Response: How Do Equity Indexed Annuities Stack Up?
April 10, 2011 by Sheryl J. Moore
PDF for Setting it Straight with Lon Jeffries
ORIGINAL ARTICLE CAN BE FOUND AT: How Do Equity Indexed Annuities Stack Up?
Mr. Jeffries,
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 a “press release” that you authored for PRLog.com, “How Do Equity Indexed Annuities Stack Up.” This ‘release’ was inaccurate to the point it makes a mockery of your expertise in financial services. It is for this reason that I am reaching-out to you. I not only want to bring these inaccuracies to your attention, but I want to ensure that you have a reliable source for fact-checking information on indexed annuities in the future.
First, I would like you to know that it is inappropriate to refer to these products as “equity indexed annuities” or “EIAs.” Indexed annuities have not been called “equity-indexed annuities” 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, Mr. Jeffries.
Second, I need for you to know that it is inappropriate to refer to indexed annuities as an “investment.” Variable annuities are the only type of annuity that can be called an “investment,” as these products place the purchaser’s principal and gains at risk due to market volatility. Stocks, bonds, and mutual funds are also investments. The Securities and Exchange Commission (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 (collectively referred to as the National Association of Insurance Commissioners, or NAIC). 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. The NAIC does not permit the use of the word “investment” when referring to indexed annuities, as such.
Third, indexed annuities are not as complex as most perceive them to be. They are just fixed annuities with a different way of crediting interest. Furthermore, complexity is relative. Some would say that fixed annuities, which are the simplest retirement income product offered by insurance companies, are complex. However, if someone can understand that they have the ability to deposit their money with an insurance company, defer taxes on the monies until they begin taking income, receive 10% withdrawals of the account value annually without being subject to penalties, and have the ability to pass on the full account value to their beneficiaries upon death- then they can understand nearly every indexed annuity sold today.
Note that the perceived complexity of indexed annuities stems from the historical practice of offering numerous, complex, unique crediting formulae on the products. Historically, there have been as many as 42 different ways of calculating indexed interest on these products. However, since hitting that high point in the year 2000, the number of unique crediting methods on indexed annuities has declined annually and sits at 11 today. Of these eleven different methods, nine use the calculation (A-B)/B to calculate the gain.
Fourth, those that sell indexed annuities are not “paid large commissions for promoting these products.” In fact, the average commission paid on indexed annuities during 4Q2010 was a mere 6.37% (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, securities products such as mutual funds, stocks, and bonds pay generous, consistent commissions each year. In light of this, I think you’ll agree that the commissions paid on indexed annuities are quite fair and hardly “large,” as you would suggest.
Fifth, you don’t seem to understand the minimum guarantees on indexed annuities. Indexed annuities offer a guaranteed 0% floor in addition to a secondary guarantee called a Minimum Guaranteed Surrender Value (MGSV). This secondary guarantee is payable in the event the client cash surrenders or if the market does not perform; it provides 1% -3% interest (contingent on the value of the 5-year Constant Maturity Treasury Rate) on no less than 87.5% of the premiums paid on the contract.
Sixth, you have the value proposition of indexed annuities wrong, Mr. Jeffries. Indexed annuities are not intended to provide all of the stock market’s upside. Indexed annuities are promoted as ‘allowing the purchaser to have LIMITED participation in the market’s upside, while avoiding the downside risks associated with the market.’ You see, all gains on indexed insurance products must be limited through the use of a participation rate, cap, or spread. 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 than a fixed annuity. So, if fixed annuities are earning 5% today, indexed annuities sold today should earn 6% – 7% 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 the premiums paid plus interest at the end of the contract term. 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 with unlimited gains, Mr. Jeffries. I think that your clients would be better-served if you took note of this, as not every American is willing to tolerate market losses in exchange for the opportunity for unlimited gains.
Seventh, while it is true that insurance companies reserve the right to change the caps, participation rates, and spreads on indexed annuities in years two plus, it does not mean that insurance companies do. I can name numerous companies that have never reduced their renewal rates on their indexed annuities. You should also know that this provision is no different than that of a fixed annuity, where the insurance company has the discretion to change the credited rates in years two plus. Not to mention the fact that variable annuities have the ability to increase fees if necessary in years two plus. All fixed and indexed annuities are subject to minimum rates, as approved by the state insurance divisions that approve the products for sale in their respective states. Insurance companies are smart to protect themselves by filing products that have the ability to change rates annually, in the event of a volatile market. I personally feel much more confident that the companies offering these products today will be able to make good on their claims-paying ability, considering such flexibility in the event of unforeseen circumstances. However, it is important to remember that building-in this flexibility is not necessarily the same as utilizing it.
Eighth, you also misunderstand annuity surrender charges. 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.
That being said, indexed annuities offer many options for liquidity, should the purchaser need access to their annuity’s value. Specifically, 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. This is not the picture that you would paint of them, Mr. Jeffries. Please take note of how liquid the products truly are in your future communications about indexed annuities.
Ninth, there has never been a product feature more miscommunicated than the concept of dividends being excluded from the crediting calculation of indexed annuities. You comment that dividends are excluded from the indexed calculation on indexed annuities as if it were a detriment, Mr. Jeffries; it is not. The insurance company never receives the benefit of the dividends on the index on an indexed annuity, because the client is never directly invested in the index. The insurance company invests the indexed annuity purchaser’s premium payment in the general account, which protects them from declines in the index. The premiums are never invested in a pass-through account, which would provide the benefit of the dividends, but also expose the client to risk should the market decline. For this reason, the dividends cannot be passed on to the consumer and are never included on the calculation of any indexed annuity. By not directly investing in the index (which would pass-on the dividends), the insurance company is protecting the purchaser from losses. So, you see- this is a benefit to the indexed annuity purchaser, not a disadvantage. And while it is true that consumers will not ‘benefit’ from dividends in an indexed annuity, they also won’t risk losing their money as a result of market volatility either. It is a win-win that many risk-averse savers find appealing.
Tenth, although I can appreciate your argument on solvency risk, you fail to realize the strict scrutiny placed on the solvency of insurance companies by the insurance commissioners that regulate them. Perhaps you are unaware of the Guaranty Fund Association which protects insured persons in the event of insolvency? This association provides a guarantee to insurance company policyholders in a manner similar to how the Federal Deposit Insurance Corporation (FDIC) insures bank depositors. Interestingly, very few insurance companies have gone insolvent since the market collapsed. In contrast however, more than 330 banks have failed since the market collapsed in 2008. I believe that if more Americans understood the Guaranty Fund Association, they would have more confidence in the solvency of insurance companies than they do in the solvency of banks. Please realize the context of your statements before making them, Mr. Jeffries. Your negative persuasion toward the claims-paying abilities of annuity issuers portrays these products differently than reality. Your public, disparaging statements have the ability to inappropriately sway your readers.
Eleventh, your comparisons of indexed annuities versus stocks, bonds, and the index itself are disingenuous. As I mentioned, it is inappropriate to compare risk money places, such as investments, to safe money places, such as indexed annuities. It is most appropriate to compare indexed annuities to instruments such as CDs and fixed annuities. The average 1-year CD rate is currently 0.47% (according to bankrate.com) and the average fixed annuity rate is currently 3.50%. I would say that having the potential to earn as much as 10.20% or more annually on an indexed annuity, while deferring taxes and guaranteeing lifetime income, is a VERY attractive proposition as compared to CDs and fixed annuities. Bear in mind that the investments you compare indexed annuities to cannot provide tax deferral or an income that cannot be outlived either, Mr. Jeffries. You would benefit from understanding this important aspect in product positioning.
Ultimately what is most disturbing is that you fail to grasp that the individual purchasing an indexed annuity is likely too risk averse to make equities products a suitable investment purchase. You even go so far as to suggest that a loss of 6% in a single year “might be tolerable to an investor with a low risk tolerance.” Are you kidding? Your recommendations are not only ignorant, but reckless. The consumer risk profile for someone purchasing securities such as stocks and bonds is someone looking for “risk money places”- where they can have the potential to earn 20% at the cost of having a chance of losing 20%. The consumer risk profile for someone purchasing insurance products like fixed and indexed annuities is someone looking for a “safe money place”- where they can have a guaranteed preservation of principal plus limited interest. Indexed annuity purchasers are more concerned with the return OF their money than the return ON their money. I’m certain your clients would GREATLY appreciate this difference be taken into consideration in your selection of product solutions.
Twelfth, your suggestion that a “fee-only advisor” is best-suited to review prospective clients’ indexed annuities is ludicrous. Indexed annuities are largely NOT sold by “fee-only advisors;” how would these advisors even know how to evaluate whether or not the product is suitable if they do not understand how it works? In addition, it is silly to suggest that one can trust a fee-only advisor more than a commission-based advisor. Readers need to understand that people are taken advantage of by those selling financial services products, regardless of how the seller is paid. Plus, readers should consider that your background is in the securities business, not the insurance business, and that you stand to benefit from your silly suggestion if they follow-through to have you review their indexed annuity. Sadly, few Americans realize that registered representatives’ solution for ‘safety and accumulation’ is too often by suggesting stocks and bonds (which are both equities products with risk of loss). By contrast, the insurance agent’s solution for the same problem is an indexed annuity (which is an insurance product with no risk of loss due to market volatility). Why isn’t the registered representative a fan of the indexed annuity? For starters, he is familiar with the processes and routines that are associated with the SEC’s regulation (which is very different than those of insurance products’ NAIC regulation). In addition, equities products pay generous, consistent commissions where annuities pay commissions only one time, at point-of sale. For this reason, it is very likely that the registered representative does not sell indexed annuities at all. And if the registered representative is not selling indexed annuities, then he is competing against insurance agents that do. Our nation’s financial advisors and insurance agents have long-fought a battle to control 100% of their clients’ assets. It is a shame that everyone cannot learn to “play together” and ensure that the client has ALL of their financial services needs met, using THE most appropriate products for their needs, regardless of whom is able to sell it to them. You should be ashamed of yourself for making such an irresponsible suggestion that anyone who has purchased an indexed annuity was likely sold an unsuitable product. You clearly don’t know enough about indexed annuities to suggest ANYTHING about them. I am concerned about how your clients can discover the truth about indexed annuities; they have a right to know that these products 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 indexed annuities pay the full account value to the designated beneficiaries upon death.
7. 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.
8. Guaranteed lifetime income: an annuity is the ONLY product that can guarantee income that one cannot outlive.
YOUR clients deserve the most appropriate product for their needs, regardless of the fact that you don’t sell indexed annuities, Mr. Jeffries. I just hope that they do their due diligence prior to seeing you, and have the opportunity to realize that your retirement solutions may be swayed in a manner that is not consistent with their goals if they are one of the millions of Americans that truly are risk-averse.
In closing, I found it deplorable that you would issue your thoughts via this “press release;” suggesting that you are offering legitimate news, rather than making a revolting ploy to increase your sales and fees. Despite the fact that FINRA has no regulatory authority over fixed insurance products, I am certain that they would not approve of you making material misstatements about any product in an effort to promote your business, Mr. Jeffries. I would assume as much in all of your future public communications.
And in the future, you should actually learn how indexed annuities work before you decide to influence the general public using outright misrepresentations about the product features. It is disappointing and downright frightening that someone with so little knowledge on indexed annuities would be permitted to write about them in a public forum. I would suggest that in the future you get the FACTS about a product that you do not sell, before you decide to write about it. Your credibility comes into question when you do financial planning and provide such inaccurate information on financial services products. Compounding the matter is the obvious reality that now, more than ever, Americans need reliable, credible information on financial services products. Your clients and potential clients are being done a tremendous disservice with this “press release.” It would behoove you to remove the piece from the web and print a correction immediately.
Please, in the future, should you have a need to verify information on indexed annuities, or perform fact-checking for your commentary, feel free to reach out to us. Not only can I help to ensure your journalistic integrity, but I am always more than happy to assist others in their understanding of indexed insurance products.
Thank you.
Sheryl J. Moore
President and CEO
AnnuitySpecs.com
LifeSpecs.com
Advantage Group Associates, Inc.
(515) 262-2623 office
(515) 313-5799 cell
(515) 266-4689 fax
