HAVE Indexed Annuities Become Too Complicated?!?

December 27, 2016 by Sheryl J. Moore

A recent Investment News article highlighted commentary from myself on how indexed annuities have become “unnecessarily complex.” I stand by that comment. Now, don’t get me wrong- I love indexed annuities, and I want to see the product line continue to thrive. Further, I am always for product innovation and competition when it comes to annuities and life insurance. This is what gives consumers so many choices when it comes to their purchase! But, let me allow you inside-of-my-head for just a minute…

When I started my work in the insurance industry nearly 20 years ago, the typical indexed annuity measured its S&P 500 indexed gains over a seven-year period, likely offered two choices for allocating premiums and may have limited the indexed interest by using a spread rate. Consumers definitely had some choices when it came to their indexed annuity purchase:

• Choice of indices: 5

• Choice of indexed crediting methods: 4

• Choice of method to limit indexed interest: 3

My, have we come a long way since then!

Today, the typical 10-year indexed annuity usually limits S&P 500 indexed gains with a cap rate, and likely provides five choices for allocating premiums. Yet, the number of choices that consumers have when it comes to their indexed annuity purchase is astounding:

• Choice of indices: 65

• Choice of indexed crediting methods: 12

• Choice of method to limit indexed interest: 5

You’ll notice that the growth in the number of indices available on these products has exploded over the past two decades. One of the largest reasons for this boom is the emergence of “hybrid indices” on indexed annuities. These indexes are comprised of at least one index plus a secondary component, such as cash, stock(s), or mutual fund(s); they are often volatility-controlled. We saw the introduction of the first hybrid index in the indexed annuity market in 2007; this area of product development advanced slowly at first:

• Hybrid indices in 2007: 1

• Hybrid indices in 2013: 6

• Hybrid indices in 2014: 14

• Hybrid indices in 2015: 23

• Hybrid indices in 2016: 47

The motivator for this boom? Continued low interest rates. The typical annual point-to-point cap in 2007 was 8.00%; today it is a mere 3.55%.

It never ceases to amaze me how product innovation can thrive in a persistent low interest rate environment. Caps too low? Use a participation rate! Annual point-to-point rates too low? Use averaging methods. The search for an appealing product becomes more and more difficult as the Treasury drops lower and lower.

Enter hybrid indices. These indexes give the insurance company the ability to offer an “uncapped” indexed annuity when pricing isn’t as favorable with other, more traditional indices. (However, a spread rate or participation rate are typically used as opposed to a cap rate.)

And don’t get me wrong- by “uncapped,” I do NOT mean “unlimited.” Indexed interest on indexed annuities is always limited. After all, this is a product with a guaranteed minimum interest rate; if the potential for gains were unlimited, so would be the potential for losses.

So, back to that “uncapped” feature. Having a “uncapped” index gives the individual marketing the product the ability to say that the indexed annuity has a relatively greater potential for indexed gains because it doesn’t have a cap. Will the hybrid index truly provide greater gains than a traditional S&P 500 index?

According to the actuaries and options sellers that I work with, all indexed annuities are priced to return 1% – 2% greater interest than fixed annuities being issued on the same day. This is regardless of crediting method, index, or method used to limit gains. And while these professionals have shared that hybrid indices may provide a more favorable sequence-of-returns than other indices, they have stopped short of saying that they will outperform traditional indices.

Given all of this, you may think that I don’t like hybrid indices. Please rest assured that this is not my position at all. Remember- I LOVE competition and innovation in these products!

My primary concern with these indices (as you will read in the comments of the online article) is more about the market conduct issues surrounding insurance licensed-only agents selling indexed annuities featuring these indices. Nearly half of the individuals selling indexed annuities today are insurance licensed-only; they are not securities registered reps. What if the prospect asks, “What is the XYZ Hybrid Index?” The insurance licensed-only agent cannot answer without giving what is called “unregistered investment advice.” And unregistered investment advice is a big deal: punishable by loss-of-license, fines, and even jail time depending on the state they do business in. This issue is the primary reason that many state regulators (Iowa’s included) scrutinize hybrid index offerings on indexed annuities. While the pricing on the product still makes it a fixed annuity, the market conduct issues surrounding the product may classify it as a security.

I DO also have some concerns that there is often no online resource to obtain index values for these indices, much less identify what the index consists of; this is a particular thorn in the side of many regulators as well. Consumers need to have resources so that they can calculate their indexed gains and understand what they are purchasing. When hybrid indices first broke onto the scene, I argued with regulators for these options- “S&P 500 or XYZ Hybrid Index, it was still a fixed annuity!,” I argued. The regulators’ defense? The purchaser sees the S&P 500 values on the evening news, and in their Sunday newspaper; where can one find values for the XYZ Hybrid Index? Touché…

As a product developer and an expert on indexed annuities, I AM critical of the complexity of indexed annuities in general. While I have been doing this for 20 years, I spent nearly five years responding to and correcting every negative and inaccurate article in the indexed annuity market. I remember all-too-well the trouble that indexed annuities have gotten into because of the numerous crediting methods that have been available in the past; at one time there were 56 different ways of calculating indexed interest on these products! And this “innovation” was all in the name of low interest rates. We still receive a lot of heat because there are so many ways to limit the indexed interest on these products; caps, participation rates, spreads, forced asset allocation models, and even fees.

I knew that my comments in the Investment News piece would not be perceived positively by the indexed annuity industry at the time that I made them. How could they? I currently have 35 of the 57 companies that offer indexed annuities providing some sort of hybrid index offering. That being said, my concern is for indexed annuity products and their future. I do not think that hybrid indices are inherently “bad,” but some companies do a better job of marketing such indices than other companies do. Stories of “unlimited potential for gains” abound. Consumers are being led to believe that they will receive market-like returns when they won’t. Many insurance companies do not even provide collateral materials that explain what the index is, and how it works. Most of us could do a much better job when it comes to marketing these features.

After spending so many years correcting journalists, one has to take notice of how “complex” the public perceives our products to be. It doesn’t have to be this way. Indexed annuities are valuable tools. I started my company, just so that I could make sure that all Americans learned about them, and understood that they may be a viable option for their retirement savings plans.

To sum things up, I just think that we make the story hard-to-tell at times. What do you say that we work on that in 2017? sjm