The Truth About Index Annuities
February 1, 2010 by Sheryl J. Moore
- By SHERYL MOORE
Published 2/2/2010
Indexed annuities have become the naughty step-child of the insurance industry, largely because of today’s “sensationalism sells” mentality in the consumer and business media. Many reports on IAs simply ignore the truth or include inaccuracies.
Sadly, this has prevented many advisors from considering the product. Yet never has there been a better time for advisors to have IAs in their portfolio. Comparing some of the myths about this market with the facts can help reveal the value of these products. Here is my assessment, gleaned from several years experience as an independent market research analyst.
It is a fact that the IA industry has seen its share of lawsuits. What part of the insurance industry hasn’t? However, it is also a fact that not a single one of these lawsuits has been based on the IA itself.
A couple of IA cases were based on product misunderstanding. Take the woman who claimed that her IA was unsuitable because it had a maturity age of 115. She was able to take 10% penalty-free withdrawals annually and access her money without penalty in case of nursing home confinement, and it would pay full account value at death. However, she thought the late maturity age meant she could not access her money until age 115, when in reality it meant she must take out her money no later than age 115. She just did not understand that fact.
However, the majority of IA lawsuits have involved bad agent behavior–something not tolerated by insurance companies and insurance regulators. The companies are quick to terminate agents for misconduct, and state insurance divisions do not hesitate to impose sanctions such as license revocation and fines. Ultimately, most IA lawsuits have benefited one party: the lawyers. There were no big payouts, but there were big headlines and quick settlements.
Many in the securities industry have pointed to IA complaint levels to support calls for federal regulation of IAs. However, the fact is that IA complaints are quite low. The National Association of Insurance Commissioners’ closed complaint database shows IAs received fewer complaints in 2008 than did variable annuities. In fact, companies selling IAs averaged less than four complaints per company for all life and health insurance products in 2008.
Certainly, the IA industry does strive for 100% customer satisfaction. However, four complaints per year are hardly unreasonable.
It is a fact that many IAs offer generous premium bonuses. However, these products are not anything like the infamous two-tiered annuity, which now represents less than 2% of total IA sales in our database. In fact, 99.6% of all bonus IAs pay an upfront bonus, with no strings attached. And although these upfront bonuses can be as high as 11%, some are as little as 1% and the average is 5%.
It is a fact that the media regularly points to double-digit surrender charges when “reporting” on IAs, in an attempt to make them appear illiquid. In actuality, these products are not that different than their variable counterparts. Yes, there are a couple of IAs with 16-year surrender charges. However, some IAs have surrender charges as short as one year. Neither charge is the norm, but no one ever hears anyone talking about the low end of the spectrum.
The facts are that the average surrender charge on IAs for third quarter 2009 was 10 years and the average first-year surrender penalty for IAs during that period was 10%. Most of these 10-year products also had premium bonuses on them, a fact also overlooked by those pointing at the “lengthy” surrender charges in this market.
Want more facts that don’t make the headlines? All IAs allow the client to withdraw at least 10% of the value without penalty each year (some allow as much as 20%). In addition, nine out of 10 IAs provide penalty-free access to the annuity value in the event of triggers such as nursing home confinement, terminal illness, disability, and even unemployment. Also, all IAs pay the full account value at death.
One last myth: big fat commissions. Yes, one IA does pay 12% commission. But that’s nowhere near typical, according to the AnnuitySpecs.com database. The average street level commission paid on IAs for 3Q 2009 was only 6.43%. This little-known fact is usually the ice-breaker between brokers and IA products.
So, now that the IA truth is out there, why not consider offering IAs?
These products are priced to return about 1% to 2% greater interest than traditional fixed annuities. Can IAs earn double-digit returns? Yes, and they have. Are they intended to consistently return such results? No. What is most likely to occur is something in between. If clients are looking for that in-between, and a little more safety, the IA meets the need, and the advisor is in a position of explaining zero instead of market losses.
Sheryl Moore is president and chief executive officer of AnnuitySpecs.com and LifeSpecs.com, and indexed product resource in Des Moines, Iowa. Her email address is sheryl.moore@annuityspecs.com.
