Top 10 Indexed Annuity Misconceptions
June 7, 2011 –Negative and inaccurate publicity on indexed annuities seems to overshadow the product’s value at times. It is frustrating to see how hard it is for consumers to find accurate and reliable information on these products. I have spent the past four years personally responding to, and correcting, every published piece of misinformation on indexed insurance products. For these reasons, I thought it appropriate to list the “Top 10 Indexed Annuity Misconceptions.”
10. All indexed annuities have high surrender charges: Actually, more than 75 percent of indexed annuities sold had a 10-year surrender charge or less as of the first quarter of this year. Although there is an indexed annuity with 16-year surrender charge, no one seems to mention that there are also indexed annuities with surrender charges as short as three years.
9. All indexed annuities have big bonuses: Not so. In fact, about four out of 10 indexed annuities have no premium bonus at all. Admittedly, most of the advertisements that we see on indexed annuities are for big bonus products. But what is more enticing than seeing how you can “Earn 10 percent while your client gets a 25 percent bonus”? It’s a great teaser, but can it close the sale? In truth, more than 75 percent of indexed annuities have less than a double-digit bonus; and as of the first quarter, more than 30 percent of all indexed annuities sold had only a 5 percent premium bonus on them.
8. All indexed annuities have high commissions: In reality, the average street level commission received by the agent selling an indexed annuity as of the first quarter was 6.65 percent of premium. There is a company that pays a commission as high as 12 percent on their product, but keep in mind that there are indexed annuities paying commissions as low as 2 percent as well. One must take into context that indexed annuity commissions are even lower for older-aged purchasers and that this commission is paid one time (at point-of-sale), in exchange for servicing the contract for the entire term. So, keep that in consideration the next time some advisor points out how “high” indexed annuity commissions are, as compared to the measly 1.5 percent commission that he is paid on the mutual funds he sells (never mind that his commission is paid every single year the fund is in force!).
7. Indexed annuities are illiquid: False. Only five of the 260 indexed annuities available today offer less than 10 percent penalty-free withdrawals annually (and sales of these five products are nominal). Every other product offers 10 percent withdrawals of the annuity’s value, penalty-free and some indexed annuities allow as much as 50 percent to be withdrawn in a single year! More than one third of products available today allow penalty-free withdrawals as early as the first year, in fact. In addition, 94 percent of indexed annuities available today have some sort of surrender charge waiver, allowing the client access to their funds without penalty, such as in the event of nursing home confinement, disability, terminal illness and even unemployment. Compounding these attractive options is the fact that every indexed annuity available today pays at leastthe full account value on death. That is pretty darn liquid for a retirement income product, if you ask me!
6. Indexed annuities have countless consumer complaints: This misconception stems from a statement that was frequently made by a securities regulator back in 2005. “Thirty-four percent of all cases of senior exploitation involve variable or equity-index annuities,” he said. In an independent review of closed consumer complaints from the National Association of Insurance Commissioner’s (NAIC’s) database, I found that all 41 insurers in the indexed annuity market had a total of 79 complaints for 2011 (an average of just under two complaints each). Complaints ranged from zero to 30 with any single carrier. Now certainly, we do strive for 100 percent customer satisfaction in the insurance market, but I would hardly call two complaints per year “countless.”
5. Indexed annuities cause lawsuits:A review of 44 class action lawsuits in the insurance industry from 2002-2010 revealed some interesting data on this issue. The average policyholder benefit for being “harmed” was a receipt of the premiums paid accumulated at 4.15 percent interest. Insurance company payouts, on the other hand, were as high as $22 million for these class action settlements. But it was the lawyers who made out like bandits in the end. The average lawyer’s benefit in these class actions was $6.4 million. I am certainly no expert on this matter, but the data seems to correlate well to lawyers causing lawsuits rather than any insurance product.
4. Indexed annuities are inferior due to their exclusion of dividends in their calculations: Actually, the insurance company never receives the benefit of dividends on the index with 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 it would also expose the purchaser to risk, should the market decline. For this reason, the dividends cannot be passed-on to the purchaser 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, by trading the opportunity to receive dividends, the indexed annuity purchaser doesn’t risk losing their money as a result of market volatility. Not too bad, if you ask me.
3. Indexed annuity rates are unattractive: All rates are paltry right now. Certificate of deposit (CD) rates are averaging a mere 0.90 percent today. Fixed annuities aren’t much better at an average 3.41 percent first-year rate, declining to 2.41 percent thereafter. And yes, the average annual point-to-point cap today is only 4.11 percent. However, that is still much more attractive than sticking the money under the mattress or other purchasing alternative retirement vehicles that don’t offer tax deferral. Given the choice, I’d still take a short-term indexed annuity, thank you.
2. Indexed annuities don’t perform: WRONG! For more than a decade, I have been collecting actual indexed annuity policyholder’s annual statements (redacted) from insurance agents. Today, I have tons of statements, representing numerous companies and products. Some of my own indexed annuities have statements showing gains as low as 0% in a single year. However, I also have examples of other people’s indexed annuities that have received gains as high as 47.65 percent on indexed strategies over a one-year period. Amazing, huh? Now, is this how indexed annuities are intended to perform? No.However, sometimes you cannot predict “home runs.”
1. Indexed annuities are complex: When you get past all of the misinformation and hype, indexed annuities are just fixed annuities with a different way of crediting interest. It’s that simple.
Sheryl Moore is President and CEO of AnnuitySpecs.com, an indexed product resource in Des Moines. She has over a decade of experience working with indexed products, and provides competitive intelligence, market research, product development, consulting services and insight to select financial services companies.