Response: The good, bad and ugly
November 16, 2010 by Sheryl J. Moore
PDF for Setting It Straight with Motley Fool
ORIGINAL ARTICLE CAN BE FOUND AT: The good, bad and ugly
Dearest Motley Fool,
My name is Sheryl Moore, and I am the foremost authority in the indexed annuity market. I am an independent market research analyst who specializes in the indexed annuity and 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 and IUL 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 post at The Motley Fool, “The good, bad and ugly.” You made some misleading statements against indexed annuities in this piece, so I am contacting you to clarify. I want to make sure that your readers always have access to accurate information, so I would be happy to serve as a resource to you, should you need information on indexed insurance products in the future.
First, indexed annuities have not been called “equity-indexed annuities” or “EIAs” by those in the insurance industry 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. The interest potential of these products is limited, unlike equities investments. In addition, 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. Thank you.
You are certainly welcome to have your own opinions, even if they do reflect that you feel indexed annuities are “ugly.” However, you need to recognize that despite the fact that you “don’t like most annuities,” that annuities have their place. An annuity is the only financial services product that can guarantee the purchaser an income that they cannot outlive. Stocks cannot offer such a benefit nor can any other product. (And note that stocks cannot provide protection of principal or guaranteed lifetime income, two of the hallmark features of indexed annuities.) However, it is disingenious to compare indexed annuities to stocks, as they are intended to compete against fixed annuities and CDs, not stocks, bonds, mutual funds, or variable annuities. Let me explain.
Because indexed annuities are a “safe money place,” they should be compared against other safe money places. Investment products such as stocks, bonds, mutual funds, and variable annuities subject the purchaser 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 most certainly not appropriate to compare safe money places to the market index itself. Indexed annuities are not intended to perform comparably to stocks, bonds, or the S&P 500 because they provide a minimum guarantee where investments do not. Indexed annuities are priced to return about 1% – 2% greater interest than traditional fixed annuities are crediting. In exchange for this greater potential, the indexed annuity has a slightly lesser minimum guarantee. So, if fixed annuities are earning 4% today, indexed annuities sold today should earn 5% – 6% over the life of the contract. Some years, the indexed annuity may return a double-digit gain and other years it may return zero interest. However, what is most likely to happen is something in between. Were the indexed interest NOT limited, the insurer could not afford to offer a minimum guarantee on the product, and THAT is a variable annuity- not an indexed annuity. On the other hand, the client is guaranteed to never receive less than zero interest (a proposition that millions of Americans are wishing they had during that period of 03/08 to 03/09) and will receive a return of no less than 117% worst-case scenario on the average indexed annuity. In addition, no indexed annuity owner has ever lost a penny as a result of market downturn. This is a strong value proposition that cannot be offered by any securities product, and the primary driver for increasing sales of these products. Hopefully this explanation will assist you in gaining greater insight into the mechanics of indexed annuities and why the typical indexed annuity purchaser does not have the risk tolerance for investments such as stocks.
It is no secret that indexed annuities’ gains are limited. As I said, were the interest not limited, the insurance company could not afford the minimum guarantee. The limiting of interest (whether it be via cap, participation rate, or spread) is clearly disclosed to the purchaser at point-of-sale and all agents selling indexed annuities are abundantly aware that these products credit limited interest. For that reason, I find it silly that you suggest this is revealed in “the fine print.”
Second, indexed annuity purchasers are not willing to risk losing 26% on the off chance that they might gain 26%. This is a fundamental difference between the stock investor and the indexed annuity purchaser. They person purchasing the indexed annuity is willing to live with limited gains in exchange for principal protection. Please remember this.
Third, indexed annuities have no explicit “fees,” like variable annuities do. The “cost” that the client pays on an indexed annuity is merely time; via a surrender charge. The surrender charge on a fixed, indexed, or variable annuity is a promise by the consumer not to withdraw 100% of their monies prior to the end of the surrender charge period. This allows the insurance company to make an informed decision on which conservative investments to use to make a return on the clients’ premium (i.e. 7-year grade “A” bonds for a seven-year surrender charge annuity or 10-year grade “A” bonds for a ten-year surrender charge annuity). Investing the consumer’s premium payment in appropriate investments allows the insurance company to be able to pay a competitive interest rate to the consumer on their annuity each year. In turn, it also protects the insurance company from a “run on the money” and allows them to maintain their ratings and financial strength.
Consider the fact that indexed annuities may not be what you perceive, Motley Fool. As of 3Q2010, the average commission paid to agent on indexed annuities was a mere 6.50% (and even lower for annuities sold to older-aged purchasers). Keep in mind that this commission is paid one time, at point of sale only, and the agent services the contract for life. By comparison, many securities products such as mutual funds pay generous, consistent commissions annually. The average surrender charge for indexed annuities as of 3Q2010 is ten years and the average first-year charge is less than 11% (even less for older-aged purchasers). Yet, indexed annuities are available with surrender charges as little as three years and as low as 5% in the first year (declining annually thereafter). You must also realize that every indexed annuity permits penalty-free withdrawals of 10% of the annuity’s value annually. Some even allow as much as 50% of the annuity’s value to be withdrawn in a single year! Plus, 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 that these products pay the full account value to the beneficiary upon death, and it is clear that these are some of the most liquid retirement income products available today. In addition, indexed annuities have many benefits, including but not limited to:
- 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.
- All indexed annuities return the premiums paid plus interest at the end of the annuity.
- Ability to defer taxes: you are not taxed on annuity, until you start withdrawing income.
- Reduce tax burden: accumulate your retirement funds now at a [35%] tax bracket, and take income at retirement within a [15%] tax bracket.
- 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.”)
- Provide a death benefit to heirs: all fixed and indexed annuities pay the full account value to the designated beneficiaries upon death.
- Access money when you need it: every indexed annuity allows annual penalty-free withdrawals of the account value at 10% of the annuity’s value; some even permit as much as 50% to be withdrawn in a single year. 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.
- Get a boost on your retirement: many 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.
- Guaranteed lifetime income: an annuity is the ONLY product that can guarantee income that one cannot outlive.
Isn’t it possible that The Motley Fool staff has a misunderstanding of how these products work and how useful they can be for the right purchaser? I think so. That being the case, I would love to be a resource to all of you on indexed annuities. In the interim, I would just be happy if you restrict your “reporting” on indexed annuities to the parts that you are certain of; factual information. If I can ever serve as a fact-checking resource for you, please do not hesitate to contact me.
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
