Is the fixed annuity market like playing Russian roulette — and will you get hurt?
October 16, 2014 by George Shave
Quite possibly.” That’s the short answer.
It’s funny how quickly we forget the past. Let me take you back to 2010. Anyone working in the fixed annuity market dodged a potentially career-ending bullet when Rule 151A was vacated by the DC Circuit Court Of Appeals following the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act. For those not familiar with Rule 151A, it would have transferred the supervision of fixed indexed annuities from insurance regulators to securities regulators. Stated simply, indexed annuities would have been considered securities in a post-151A world. Thanks to the efforts of the National Association for Fixed Annuities and many others in our industry, a sound decision was ultimately made to keep fixed indexed annuities where they belong — as a class of fixed annuity supervised by the NAIC.
Today, I look back on 151A and view it as a shot across the bow of a ship called Up Not Down. It was a message that we need to be clearer in our communications with consumers and to be certain we were portraying indexed annuities as the safe money products they were initially designed to be.
It was also a message to set realistic interest rate expectations. Fixed annuities are not securities. They don’t put any of the premium or interest earnings at risk, and they afford our clients the opportunity to achieve better interest rates, which should outperform other safe money vehicles. And to that goal, they have delivered. You needn’t look any further than your clients’ indexed annuity statements this past year. Regardless of what crediting strategy you selected, your clients probably earned far more interest than the banks offered. But if you’re still a skeptic, go find yourself a copy of “Real World Returns,” by Jack Marrion. You’ll quickly see that fixed indexed annuities do, in fact, deliver better interest rates than other safe money vehicles.
What I see in the market today concerns me a bit. Carriers are playing with fire in their next generation of products, getting further away from the basic value proposition of fixed indexed annuities. It’s a game of Russian roulette; only in this game, the gun is loaded with multiple bullets. Eventually, the gun goes off and there are casualties. Will you be among them?
The first bullet: the uncapped game
In September of this year, the Iowa State Insurance Department fired yet another warning shot in Bulletin 14-02, warning IMOs, agents and carriers of the pitfalls surrounding the deluge of so called “uncapped strategies. Read for yourself:
…the Division reviewed advertisements on annuity products in which the advertisements offer ‘uncapped’ rates of return. While much of the observed advertisements purport to be targeted at insurance producers, if the advertising is viewed by a consumer it has the capacity to contribute to inflated expectations of future performance of the annuity product. These expectations are likely to be inflated indirectly through subsequent and related representations made by producers reiterating the advertisements’ claims although, in reality, the referenced rate is actually limited by spreads, participation rates, or the design of volatility controls, significantly reducing the actual return.
It seems to me that we are once again dangerously close to abandoning the true value proposition attached to indexed annuities: to outperform other safe money vehicles. Isn’t it good enough to earn 5 percent in a fixed safe money product at a time when other rates are far worse? Indexed annuities don’t need to offer uncapped potential, and agents and IMOs shouldn’t be selling them that way. Besides, too many will portray “uncapped” to mean the same thing as “unlimited,” and we all all know that the moving parts of these products restrict upside interest. And if we decide it’s about chasing market-linked returns, aren’t we essentially walking back into an ambush by regulators? A reminder to agents, IMOs and carriers alike: We’re trying to beat the banks, not the stock market.
The second bullet: a proliferation of new indices
Is is just me or has anyone else noticed a wave of next gen products featuring new indices we’ve never heard of? Suddenly, the time-tested indices our clients are accustomed to seeing (and that we’re used to selling) aren’t good enough. What changed? I’m guessing the carriers will tell us that offering proprietary indices is a function of options pricing, which translates to more earnings potential for our clients. I’m not opposed to helping clients earn more, but I am concerned that we will fall prey to past sins; namely, positioning these indices too aggressively with respect to credited interest. Carriers are designing brochures that make these new indices sound more like actively managed investments than fixed annuities and to be truthful, that really scares me in the wake of 151A. I’m not really sure why we need to invent new indices that will only confuse the consumer and clutter the space.
Unfortunately, this problem goes even deeper, and the Iowa Bulletin released in September went on to address these new indices:“…some marketing materials depict charts of recently developed ‘proprietary indices’, which did not exist during the illustrated time frame, but are back-casted and hypothetically demonstrate how they would have outperformed traditional indices.”
In other words, carriers have taken to creating’synthetic’ indices which didn’t exist before the carrier introduced the product. There is no way to view actual past performance. Instead, carriers are using brochures with hypothetical preinception return data, but this pushes the limits of the back-casting scenario. Almost as risky, carriers have software that can print out back-casting illustrations. They aren’t real — the index didn’t exist; yet the return data shows different 10-year periods in our history as if it did.
Let’s put away the gun
For the last two decades, I’ve been an avid fly fisherman. Besides my family, it is my one true earthly passion. Almost all fly fisherman share a single code: catch and release. By releasing what we catch, we preserve an expendable resource for future generations to enjoy. That’s the place from which I write this article. I’m pro-annuity and I only want to see that we are good stewards of the market so that millions more American consumers can benefit from indexed annuities.
The fixed indexed annuity market has experienced incredible growth, largely because its value proposition is the same today as it was in 1992, when the first indexed annuity entered the market. It is a safe money product that provides a legitimate opportunity to outperform other safe money vehicles. It credits interest when major market indices rise and preserves that interest when markets fall. And today, thanks to the evolution of income riders, these products are delivering meaningful retirement income solutions for the millions of baby boomers that are aging out. Getting away from these basic but sound value propositions is a mistake. And if we aren’t careful, we’re inviting regulators to take a more direct shot at the good ship Up Not Down.