A letter in response to the article on FIAs, "Perfect Investment: Often a Trick, not a Treat"Article added by Steven Delaney on November 18, 2010
Steven Delaney

Steven Delaney

Chalfont, PA

Joined: November 15, 2007

Dear Humberto,

I am responding to your article, “Perfect Investment: Often a Trick, not a Treat.” You’re really not helping anyone by enlisting yourself as another journalist that provides misinformation when it comes to financial concerns, which is exactly what I consider this slant on fixed indexed annuities to be. People should be careful what they say and what they write about, and some may consider this article a form of negligence. I don’t understand why you have not taken the time to show the world how consumers who placed their nest egg in fixed indexed annuities (FIAs) did so well in the volatile market of the past 10 years. You would think the press would find the FIA to be unique, in that the client never participates in a down year, as in 2000, where the client was credited “a very safe ‘0’ rate of interest.” You would think the press would find it interesting that a down year would actually provide a new plateau for growth, allowing the consumer to participate in the recovery of the market index. One would think you would want to write about something positive, something evolutionary, rare and refreshing. The FIA is truly unique.

To say ''They should be outlawed as a fraud on the public,'' as you do in your article is absolutely absurd. Do you know how much money people have lost gambling in the share markets as per the advice of “financial advisers?” You and your contributors may have some misunderstandings relative to the spectrum of risk and return, and the benefits of life insurance relative to fixed indexed annuities. Your article spits out all kinds of information/misinformation; some of it is simply a description of how these products work. For example, “They don't invest directly in stocks, but combine fixed-income investments and derivatives such as options and swaps tied to an index. That's how they can promise preservation of principal or even a minimum return with the potential for higher gains.” True, but isn’t that a good thing? So what is your point?

Later, your article states, “’That's an enticing combination after the markets of the past 10 years,' said Robert Carlson, an investment adviser in Virginia with a middle-of-the-road view.”

Again, what is your point? Do you recollect the “lost decade” of 2000-2009? Are you saying a person would have been better off if they were invested in the stock market over the last 10 years vs. placing their savings in an insurance product that protected their principal and locked in their gains, also providing them the lifetime income so many economists point to as a saving grace for America’s retirees? In retrospect, wouldn’t a fixed indexed annuity have been a prudent choice compared with all other products found on our spectrum of risk and return? Yes, it would have been. Oh, unless that crystal ball of yours would have told you and all your experts exactly when to buy low and sell high, so you would have made money when most folks actually lost money in the stock market.
You also state, “’Although sales set a record of $30 billion in 2009 and are on a pace to top that amount this year, it's not unusual for investors to be unpleasantly surprised at returns,’ said Carlson, editor of the newsletter Retirement Watch.”

OK, two things here: 1) people never lost money when the stock market went down and 2) people made money when the stock market increased and they were credited interest to their account. Were people surprised when they saw their investment decrease by the amount their underlying securities decreased, plus the fees, costs, etc.? You appear to have an agenda, my friend, and you are providing misinformation to your readers, just like so many other talking heads who have not done their homework. Sorry, but that’s how it looks to many of us.

Continuing, you say, “As a rule, newer index annuities capture only a portion — sometimes a small portion — of the gains of an index.”

OK, that is all that is expected of them — moderation. This is a savings product; you are not stock picking, hoping to rip the cover off the ball and earn 20 percent and 30 percent returns. Such a return requires tremendous risk, that many Americans cannot afford to take, and shouldn’t have been taking.

Regarding compensation, you state: “Many sellers, who typically earn commissions from 5 percent to 9 percent or higher, gloss over this point.”

The bottom line is this: People should be aware that financial products pay commissions to the adviser, whether they are a fee-only planner, registered rep, broker, etc. Some pay 1 percent as a management fee on account balances to the adviser each and every year, but the consumer is also paying other costs relative to the particular investment vehicle (mutual fund, ETF, REIT, etc.). Annuity commissions may be paid up front, meaning only once, regardless of how long the annuity is held. People need to apply some common sense here. Longer term annuities pay a greater commission than shorter term annuities. However, the consumer receives a benefit in this regard; the more time you give an insurance company to work with your money and invest in the general account of the insurance company, the better the chance the client in turn may receive either a higher interest rate, a higher participation rate and/or cap, or a premium bonus.

You state, “Other drawbacks include lengthy surrender charges, some 15 years or longer, and the complexity of the formulas to credit returns.”

In this regard, insurance companies design products to benefit both the company and the client, and contracts do range in length from one to 16 years. All this is true, but this is a personal decision that may benefit some, and is why folks can choose amongst various products. How long do people hold on to the average mutual fund? Not that long, and they pay the price for jumping from one mutual fund to another, in terms of fees and loads, plus the taxation of turnover in the fund. People hang on to mutual funds for a long time — often longer than they should — exposing themselves to the ups and downs of the market, without proper management, causing these consumers to lose money. There are various reasons why a consumer may be perfectly comfortable with an annuity that has surrender charges which last for a period greater than six, seven, 10 or 12 years.
You report, ''’The return formula is the real trick,’ Carlson said, with more than 30 in existence. Formulas usually contain an annual ‘cap' no matter how high the index rises, and/or a 'participation rate,' or maximum percentage of the index gain to be credited, and/or a 'spread' subtracted from the index's return.”

OK, that is how they work; you get part of the upside and none of the downside. Are you not familiar with “slow and steady wins the race?” We are talking about a conservative place to keep your nest eggs — an insurance company!

You state: “Then there are several ways to calculate the return of the index, including 'point-to-point' and 'averaging' methods that can result in widely different numbers.”

First, the fixed indexed annuity with an annual reset crediting method is a simple product.If the S&P 500 index moves in a positive direction by 10 percent on an annual, point-to-point basis comparing day one with day 365 — and you had 100 percent participation with a 6 percent cap — you would be credited with a 6 percent interest credit to your account value. If the S&P 500 index moves in a positive direction by 18 percent, you would again receive 6 percent on your account. Simple.

If the S&P 500, to which the majority of FIAs are linked, were to fall 10 percent, the FIA credits a wonderful number — zero. But you would have a new lower plateau for growth, because the starting index resets at the lower index value, by which the consumer benefits greatly. If the S& P 500 were to fall by 33 percent, your annuity contract would not only credit the fabulous number zero, but you would have a new plateau for growth — and again, the consumer benefits greatly.

Second, with monthly averaging, the indexed interest is credited to this account by calculating the percentage change of the average of the 12 monthly values of the S&P 500 Index and the closing values on the same day each month. Add them up, divide by twelve, and compare them to the index value at the beginning of the year. Then, subtract the indexed interest spread, or apply a cap. Not really that difficult; not something that cannot be explained. It is fifth grade math. Again, if the result is zero or negative, the account will be credited at 0 percent that year, so there is no loss in your account.

Moving on, you state, “Annuity sellers like to cite a paper from the Wharton Financial Institutions Center, an independently managed site at the University of Pennsylvania, that found index annuities have provided 'competitive' returns. For five-year rolling periods, average annualized returns ranged from 9.19 percent in 1997-2002 (9.39 percent for the S&P 500) to 4.19 percent in 2004-2009 (S&P 500 lost 1.05 percent a year). Half the time, though, annuity returns averaged 4.69 percent or less.”

Notice that people made money and their nest egg was safe? Those are good numbers when everyone else lost money, right? What are you expecting from a product that provides minimum guarantees with an opportunity to earn more by crediting additional interest if the S&P 500 increases in a contract year? This is a savings product — technically an insurance product — it is not an investment. People can lose money with investments, and there is no market risk with the fixed indexed annuity. Don’t you get that? You are not supposed to earn double digit returns, but truth be told, fixed indexed annuity owners can with certain crediting strategies. In fact, they have earned returns approaching 20 percent or more. Did you know that? Those are not the returns one would/ should advertise or promote, but they do happen.
You go on to say, “Results were limited to 136 contracts from 15 companies that chose which products to submit, the paper said.”

OK, there was a survey, and all of the companies may not have responded. Call me and we can look at the past 20 years over various crediting methods, and you can see what the returns look like. They look like those stated. Point is, the survey is real, and the returns by those submitting data are real. Do you believe the professors, both credentialed, and the well-schooled economist involved, are trying to dupe the public? Really? The Wharton School would allow this sort of thing with an organization that bears their name?

“The person listed first among three authors (not in alphabetical order) is Jack Marrion, president of Advantage Compendium. Marrion is also the author of “Change Buyer Behavior and Sell More Annuities,” a book written to help 'close more annuity sales,’ according to the introduction.”

Not the devil, but an expert in the industry who collects data, and makes points that those less knowledgeable don’t, about the merits of annuities born by the statistics. Hey, you can call him for a contribution if you like, I’m pretty certain he speaks from the data.

Moving on, you state, “Roth and Swedroe said investors can build the equivalent of an index annuity by putting enough of their money in a certificate of deposit that will grow to the total principal amount at maturity, and the rest in a low-cost stock index fund.”

No, they can’t. They cannot lock in gains, and they provide no opportunity for the living benefits, the guaranteed withdrawal benefits or annuitization.

“Even if the fund goes to zero, they'll get their original principal back.”

Yes, but where is the minimum guarantee interest provided by fixed indexed annuities? Where is the access to their entire account value, plus locked-in gains in terms of liquidity, provided by the fixed indexed annuity?

“Any long-term stock gains will be taxed at a lower rate than the annuity interest, and they will earn stock dividends.”

You are assuming you have gains in the stock index fund, but you may or you may not, right? And what if you need access to your money in a down market? Are you beginning to see the problem with your assumptions, your contentions and the experts you cite?

Savings and investments; those are your choices along the spectrum of risk and return. So, unless you have a crystal ball, you may be dispensing dangerous information in your articles — especially if your advice results in driving people to investments who should not be involved with them. Perhaps many of your readers cannot really afford to take the risk, or they describe themselves as conservative or as one who does not want to expose their savings to the share markets — to stock market risk — which is where you and your experts are shepherding folks.
In order to understand the spectrum of risk and return combined with life insurance principles that provide the guaranteed income for life, you need to be cognizant of the fact that insurance companies reserve for their future obligations. With mutual funds, variable annuities and stock portfolios, no reserving is done to protect consumers’ principal, because these consumers are involved in speculation/gambling — fine if you have the discretionary dollars, the ability to actually accept the risk of the stock market, plus all of the fees.

You really need to consider the efficiencies and the leverage that consumers benefit from when they are able to take advantage of life insurance and actuarial pooling concepts such as life expectancy tables. Life expectancy tables provide the risk free part of the equation here, enabling the consumer to get financially sound leverage. Some people die young, some live to age 100 or more, and some people die right at the average life expectancy. Then you must figure in lapse ratios, where people will walk away with their account values and not exercise their guaranteed withdrawal benefit. Or, if the consumer does opt for lifelong income, they have an option (liquidity), they may change their mind in ensuing years and, again, walk away with their account values. I trust that the average consumer may not have a handle on these issues, and this obviously eludes many financial advisers, as well. If you had a handle on this material, you probably would not have written the article.

Consider, a consumer allows the cost of managed money or variable annuities to siphon off the money that would be available to them in terms of free 10 percent withdrawals or a lump sum walk-away value. Later, they will ask their adviser why they allowed them to participate in both the ups and downs of the share markets, and simultaneously pay ridiculous costs, which can be in excess of 3 percent. The other fact of the matter is this: Relative to variable annuities with living benefits, people don't have the upside potential they think they have. This is because the variable annuity companies customarily require a forced asset allocation into stocks and bonds, limiting the upside potential the clients believed they have, but in reality, don’t.

In terms of stock market returns, consider a historical perspective. You could look at the past 100 years in the stock market as a reference for pondering future performance if you like. However, that may not be very helpful as we know past performance is no predictor of future performance. In the 2001 book, “Millennium Book II: 101 Years of Investment Returns,” Elroy Dimson and Paul Marsh report that the U.S. stock market returned an inflation adjusted 6.7 percent.

Not bad, but consider a couple of points: a) that money is not typically invested for 101 straight years, as people need to use their savings and investments during their lifetime, and b) timing, relative to "buying when the price of stocks are low and selling when the price of stocks is high." Your "market timing" (when you decide to buy and sell securities), may work out for you, or it may not. Also, this 6.7 percent figure is a numerical change in the value of stocks. It does not take into consideration frictional costs, which are the charges associated with investments, such as bid- ask spreads, management, distribution and/ or transaction fees. Finally, it does not
Below is a bit of information you may find interesting, relative to a historical look back at the ups and downs of the stock market.
  • Consider the fact that the great Bear Market of 1929 to 1933 wiped out all of the gains since 1901.
  • Consider that on February 9, 1966, the Dow Jones Industrial Average peaked at 966.
  • The DJIA index didn't reach 1000 until six and a half years later, on November 14, 1972.
  • Two years later, the Dow closed at 577.
  • The Bear Market of 1973 and 1974 wiped out the gains of the 1960s.
  • The DJIA index didn't reach 1000 again until 1982.
Your readers come from different life experiences, different investment experiences, and perhaps, different recollections of what actually transpired in the stock market over the last 20 years. Therefore, it would be helpful to look back at what actually transpired.

• During the 1990s, it seems as if everyone made money in the stock market, as there were only two modest negative returns. Eight years were positive and six years provided double digit returns: -6.5 percent, 26.31 percent, 4.46 percent, 7.06 percent, -1.54 percent, 34.11 percent, 20.26 percent, 31.01 percent, 26.67 percent, 19.53 percent.

• In the three short years to follow — 2000, 2001, and 2002 — you saw returns of -10.14 percent, -13.04 percent, and -23.37 percent, thereby giving back 47 percent of your money, plus fees, if you were invested in the S&P 500, or similar securities.

• If investors got upset with those three years, and decided to take their money out of the stock market, they would have missed a positive 26.38 percent uptick in 2003.
• The years that followed produced returns of 8.99 percent, then 3 percent, 13.62 percent, 3.53 percent, and then, wham — a -38.49 percent in 2008.

• If "investors" got upset and/or paralyzed again, and decided to take their money out of the stock market, they would have missed a positive 23.45 percent return in 2009.

• The lost decade, 2000 through 2010, started with the Dow Jones Industrial hovering around 10,000. In September of 2010, 10 years later, it is still hovering around 10,000.

• Consider that an investment in the numerical value of the benchmark index S&P 500 on January 1, 2000 (allowing for dividends and investment cost to cancel each other out) would leave you with approximately 75 percent of your original investment 10 years later, but this is only if you remained "invested". If you got upset and got out of the market just before the returns of 2003 and/or 2009, the returns would be worse than that.

If you just look at the last 10 years and assume a conservative 6.5 percent cap annual reset design — in some years the caps were 10 percent, 9 percent,8 percent,7 percent etc. — you would have 137 percent of your original principal, and that is without any form of premium bonus applied to many policy holders; in fact, bonuses as high as 10 percent. Such a premium bonus, combined with the 6.5 percent cap example, would result in the consumer having 151 percent of their original premium. Those who decided indexed annuities were not appropriate for their clients should feel remorseful, because their obstinacy, ignorance and bias resulted in real losses on their client’s account statements that may or may not come back in time for the client.

Those financial advisers who examined and included the fixed-indexed annuity into their portfolio of available products served their practice, and their clients’ nest eggs, very well.

FIAs are tied to major stock market indexes such as the S&P 500, and not to the performance of individual stocks or mutual funds, allowing the insurance company to reserve for and provide complete safety of principal, plus minimum interest rate guarantees. FIAs are fixed financial products. They are not securities products. Fixed indexed annuities are an excellent alternative savings vehicle, a choice for people who are planning to retire, or who are already retired. So, if you are planning to retire someday, and you need to protect your nest egg and have guaranteed income, it is not a matter of “if” you will utilize income annuities, fixed annuities or fixed indexed annuities, but perhaps a question of how much of your nest egg you may place in an annuity. Note that I did not mention variable annuities,
Again, not only is there zero market-risk associated with fixed indexed annuities, but when the market goes up and you have a gain in your account, your gain is locked-in and yours to keep. It cannot be taken away, so you cannot lose your principal, or your gain (assuming you remain in the contract for the full surrender charge period, which ranges from four years to 16 years).

Fixed indexed annuities provide the consumer with zero market-risk, with the potential for moderate returns. They appear in the middle of our spectrum of risk and return. They provide a rate of return expected to be greater than that of many fixed products, but less than many market sensitive products. The market-risk associated with FIAs is still zero. Only fixed-indexed annuities can do this.

Now, I am going to tell you three things that you need to remember or consider with fixed indexed annuities: 1) Safety of principal — and as a bonus, consider that all of one’s gains are locked-in annually as well, and are also protected from any future market downturns, 2) Excellent liquidity, and 3) guaranteed income you cannot out live.

Let me elaborate on the liquidity issue: Most annuities provide a 10 percent free withdrawal each year. With long term care needs and terminal illness scenarios, you can often access your money, all of it, with no surrender charges, or receive it over x number of years. Point is, consumers have a known, vs. an unknown charge relative to liquidity, when you are talking about annuities (because of disclosed surrender charges) vs. stocks and/or bonds (where consumers are subject to market values), as the stock market goes up and down. Considering the reality of stock market returns and consumer behavior combined with timing concerns, one could lose substantial amounts of their principal if one’s nest egg is parked in market sensitive investments.

In closing, if your recommended financial product of choice provides safety of principal, locks-in annual interest credits, provides greater guaranteed income than one could obtain in any other financial product, and at the same time provides excellent liquidity, you have found a product that mirrors the benefits of a fixed-indexed annuity. If you have any questions you can send me an email. Thank you very much.

Sincerely,
Steven Delaney
President American Annuity Advocates
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