June 13, 2006
TO: Jane Bryant Quinn
FROM: Mike Tripses. NAFA Chair
Re: “Capital Ideas” Newsweek May 29
NAFA appreciates the exposure you give the concept and the product in your “Capital Ideas” column in the May 29th issue of Newsweek. However we think your conclusion that, “you’d be smart to avoid” indexed annuities is abjectly poor advice and many of your “facts” are incorrect if not wholly misleading. You outline your article with four questions which we would like to help answer.
How does an equity-indexed annuity work?You state that an indexed annuity is “an investment product.” First and foremost, fixed declared rate and index annuities are NOT investments as defined by securities legislation and regulation or the SEC. They are insurance products that credit an interest rate that may be based on financial index values. The interest rate in an indexed interest strategy is calculated based on an objective index rather an interest rate declared by the company. As with all fixed annuities, they are highly regulated under state insurance laws. The value to a purchaser is a potentially higher interest rate, by allowing more variation in rate based on the indices but with the minimum guarantees of value required of fixed annuities.
You also statecorrectly that indexed annuities are a “different animal” than variable annuities but state that variable annuities are a product that promises safety combined with stock market growth and that indexed annuities have a “link to stocks [which] is murky.” Indexed annuities are NOT linked to stocks – murkily or otherwise. Interest earned in an indexed annuity is clearly based on the increase of a particular index, most commonly the S&P 500. Variable annuities, on the other hand are the epitome of risky securities where the full equity performance (up or down) is passed through to policyholders via a unit linked calculation out of each sub account of the separate account. Indexed interest in a fixed annuity is the true middle ground between declared interest annuities or accounts (no volatility, but no upside potential) and securities (upside potential, but volatile earnings or even losses). Indexed interest provides (some larger gain potential, with some volatility but no losses).
Some indexed annuities have more “complex formula(s)” but many are as simple as the annual point to point with cap, for example:
1. Take a beginning S&P500 index value of 1210 .08 (March 2nd, 2005) and ending index value one year later of 1291.24; the increase is 6.7%.
2. If the pre-declared cap for the year is 10%, the interest credit is 6.7%.
That’s it, not that complex. If the increase % had been greater than 10%, the interest credit would have been “capped out” at 10%. In most contracts, next years interest is calculated the same way with a new starting and ending index values and is credited to last years ending balance. The interest credit is not “vaguely connected” to the index; it is clearly and explicitly connected, but also it clearly is not the same as owning the equities. This is an understandable trade off to consumers given that there are no negative credits (“losses”) and in fact minimum guaranteed values which must grow in fixed annuities. Once again, a true “middle ground” concept. How is this “a complicated product” which “favor(s) the seller”?
What does it cost?Your claims “costs are both hidden and high”, and ranges from “7 percent to 15 percent”, are outlandishly incorrect. In fact, a recent published study of all products sold in 2005 show that less than 3.5% of all indexed annuities sold in 2005 paid over 10% commissions and almost 60% were less than 7%. If one compares asset fees of 1% or more charged each and every year for a mutual fund or an asset wrap account over the duration of financial plan against the 5% to 10% commission paid ONCE to the agent, a more realistic conclusion might be that the playing field of fees and commissions is remarkably level.
You admonish that expenses are deducted before the insurer credits you with interest. You are right, fixed annuities are “spread” products, but why is that bad for the consumer? They are no different than other insurance or investment products. What other spread products (certificate of deposit, non-indexed fixed annuities, bonds etc.) provide the itemized expenses for producing, selling and maintaining the product. Do you advocate that a “smart” consumer avoid purchasing CDs because the spread is not disclosed? As in any free market, the consumer chooses product based on the benefits the product provides and should match the product to his or her needs and desires.
What are the problems?You state that “you earn less than expected.” This would be true if a prospect is led to believe they will always achieve interest credits equal to 100% of a stock index increase but never any decrease. Few consumers are this economically illiterate. All company materials, which must comply with state insurance advertising laws, fully disclose the actual method of calculating the interest. Nearly all agent training and therefore agent presentations to clients reveal that in most cases the interest credit will be based on SOME of the index gain, but NO index loss. The proof of this is in the consumer complaints on indexed annuities, which are lower than either variable annuities or non-indexed fixed annuities.
Indexed annuities are insurance contracts that provideguarantees of principal, interest, payout options, as well as more liquidity than many other financial products. How many bank CDs allow full value to be paid out without interest penalty upon death, nursing home confinement, terminal illness, election of a lifetime income or upon a simple request for 10% of proceeds each year? In any case surrender charge lengths are available from 4 years and up.
What are the regulators doing?“You state that disclosure is spotty and enforcement uneven.” In reality indexed annuities are already heavily regulated and enforced by fifty state statutory reserve guidelines, minimum non-forfeiture laws, insurance company investment laws, GAAP reporting standards, and Actuarial Guideline 35. The marketing and sales of indexed annuities are also highly regulated by state insurance laws; including, comprehensive insurance trade practices provisions covering misleading presentations, false advertising, full disclosure, etc. NAFA supports such laws, which protect consumers from unethical and misleading sales practices.
In addition, the NAIC adopted the Consumer Protections in Annuity Transactions Model Law in 2003 covering senior citizens and will soon adopt an expansion to include consumers of every age. NAFA has sponsored meetings and information on this consumer protection law and its Board of Directors voted unanimously on March 2nd to support adoption and passage of the latest model.
In May 2006, the NASD and Minnesota Insurance Department held a joint Round Table and determined that it would establish working groups to address: suitability, disclosure, advertisements, and training to review any gaps and share best practices. Furthermore, the two states holding over 67% of the total premiums for indexed annuities require that those businesses domiciled in their state follow the model in ALL states in which they do business. Most importantly, insurers arevoluntarily requiring their agents and brokers to follow suitability standards because it is good for the customer and good for business.
NAFA believes that there are many financial and lifestyle choices to consider when purchasing an annuity and when choosing between annuity products. No one insurance, savings or investment product is right for all people all of the time. The advantage of a free market system is that more choices allow customers to target specific needs and meet specific goals. Your readers deserve to be toldthe facts about all their choices so that they can make the one that is right for them.
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NAFA is the National Association for Fixed Annuities.
NAFA was created to foster a better understanding of traditional, payout and indexed annuities.
It is the only independent, non-profit organization dedicated solely to the promotion and preservation of these unique products.
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