Response: Equity-indexed annuities: investor-friendly?
April 23, 2011 by Sheryl J. Moore
PDF for Setting it Straight with The Mutual Fund Store
ORIGINAL ARTICLE CAN BE FOUND AT: Equity-indexed annuities: investor friendly?
The following email was sent to the owners of The Mutual Fund Store, in response to the article below:
Dear Principals of The Mutual Fund Store,
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 am contacting you, as the author of a blog that was published at www.mutualfundstore.com, “Equity-indexed annuities: investor-friendly?” This blog had a surprising number of inaccurate and misleading statements about indexed annuities in it. I am contacting you in response to these inaccuracies, so that you can address these mistakes and ensure that your readers have accurate, unbiased information on these products in the future.
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.
Second, those who purchase indexed annuities are not “investors.” 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.
Third, not all annuities “provide fixed rates of return;” certainly not indexed or variable annuities. Only fixed annuities provide a fixed rate of return.
Fourth, fixed and indexed annuities do not have “expense rates,” much less such rates that are “ultra high.”
Fifth, while it is true that the guarantees on annuities are “only as good as the financial standing of the company issuing the guarantee,” you fail to mention that insurance companies are backed by an insurance program that is similar to what is provided to banks via the Federal Deposit Insurance Corporation (FDIC). State Guaranty Fund Associations provide a FDIC-like insurance to insurance companies, and protect annuity and insurance purchasers, in the event of insurer insolvency; you can find out more about this program at www.nolhga.com.
Interestingly, very few insurance companies have gone insolvent since the market collapsed in 2008. In contrast, more than 330 banks have failed since that period. I believe that if more Americans understood the Guaranty Fund Association, they would have more confidence in the solvency of insurance companies than they do in the solvency of banks. Please realize the context of your statements before making them, ladies and gentlemen. 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.
Sixth, it appears that you need additional information on the basics of annuity products. 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. These payments are typically fixed on fixed and indexed contracts; while the payments are subject to fluctuate on variable annuity contracts. However, all types of annuities have choices for products that provide inflation-adjustment or cost-of-living-adjustment provisions on their payments.
Seventh, your description of annuity payment options is incomplete. Most companies offer a minimum of four different annuity payout options:
1. Life payout: Annuitants receive the largest checks with a life payout option, but payments will only continue for their lifetime- regardless if it ends tomorrow or fifty years from now.
2. Joint and survivor payout: The joint and survivor option guarantees a spouse will continue to receive retirement income if the annuitant dies. Payments are based on the life expectancy of two people with this option, the annuitant and a designated beneficiary (usually the spouse of the annuitant). Under this option, if the annuitant dies first, the survivor will continue to receive payments for the rest of his/her life. The amount of the survivor’s payments are determined at the time the annuity is started and often set at half, 75 percent or 100 percent of the amount to be received by the initial annuitant.
3. Life-with-period-certain payout: Annuitants receive a lifetime income plus a guarantee of payments of 10-20 years or more with this option. If the annuitant should die within that time, their beneficiary collects the remaining payments.
4. Refund annuity: The refund annuity option guarantees a return of the premiums paid (in the purchase of the annuity), to the designated beneficiary if the annuitant dies before full payment has been made.
Note that many companies offer a combination of these payout options as well (i.e. joint and survivor with a 10-year period certain).
Eighth, your statement that indexed annuities contain “several features that are not investor-friendly” is based on misinformation. Take note that indexed annuities are actually quite consumer-friendly; these products offer 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 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. Guaranteed lifetime income: an annuity is the only product that can guarantee income that one cannot outlive.
Ninth, you cannot purchase an indexed annuity with a surrender charge of 18 years today. The longest surrender charge available on these products is 16 years and the median surrender charge as of 4Q2010 is ten years. Note that this median is influenced by the fact that sales of products with premium bonuses have been in demand since the persistence of low interest rates; products with premium bonuses tend to have longer surrender charges.
Tenth, you fail to take into consideration that 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 detriment, 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 in the event of a market downturn and indexed annuity purchasers do not. Ultimately, if a consumer were looking for unlimited gain potential, an indexed annuity would not necessarily be the appropriate product to fulfill their accumulation needs.
Eleventh, the insurance company does not “take[s] all gains beyond the cap stated in the contract.” You would benefit from basic education on indexed annuity pricing. The insurance company does not get to keep the gain in the index above and beyond what is credited to the client. The insurance company invests the majority of their indexed annuity budget on bonds [97 cents of $1], which cover the minimum guarantee on the product. A small percentage of that budget goes to purchase options, which provide the indexed linked interest on the annuity. The insurance company takes their [three cents of the $1] to the option seller, and asks how high of a cap or a participation rate it will allow them to offer on their particular indexed annuity crediting method (by contrast, they may ask how low of a spread they can offer). Based on market conditions, the option seller may tell them it will afford them an 8% cap for the clients (although the next week the same three cents may only purchase a cap of 7.0%). If this is the case, and the market goes up 10%, the client only gets 8%. The remaining 2% is a wash, because the option was only for 8%; the insurance does not have the ability to keep the 2% difference.
Twelfth, you fail to grasp that the individual purchasing an indexed annuity is likely too risk averse to make equities products a suitable investment purchase. The consumer risk profile for someone purchasing securities such as stocks and bonds 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 indexed annuities is someone looking for a “safe money place”- where they can have a guaranteed preservation of principal plus limited interest. Indexed annuity purchasers are more concerned with the return OF their money than the return ON their money. I’m certain your clients would GREATLY appreciate this difference be taken into consideration in your selection of product solutions.
You should know that 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 than a fixed annuity. 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, dear friends. I think that your clients 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.
Thirteenth, the Financial Industry Regulatory Authority (FINRA) is a firm that oversees broker dealers and their registered representatives. FINRA has no regulatory authority over fixed insurance products such as indexed annuities. Interestingly, few indexed annuities are even sold through their distribution (9 out of 10 indexed annuity sales are through an independent agent). This self-regulatory organization has had to be contacted and corrected numerous times on the inaccuracies in their misstatements about indexed annuities (see attached), which has been actively disseminated to securities regulators. This alone provides ample evidence that FINRA is not a credible source of information on indexed annuities.
Sadly, your readers and prospective clients are likely ignorant of the fact that you are in the securities business, not the insurance business. They probably don’t know that you sell products that compete for the same dollars that annuities do! This is important for readers to know because securities/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 securities/registered representative a fan of the indexed annuity? For starters, s/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 securities/registered representative does not sell indexed annuities at all. And if the securities/registered representative is not selling indexed annuities, then s/he is competing against insurance agents that do. Our nation’s securities/registered representatives 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.
Ladies and sirs- indexed annuities have so many good features and they are a wonderful product solution for millions. I am not suggesting that they are right for everyone. Would you just open-up to the possibility that there is more here than just “an opportunity to disseminate juicy misinformation?” You are hurting your readers and prospective clients when you position these products in such a negative light. Americans need credible and reliable information on financial services products now, more than ever. I hope that I can be of assistance to you in the future in your pursuit of this endeavor.
I don’t expect you to sing the praises of indexed annuities, but if you desire to write about them, please feel free to reach-out to my firm for your fact-checking. I’m happy to help you maintain the credibility and accuracy of your public statements on these financial services products.
Sheryl J. Moore
President and CEO
Advantage Group Associates, Inc.
(515) 262-2623 office
(515) 313-5799 cell
(515) 266-4689 fax