Response: Beware the Siren Call
December 31, 2009 by Steve Stang
PDF for Setting It Straight with Steve Stang
ORIGINAL ARTICLE CAN BE FOUND AT: Beware the Siren Call
Steve,
I am an independent market research analyst who specializes exclusively in the indexed annuity (IA) 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 on IAs 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 wanted to contact you about your recent blog, “Beware the Siren Call.” There were several inaccurate statements in the article, which caught my attention. Because I know that you want to ensure that your content is accurate, and I know that you want your clients to find you credible, I am reaching out to assist you.
First, indexed annuities have not been referred to as “equity indexed annuities” 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. 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.
Second, indexed annuities are NOT investments. They are insurance products, similar to fixed annuities, term life, universal life and whole life. Stocks, bonds, mutual funds, and variable annuities are investments. Insurance products are regulated by the 50 state insurance commissioners of the United States. Investments are regulated by the Securities and Exchange Commission (SEC). Insurance products do not put the client’s money at risk, they are “safe money products” which preserve principal. Investments, by contrast, can put a client’s money at risk and are therefore appropriately classified as “risk money products.” Investments do not preserve principal.
Third, my company is the firm that releases the sales of indexed annuities each quarter; in fact we are the firm that provided The Wall Street Journal with the sales data for their 9/2/09 article. You’ll note, however, that Leslie Schism’s WSJ article was ridden with inaccurate information. You can see my past two corrections to her attached.
Fourth, you allude that indexed annuities are complex. Complexity is relative to your audience. complexity is relative. Some would say that fixed annuities 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, 95.2% 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 fully understands indexed annuities.
Fifth, I find it laughable that you cite the fact that indexed annuities are not backed by the Federal Deposit Insurance Corporation (FDIC). You talk about it as if that is a negative! Did you know that 81 banks have failed so far this year? Did you also know that the FDIC fund is in danger, and currently down 20% this quarter? I’d be remiss if I didn’t point out that the state guaranty fund associations are not experiencing the same difficulties. In addition, NOT A SINGLE INDEXED ANNUITY PURCHASER HAS LOST A PENNY AS A RESULT OF THE MARKET DECLINES, BANK FAILURES, OR GENERAL WEAKENING OF THE ECONOMY. Maybe that will put your comparisons of the guaranty fund association and the FDIC into perspective.
Sixth, indexed annuities are not intended to return the full gain of the index. Companies that sell indexed annuities must also pay for the guarantees on the products; a costly expense. For this reason, the index linked interest on these annuities must be limited. Were it not limited, the product would have no guarantee, and THAT my friend, is a variable annuity. Millions of Americans, myself included, are quite happy for the limiting of interest on indexed annuities. At least our money has been safe from market declines- our worst case scenario is receiving zero interest crediting each year that the market drops. In addition, when the market recovers, indexed annuity clients are in a supreme position to consistently benefit from the market gains. When the market ends low, this is the new starting point for the next year’s indexed interest crediting. I’d venture to say that an indexed annuity (IA) could easily outpace a variable annuity (VA) when you compare the zero floor on IAs to the market losses on a VA. To reiterate, indexed annuities are a “safe money place.” They should not be compared against stocks, bonds, mutual funds, or the index itself. They compete against other “safe money places,” such as fixed annuities and certificates of deposit (CDs).
Seventh, I am constantly amused that people like you continue to site the fact that indexed annuity crediting calculations exclude dividends as a weakness of the product. In fact, a little education about the basic concept of an indexed annuity would go a long way with this concept.
1. An indexed annuity is an insurance product, not an investment.
2. The annuity owner is never directly invested in stocks, or a stock index, when they purchase an indexed annuity.
3. The insurance company holds the money that backs their indexed annuities in their general accounts, not a separate pass-though account (like a variable annuity).
4. Because the client is never directly invested in the index, they cannot gain from the dividends on the index.
5. The insurance company’s general account assets cannot gain from the dividends on the index for the same reason.
Hope that is helpful to you. Indexed annuities are not intended to compete with securities or the index itself, Steve. These are “safe money products” which provide a preservation of principal and a guarantee. They are intended to be compared against other safe money instruments such as fixed annuities and CDs. Indexed annuities are only intended to provide 1% – 2% greater interest crediting than these traditional fixed rate products. Although some years an IA may receive double-digit gains, others it will receive zero. Over the life of the contract, the index annuity should outpace today’s fixed annuity rates by 1% – 2%. To compare this product to any equity investment is ignorant.
Eighth, it is patently false for you to say “Typically, but not always, there is a minimum amount of interest that is credited.” EVERY SINGLE INDEXED ANNUITY EVER OFFERED HAS HAD A MINIMUM GUARANTEE. The Minimum Guaranteed Surrender Value (MGSV) on indexed annuities is not appropriately compared to the guaranteed annual return of a fixed annuity or CD. An indexed annuity MGSV provides a guaranteed minimum value, in the event the client cash surrender the contract or if the index does not perform favorably over the duration of the annuity contract. A fixed annuity guarantee, by contrast, credits a minimum amount of interest every single year. A guarantee this rich is costly for an insurance company to purchase. Insurance companies offering indexed annuities must be able to afford the index linked interest on the contract, in addition to the guarantee. For that reason, the minimum guarantees on indexed annuities are slightly lower than those provided on fixed annuities. By contrast, indexed annuities provide slightly higher interest crediting potential than fixed annuities. In fact, the average indexed annuity would receive a return of premiums paid, plus nearly 18% interest at the end of the contract. Millions of Americans today would likely agree with Mark Twain’s famous quote, “I am more concerned with the return OF my money than the return ON my money.” Having a guaranteed return of 118% would be the icing on the cake for these folks!
Ninth, it is inaccurate for you to say that an indexed annuity “may apply 1.5% interest to 85% of the total value.” The National Association of Insurance Commissioners (NAIC) enforce standard non-forfeiture laws (SNFL) on all annuities. Because of the SNFL, no annuity has a minimum guarantee lower than 1.5% interest credited on 87.5% of the premiums paid. By contrast, some indexed annuities pay a minimum guarantee as high as 100% at 3% interest. If you need additional information on indexed annuity guarantees, please let me know.
Tenth, there is only one product today where the client will forfeit their indexed interest if they request a cash surrender without annuitizing. This two-tiered annuity accounts for only 1.64% of sales as of 2Q2009. For this reason, it is disingenuous for you to imply that indexed annuity owners may not be able to liquidate their monies. All annuitants are subject to surrender charges in the event that they wish to fully cash surrender the product before the expiration of the product term. These surrender charges are merely what allows the insurance company to credit competitive interest rates to the annuity, during the time that the client has agreed to keep their money with the insurance company. The insurance company invests the consumer’s premiums, in order to make a return on the money, and credit a competitive interest rate. Without a surrender penalty, the insurance company would incur tremendous expenses that they would not be able to recover. In short, surrender charges are a pricing measure that allows insurance companies to make good on their promises, and back-up their claims-paying abilities. In fact, it may surprise you to know that indexed annuities are available with surrender charges as short as one year. And although the average indexed annuity surrender charge is ten years, the majority of these longer-term products are offered with a premium bonus, which provides an immediate boost to the annuitant’s cash value. Longer surrender charges are necessary to appropriately price for such an incentive. Furthermore, indexed annuities are some of the most flexible, liquid products available today. All indexed annuity consumers are given access to 10% of their annuity’s value, annually, without being subject to surrender penalties (some even allow as much as 20% to be taken). In addition, 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 these products pay the full account value to the beneficiary upon death, and I think you’d have to agree that indexed annuities are one of the most liquid products available today.
Eleventh, although insurance companies reserve the right to reduce rates on indexed annuities, they can never reduce it prior to the first policy anniversary. In addition, the company cannot lower the rates below the guaranteed minimum caps/participation rates and maximum spreads that are filed with the state insurance commissioner. This is NO DIFFERENT than how an insurance company can reduce the rates on a fixed annuity, or increase the mortality and expense charges on a variable annuity. Insurance companies must price these products appropriately, and that means building-in the ability to reduce rates, should the volatility of the markets require it. However, just because the insurance company has the ability to change these rates, does not mean that they DO.
Twelfth, the reason some indexed annuities have escalated surrender charge is because there is a premium bonus on the contract. Surrender charges must be increased or extended in order to cover the costs and risks of offering a premium bonus on an annuity. One cannot appropriately price a bonus onto an annuity without increasing surrender charges.
Thirteenth, the average street level commission on indexed annuities as of 2Q2009 was 6.46%. There are only eight annuities available today with a commission of 10% or greater. It would be greatly appreciated if you would also take into consideration that the agent selling an annuity is paid only one time (at point-of-sale), and expected to service the contract for life. Compare this to the consistent, generous commissions paid on products such as mutual funds, and I think you’ll agree that indexed annuity commissions are quite fair.
Fourteenth, although you scoff at average annual returns of 5% – 6%, I’m certain many of your clients would be happy to receive that much, as opposed to a decline in their retirement accounts. Indexed annuities are the perfect product for someone who wants the safety of guarantees and principal protection, but is not able to stomach the volatility of the market. And although I have seen actual contracts receive in excess of a 30% gain in a single year, indexed annuities are not priced to return gains such as these on a regular basis. Again, indexed annuities are only intended to provide 1% – 2% greater interest crediting than products such as fixed annuities. Considering that the average first-year rate for a fixed annuity today is 4.36%, I’d say indexed annuities are earning what they’re intended to.
Other benefits of indexed annuities include (but are 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 your beneficiaries upon death.
7. Access money when you need it: fixed annuities allow annual penalty-free withdrawals of the account value, typically at 10% of the annuity’s value (although some indexed annuities permit as much as 20% of the value to be taken without penalty). 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 fixed and 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.
In the future, it would be much appreciated if you could limit your blogging of indexed annuities to the FACTS. Should I be able to assist you in your fact-gathering, please do not hesitate to contact me.
Thanks!
Sheryl J. Moore
President and CEO
LifeSpecs.com
AnnuitySpecs.com
Advantage Group Associates, Inc.
(515) 262-2623 office
(515) 313-5799 cell
(515) 266-4689 fax
