% of all cases of senior exploitation involve variable or equity-index annuities.” Note that it says “variable OR equity index annuities.” This is a nifty little way to negatively position this data; isn’t it comparable to saying that serial killers and newborn babies account for the most heinous criminal acts in the United States? For all that we know, there was ONE case involving an indexed annuity and 99 involving variable annuities. You must also take into perspective that 70 percent may sound shockingly high, but 3.5 complaints out of a total of 5 complaints is also equal to 70%. In market research, we call this “massaging the data,” Mr. Berko. It isn’t as difficult to make your audience see the data differently using such methods.
If you are truly looking for credible data on market conduct issues with indexed annuity sales, you should evaluate the National Association of Insurance Commissioner’s (NAICs) closed complaint database instead of looking to securities regulators that not only don’t understand indexed annuities, but also have no jurisdiction over the regulation of such insurance products. Specifically, investments (products where consumers risk the loss of principal AND gains) such as stocks, bonds, and mutual funds are regulated by the SEC, the Financial Industry Regulatory Authority (FINRA), and NASAA. Indexed annuities are fixed insurance products; similar to fixed annuities and whole life insurance. These fixed insurance products never put the purchaser’s principal or gains at risk due to market volatility. Indexed annuities, like other fixed insurance products, are regulated by the 50 state insurance commissioners of the United States. Together, they form the NAIC. This is why the NAIC is the only credible source of information on indexed annuity complaints. For your information, I have provided data below from the National Association of Insurance Commissioner’s Closed Complaint Database:
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 several years, but the average has declined consistently for many years. Conversely, variable annuity complaints (which are overseen by the SEC, FINRA, and NASAA) 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, Mr. Berko, but I would contend that an average of only 3.29 complaints annually, per company, is quite reasonable and not indicative of “slick schemes and broker dreams.”
That being said, I think it would be appropriate to give P.B.’s insurance agent the benefit of the doubt in this exchange. Based on the limited information available in his letter, it seems that an indexed annuity may have been a perfectly appropriate suggestion for this risk-averse retiree. Ultimately, neither you or I can speculate what may or may have not been an appropriate purchase for your reader without performing the rigorous suitability analysis and paperwork that was required by law to be performed by the reader’s insurance agent.
I resent your insinuation that indexed annuity salespeople are “sociopathic liars” and “dumber than a fistful of worms.” You are obviously basing your judgment on inflated, inaccurate articles reporting on indexed annuities being used as the instrument of bad agent behavior. I have news for you, Mr. Berko. Every financial product has, at one time or another, been the instrument of bad agent behavior. Indexed annuities are just a tool in the 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. It goes without saying that as the foremost authority in the indexed annuity market, I have to tell you that I am livid over your suggestion that indexed annuities are an “evil product.” May I suggest that you should properly understand these products before you reserve judgment about them.
You are absolutely wrong in your assertion that indexed annuities “have more confusing charges and fees than your cell phone…” Indexed annuities have no explicit charges or fees, Mr. Berko. It sounds like you are confused. Not all annuities have “fees” the way that deferred variable annuities do. Income annuities as well as fixed and indexed deferred annuities specifically have no explicit fees. The “charge” 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. Some of these annuities may have optional features that the purchaser can choose to add-on to the base contract, in exchange for an annual fee. However, indexed annuities do not have fees in and of themselves.
You mention that indexed annuities have limitations to their gains, as if it is a detriment to the purchaser; it is not. The indexed interest on indexed annuities must be limited, or the insurer would not be able to provide a minimum guarantee on the contract. So, while you may see the limitation of indexed gains as a disadvantage, it is actually what protects the annuity purchaser from the risk of losing money. In order to offer unlimited gains on an annuity, you must also pass-on unlimited risk. This is why variable annuity purchasers risk losing their principal and gains in the event of a market downturn. However, if a consumer were looking for unlimited gain potential, an indexed annuity would not necessarily be the appropriate product to fulfill their accumulation needs.
Alternatively, those interested in knowing more about indexed annuities should be well-informed on their value proposition. Unfortunately, I feel that this proposition is different than what you seem to communicate in your article. Indexed annuities 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. 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 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, Mr. Berko. I think that your readers would be better-served if you took note of this, as not every American is willing to tolerate market losses in exchange for the opportunity for unlimited gains.
It is absolutely clear that you misunderstand how these products work when you make statements such as “the calculations of an annuity’s index values…are pre-calculated to maximize the insurer’s profits while mitigating the policyholder’s gains.” Although the crediting calculations used for indexed interest on these annuities are pre-calculated and clearly disclosed in the contract and product brochures, NO ONE CAN PREDICT THE FUTURE PERFORMANCE OF THE MARKET. For this reason alone, it is preposterous for you to insinuate that the underwriting insurance company has control over the amount of indexed interest credited to indexed annuity contracts.
As for your statement that indexed annuities have commissions of “10 percent or more,” you are again providing skewed information. The SIX indexed annuities that pay a commission of ten percent or more accounted for precisely 0.65% of all indexed annuity sales for 4Q2010, Malcolm. 0.65%! The products that give the indexed annuity market the most amount of negative attention account for less than 1% of all sales! Furthermore, the average commission paid on indexed annuities during the same period was a mere 6.37% (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, securities products such as mutual funds, stocks, and bonds pay generous, consistent commissions each year. In light of this, I think you’ll agree that the commissions paid on indexed annuities are quite fair and hardly inflated, as you would suggest.
While you are quick to point-out that surrender charges can be 15 percent or higher, you fail to note that these higher-penalty products credit a premium bonus of as much as 10% of the premiums paid to the annuity’s value on the day it is issued (i.e. an annuity purchaser deposits $100,000 with an insurance company and immediately gets a boost in cash value to $110,000). The insurance company selling such a product must offset the risk of offering such a lucrative bonus, and provide a disincentive for the purchaser to merely obtain the increase in value from the bonus and cash surrender thereafter. That being said, if someone wants to minimize the surrender charges on their annuity contract, they should purchase an annuity without a bonus. However, it may interest you to know that the average surrender charge for indexed annuities as of 4Q2010 is ten years and the average first-year charge is less than 11% (even less for older-aged purchasers). Again, the facts are far different than what you suggest in your advice column…
Notwithstanding, indexed annuities offer many options for liquidity, should the purchaser need access to their annuity’s value. Specifically, 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, Mr. Berko. Please take note of how liquid the products truly are.
I hate to be the first break it to you, but indexed annuities don’t have prospectuses. Securities products which have the potential for loss of gains and principal are sold via a prospectus. Indexed annuities are insurance products that guarantee a return of principal plus interest, and are therefore sold via an insurance contract. And while you mislead your readers into believing that indexed annuity contracts are long and/or difficult to understand, the average indexed annuity contract is a mere 26.7 pages long and is required by the NAIC to be accompanied by plain-language disclosures. Contrast this to the average 200+ page prospectus used on variable annuity contracts, and I think you will agree that an indexed annuity contract is relatively simple to evaluate. Furthermore, I find it reckless that you would imply that your readers not bother reading their contracts. Every client needs to bear responsibility in understanding the paperwork that they sign and ask questions if they do not understand. Would you sign mortgage paperwork that you didn’t understand? A divorce decree? A vehicle loan? Likewise, an annuity is a contract and should be read prior to signing/purchase.
And by the way, the surrender charges on indexed annuities are clearly disclosed in a minimum-NAIC-required font size on the third page of the contract. I am certain that your “daughter- who is a lawyer- and her husband- who is a judge- would” NOT “need hours to locate that information.”
It would be of interest to you that indexed annuities are rarely sold by brokers. In fact nearly nine out of ten indexed annuity sales are made by independent insurance agents.
It is of the utmost importance that readers understand that it is inappropriate for you to direct them to the Financial Industry Regulatory Authority for information on indexed annuities. FINRA has been contacted and corrected numerous times on the inaccuracies in their Investor Alert on Indexed Annuities (see attached), which you would direct your readers to locate. FINRA is not a credible source of information on indexed annuities. They are responsible for the oversight of broker dealers and member firms that sell securities. They have no regulatory authority on insurance products such as indexed annuities, and in fact have a vested interest in indexed annuities being regulated as securities so that they can increase their revenue and job security. In the future, if you are looking for a reliable regulatory resource on fixed insurance products (such as indexed annuities), I encourage you to seek out Susan Voss or Jim Mumford at the state of Iowa Insurance Division (Susan is the Iowa commissioner and president of the NAIC, and Jim is the deputy commissioner for Iowa). Not only are these regulators credible, but 41.32% of indexed annuity sales flow through Iowa-domiciled insurance companies; for that reason they have become authorities on indexed insurance products. Please let me know if you need contact information for either Susan or Jim, and I would be happy to provide it to you.
Malcolm, I couldn’t help but laugh aloud at your suggestion that readers hire “a professional money manager who can give [them] conflict-free counsel.” This statement made it blatantly obvious that your background is in the securities business, and that you need additional exposure to the insurance business. This is important for readers to know because securities-licensed registered representatives’ solution for ‘safety and accumulation’ is offering stocks and bonds (which are both equities products with risk of loss). By contrast, the insurance agent’s solution for the same problem is an indexed annuity (which is an insurance product with no risk of loss due to market volatility). Why isn’t the registered representative selling indexed annuities? For starters, he is familiar with the processes and routines that are associated with the SEC’s regulation (which is very different than those of insurance products’ NAIC regulation). In addition, equities products pay generous, consistent commissions where annuities pay commissions only one time, at point-of sale. For this reason, it is very likely that the registered representative does not sell indexed annuities at all. And if the registered representative is not selling indexed annuities, then he is competing against insurance agents that do. So even if an indexed annuity were the most suitable retirement vehicle to address your readers’ needs, it is highly unlikely that a registered representative will ever discuss the product with them!
The overall message here is that our nation’s financial advisors and insurance agents have long-fought a battle to control 100% of their clients’ assets. It is a shame that everyone cannot learn to “play together” and ensure that the client has ALL of their financial services needs met, using THE most appropriate products for their needs, regardless of whom is able to sell it to them. You would do your readers justice by being informed on this unfortunate dichotomy.
Mr. Berko, indexed annuities have so many good features and they are a wonderful product solution for millions. Would you just open-up to the possibility that there is more here than just “a juicy story” here? You are hurting your readers when you position these products in a bad light. They need credible and reliable information on financial services products now, more than ever. Did you know that indexed annuities have many benefits 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 the designated beneficiaries upon death.
7. 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.
8. 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.
9. Guaranteed lifetime income: an annuity is the ONLY product that can guarantee income that one cannot outlive.
PLEASE be conscientious in your future commentary on financial services products, especially indexed annuities. (As there is no excuse for the perpetuation of inaccurate information in this market- I am always available to validate information.) I would like to suggest that The Chicago Sun-Times consider a correction to your column. Or better yet, use this point-of-contact as an opportunity to educate your readers and humble yourself by writing a clarifying column yourself!
If you should ever have a need for information on indexed insurance products, I humbly extend an offer to assist you with your fact-checking needs.
Thank you.
Sheryl J. Moore
President and CEO
AnnuitySpecs.com
LifeSpecs.com
Advantage Group Associates, Inc.
(515) 262-2623 office
(515) 313-5799 cell
(515) 266-4689 fax
