Response: Cluttered annuities typically make for bad Investments
December 31, 2009 by John Henry McDonald
PDF for Setting It Straight with Austin8
ORIGINAL ARTICLE CAN BE FOUND AT: Cluttered annuities typically make for bad Investments
Mr. John Henry McDonald:
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 recently had the occasion to read your article, “Cluttered annuities typically make for bad investments” on the Austin 8 news website. While reading your article, I noticed an alarming number of inaccuracies and false information. I am reaching out to assist you in light of these errors. I understand that you are not a fan of indexed annuities, and you have every right to biased against them if you so desire. I suggest that before you make a decision on these products, you get the facts. In addition, you owe it to your clients, Austin 8’s viewers and to the millions of Americans who have been misled by unscrupulous advisors to report accurate information.
First of all, 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.
Contrary to what you allude, the number one determinant of “yields of” indexed annuities is the performance of the stock market index. As we are all aware, no one can predict the performance of the stock market or any index itself. Option costs for the caps, participation rates, and spreads on indexed annuities are set by option sellers and dictated without the control of insurance companies. For these reasons, it is disingenuous for you to indicate that the yields of indexed annuities are at the discretion of insurance companies.
Furthermore it is absolutely false so say that “the minimum floor level required by the National Association of Insurance Commissioners (NAIC) is 87.5%.” The minimum floor on indexed annuities is ZERO percent. Some indexed annuities have a minimum floor as high as 2%. You seem to be confusing the minimum guarantees of all fixed annuities with an indexed annuity floor. No fixed or indexed annuity can offer a minimum guarantee less than 87.5% of the premiums paid, credited at 1% – 3% interest (as based on the 5-year Constant Maturity Treasury Rate).
Mr. McDonald- one cannot “invest” in an indexed annuity. An indexed annuity is an insurance product, not an investment. Other insurance products include fixed annuities, term insurance and whole life. Alternatively, investment products include variable annuities, stocks, mutual funds, and bonds. 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 all of a client’s money at risk and are therefore appropriately classified as “risk money products.” Investments do not preserve principal where insurance products do.
There is no such thing as a “yield-spread cost factor” on indexed annuities. It is distressing how you are blatantly misleading your readers with such inaccuracies. Furthermore, all terms of an indexed annuity are always clearly and fully-disclosed in the materials that are presented to the purchaser.
It is important to note that not all indexed annuities utilize a cap. Perhaps some basic education on indexed annuity crediting would help here. Indexed annuities have a minimum guarantee, and in order to provide that minimum guarantee the insurance company must limit the interest credited to the indexed annuity. (Were the interest not limited, there would be no minimum guarantee, and that my friend is a variable annuity.) The options seller will not pass-on unlimited gains on a product that does not have unlimited risk. The three ways in which an insurance company may limit the interest credited to these products are by using 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. Regardless of whether the interest is limited by a cap, participation rate, or spread- all indexed annuities are priced to return about 1% – 2% greater interest than fixed annuities and certificates of deposit (CDs) are crediting. So, if fixed annuities are crediting 5% today, an indexed annuity sold today should earn 6% – 7% over the life of the contract. In some years, the indexed annuity will earn zero (in the event of market declines); in other years it may receive double-digit gains. What is most likely to occur on a regular basis is something in between. Indexed interest on indexed annuities sold today could be as much as 12% or even more.
All insurance companies must file their fixed, indexed, and variable annuities policy forms with the state insurance division. When fixed and indexed products are filed, they provide for both a current rate of interest crediting and a guaranteed minimum. Fixed annuities have a current interest rate as well as a guaranteed minimum interest rate. Rates on fixed annuities cannot drop below the guaranteed minimum interest rate in years 2+. Indexed annuities have a current potential interest rate (via a cap, participation rate, or spread) and a guaranteed minimum surrender value; they also have guaranteed minimum caps/participation rates and guaranteed maximum spreads. Rates on indexed annuities cannot drop below the guaranteed minimum surrender value OR exceed the maximum spread or drop below the minimum caps/participation rates in years 2+. When variable products are filed, they provide for both current charges and guaranteed charges (for mortality and expense, riders, etc). The manner in which insurance companies have the ability to adjust the rates in years 2+ of an indexed annuity is no different than the manner in which they adjust rates in years 2+ on a fixed annuity. Furthermore, this is no different than how insurance companies have the ability to adjust the charges in years 2+ on a variable annuity. All insurance products and many investment products may have rates or charges that vary in years 2+. Insurance companies must have the ability to adjust their rates beyond the first year of the annuity contract whether it is fixed, indexed or variable. If their investments perform favorably, they want the flexibility to be able to credit a higher-than-anticipated rate to their policyholders. In turn, if investments perform lower than expected, they would need the ability to adjust rates downward. This ability to change the rates in years 2+ is what keeps an insurance company solvent, in the event that the market takes an unexpected turn. There is simply no way to guarantee that the economy will not change, and therefore no way to guarantee that a product will credit the rate it is sold at for the life of the contract (regardless of whether it is indexed annuities or universal life insurance).
The average surrender charge for indexed annuities as of 2Q2009 was 10 years. A majority of indexed annuity sales do have a premium bonus that provides an immediate boost to the purchaser’s account value. However, only one premium bonus product in the entire indexed annuity market has a provision where the client will not receive the premium bonus unless they annuitize. This two-tiered annuity accounts for less than 1.7% of total sales as of 2Q2009. In light of this information, I am certain you can see that premium bonuses can indeed benefit the purchaser.
You warn that purchasers should be “aware of surrender charges.” Everyone who buys retirement income products should be aware of any limitations on liquidity in their contracts- indexed annuities are no different. Yet, you paint them as inflexible, illiquid products. In fact, 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 annually). 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 would have difficulty implying that these products are inflexible.
Are you aware of the difference between “safe money” products and “risk money” products? I am certain your clients would want you to know the difference. Safe money products such as fixed annuities, indexed annuities, and CDs protect the purchasers principal (the amount originally deposited). Risk money products such as variable annuities, stocks, bonds, and mutual funds DO NOT protect the purchasers principal. While safe money products provide limited gain potential and limited risk, risk money products provide unlimited gain potential and unlimited risk. Purchasers of indexed annuities are risk-averse consumers who want the safety and guarantees that fixed annuities provide, but want a little greater growth potential than what a fixed annuity can provide. These people do not have the risk profile of someone who would want to purchase bonds much less someone who would invest in the S&P 500 index itself. You would do well to take note that one is not an alternative for the other. While an indexed annuity does not have the ability to return the same amount as the S&P 500 on a consistent basis, it also isn’t subject to the market drops. Worst case scenario is 0% interest with this product- can you say the same about the products you are suggesting as an alternative? No.
Besides, why would someone take your suggestion to buy a $70,000 10-year bond, when that same $70,000 when placed in a 10-year indexed annuity would be guaranteed to return no less than $90,546 and $132,537 if the market returns a mere 7% annually. This indexed annuity purchaser could receive a return of as high as $209,256 with a cap of 12% if the market consistently increased 12% or more. The point is that the indexed annuity would only need to return 4% to reach a return of $100,000 at the end of ten years, BUT IT COULD RETURN A LOT MORE. So you tell me- would you take the bond, or the annuity that guarantees the client does not run out of income as long as they live while also providing tax-deferral? I believe the solution is simple.
Only an indexed annuity can provide a minimum guarantee, index-linked interest, tax deferral, and an income that the client cannot outlive.
It would be greatly appreciated if you could get the facts before you decide to write about these products in the future. I would also suggest that News 8 Austin print a correction to this article. Now more than ever, Americans are looking for reliable sources of information on where to put their retirement funds. When disseminating information that is not accurate, your credibility comes into question. Should you have a need for accurate information on these products in the future, please do not hesitate to contact my firm.
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
