Response: Are Annuities a Good Investment?

July 12, 2010 by Sheryl J. Moore

PDF for Setting It Straight with InvestingBlog

ORIGINAL ARTICLE CAN BE FOUND AT: Are Annuities a Good Investment?

Dear Jordan,

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 am contacting you, as the author of a blog that was published at www.investingblog.org, “Are Annuities a Good Investment?” This article had an astounding 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 inaccuracies and ensure that your readers have accurate, unbiased information on these products in the future.

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, not all annuities are investments; only variable annuities, which place the purchaser’s principal and gains at risk of market volatility. Stocks, bonds, and mutual funds are also investments. The 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. 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.

Third, it is irresponsible to suggest that annuities “shouldn’t be purchased until you plan on retiring.” Deferred annuities provide tax deferral and accumulate interest until income payments are taken. For this reason, an deferred annuity is a valuable retirement income product for people of all ages. I bought my first annuity while in my 20s and have no complaints about the purchase whatsoever. It was absolutely appropriate for me and I have more than thirty years left until I retire!

Fourth, whos “investing 101 guidelines” are you referring to? I’ve never seen any guidelines which advise against the purchase of annuities. Ever.

Fifth, you say that “annuities generally provide lackluster returns.” Where did you obtain your return information? Indexed annuities in particular have outpaced traditional fixed money instruments by 1% – 2% annually. I have seen numerous indexed annuity annual statements showing double-digit returns; one as high as 47.65% in a single year! I would caution that throwing statements out like this in the future, without data to back it up, is quite ignorant.

Sixth, annuities are not ‘reverse life insurance.” Life insurance guards against the risk of dying too soon, and annuities insure against the risk of living too long. Perhaps that is what you are thinking of when you reference ‘reverse life insurance?’

Seventh, insurance companies selling annuities do not “bet that [the client] won’t live very long.” You obviously have no knowledge of basic annuity pricing. You are making blanket statements about annuities when in reality you are trying to make reference to immediate annuities or annuitization. Here is some basic annuity information, which should prove helpful to you:

Annuity Risk Spectrum

What is a Fixed Annuity (FA)?
A contract issued by an insurance company that guarantees a minimum interest rate with a stated rate of excess interest credited, which is determined by the performance of the insurer’s general account. A Fixed Annuity is considered a low risk/low return annuity product.

What is an Indexed Annuity (IA)?
A contract issued by an insurance company that has a minimum guarantee where crediting of any excess interest is determined by the performance of an external index, such as the Standard and Poor’s 500® index. An Indexed Annuity is considered a moderate risk/moderate return annuity product.

What is a Variable Annuity (VA)?
A contract issued by an insurance company where crediting of any interest is determined by the performance of underlying investment choices that the annuity owner selects. A Variable Annuity is considered a high risk

There are three questions that must be answered, when looking into what type of annuity is right for an individual:

1.         What level of market risk am I willing to assume with the annuity?

• If more concerned about a high minimum guarantee, regardless of the lower level of interest accumulation, consider a fixed annuity.
• If willing to accept a lower minimum guarantee than a fixed annuity, but looking for potentially greater interest accumulation, consider an indexed annuity.
• If willing to accept no minimum guarantee, in exchange for the possibility of unlimited interest accumulation, consider a variable annuity.

2.         How soon will I be taking income?

• If within the first year, consider an immediate annuity (offered in fixed, indexed, and variable types).
• 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?

• If only a single payment, consider a single premium immediate annuity or a single premium deferred annuity.
• If making more than one payment, consider a flexible premium deferred annuity.

Eighth, when an indexed annuity is annuitized, the payments do not “go up with the stock market.” The monthly payments on an indexed annuity are fixed, just like a fixed annuity. However, the excess interest that is credited to an indexed annuity during the deferral period can increase, based on the performance of an external stock index.

Ninth, insurance companies do not “cap the appreciation rate” on indexed annuities “to make money.” The limiting of the indexed interest on these annuities is what allows the insurance company to be able to afford the minimum guarantee that is provided to the consumer. So, regardless of the market’s performance, the worst the client can receive is zero interest crediting- no risk to principal as a result of market losses. No other product can offer such a strong value proposition, coupled with the insurance benefits of the indexed annuity. It is important to note that if the potential gains were unlimited on indexed annuities, there would be no guarantees, and THAT would be a variable annuity, not a fixed insurance product. We in the indexed annuity industry, are happy for this differentiation, as it is what drives the sales of these products.

Tenth, it is irresponsible for you to suggest that caps are generally “around 7%,” as the terms of the contract help to determine the cap, in tandem with the market’s performance and option costs. Today, annual point-to-point caps for products with no bonus average 5.38% and range from 1.25% – 9.65%.

Eleventh, it is quite obvious that you do not understand indexed annuity pricing when you suggest that the client will “earn the return of the respective stock index up to 7% at which point the remainder is kept by the issuing financial planner.” Your account of how insurance companies purchase options to account for the indexed appreciation on these products was pretty accurate, which is why I am so perplexed to see you make this statement. The insurance company invests the monies that back indexed annuities in their general account. They invest in high-quality bonds in order to provide the minimum guarantee on the contract. They purchase options to provide the limited index-linked interest on the contract. Never, at any point, does the insurance agent/advisor have any part in this transaction.

Twelfth, the insurance company does not keep the difference of the market appreciation and the cap. The insurance companies have no control over the prices for the bonds and options, but have a certain amount of money that they have budgeted to purchase these items. So, the insurance company uses more than [95%] of their budget to cover the annuity guarantees with the bonds and the difference goes to the options budget. The option seller might tell them that their $0.05 (5% of our dollar budget) will purchase a cap of 8% on an annual point-to-point indexed annuity with a minimum guarantee of X. So, if the market goes up 8% or more, the client receives only 8%. The difference in the market appreciation is not passed on to the insurance company, as they were sold an option for a cap of 8%. However, if the market goes down, the option expires and the client receives 0% interest. Note that while $0.05 may afford the insurer an indexed annuity cap of 8% this month, it may only purchase them a potential indexed annuity gain of 6% next month, because of market performance and option costs.

 Thirteenth, indexed annuities do not have “annual fees” and neither do fixed annuities. Variable annuities do. Your blanket statement is disconcerting considering that you haven’t even mentioned variable annuities in your article.

Fourteenth, it is irresponsible to compare annuity performance to index fund performance. Because indexed annuities are a “safe money place,” they should be compared against other safe money places such as certificates of deposit (CDs) or fixed annuities. Products like stocks, bonds, mutual funds, and variable annuities are “risk money places,” where the client is subjected 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 always inappropriate to compare safe money places to the market index itself.

Fifteenth, you say that the “safety and security” of fixed and indexed annuities come “at a price that is far too expensive.” Tell that to the people who lost nearly 50% of their retirement funds from March of 2008 to March of 2009. Do you think that they would be willing to purchase a product with limited upside potential and a minimum guarantee, so that they could avoid losing half of their nest eggs in the future? Millions of Americans chose this alternative, purchased fixed and indexed annuities, and were sleeping soundly at night during the market collapse, knowing that their principal and gains were protected from market fluctuations without the fees that are associated with investments.

Sir, indexed annuities have 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 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.
9. Guaranteed lifetime income: an annuity is the ONLY product that can guarantee income that one cannot outlive.

I suggest that you educate yourself on annuities before you decide to write about them again. I am surprised that FINRA has not contacted you about the inaccuracies on your blog to-date. Please make a correction to this piece or delete it from your site. In the future, you can contact us if you should have any need for accurate information on these products.

Thank you.

Sheryl J. Moore

President and CEO

AnnuitySpecs.com

LifeSpecs.com

IndexedAnnuityNerd.com

Advantage Group Associates, Inc.

(515) 262-2623 office

(515) 313-5799 cell

(515) 266-4689 fax

Originally Posted on July 12, 2010 by Sheryl J. Moore.