Why five-year FIA reset products are dumb and dumber right now
By Kevin Startt
It's an excellent time right now to encourage caution, communicate with clients and go over the reasons why their stock- or bond-linked indexed annuities are up and why the commodity-driven indexed product is way down.
The toughest job in the world has got to be selling door bells and doors door-to-door. Can you imagine ringing the door bell at each house in the neighborhood and asking, "Can I interest you in a door or bell?" and realizing that, shoot, they already have one?
That's kind of the way one feels when they realize that Einstein's definition of insanity holds true with anyone considering an uncapped five-year FIA reset product today. Insanity is defined as doing the same thing over and over. Investors are, again, not learning, and they're making the same mistakes. Another five-year uncapped product was released recently with a spread that was greater than the illustrated returns. If the indexed annuity ever wants to achieve the success of the mutual fund industry in the 1980s and 1990s and exchange traded funds in the 2000s, distributors must realize that the typical fund investor or even variable annuity investor will not pay more in annual spreads than the product has yielded.
Secondly, they will probably not do that with interest rates at all-time lows and with the Dow at an all-time high, even with 10 percent annual liquidity. The contrarian argument might be that the market has been up better than 60 percent of the time over a five-year period, but savers and investors remember that the last two downturns occurred in their lifetime and are part of the 40 percent of time the market was down over a five-year period. Or do they? Certainly, recent equity fund flows are showing a great rotation from risk off to risk on, but whether they show a long-term trend or not will be confirmed in the spring when previous rallies have gone off track. The smart money is exiting the market, including the revelation recently that many hedge funds and private equity funds are bailing as they recognize one of two facts: 1) The unprecedented government intervention is making the late FDR and John Maynard Keynes blush and will result in higher inflation, and 2) interest rates are crushing stocks.
Right now, the QE2 is on steroids, feeding $82 billion in Treasury purchases by the Fed each month, releasing the power for businesses and individuals to spend or invest, and no one is responding. The above institutions and company insiders are hoarding cash or paying out dividends, rather than adding jobs and investing. The disconnect between the economy, wage growth and the stock market is unprecedented and a facade. The Fed is forcing individuals into taking more risk in stocks and alternatives. So, the question remains: Why not buy a good, uncapped five-year point-to-point indexed annuity with a generous income rider? Here are the reasons, beside the facts that individual investors are lagging indicators of market performance and the market is not cheap by historical standards:
1. 2000 or 2009 would have been the time to pioneer these products, yet the annuity industry is notorious for creating products based on past performance. How many VAs or FIAs contained a commodity or real estate option in 2000 at the outset of a raging 12-year bull market for commodities? The answer is three out of 60 sponsors.
2. The market, as measured by the S&P 500, is near an all-time high, and history teaches us about sequence risk and buying high, selling low and losing money. Most investors are still upside down in their variable annuities, according to Morningstar, and are holding out for the death benefit. This is my favorite oxymoron for a product that is supposed to provide a lifetime of safe income, not help one die with dignity and dispose of wealth to the kids. 3. Stocks are selling at a PE multiple of 15.8 based on this year's earnings and have not gotten back to their inflation adjusted levels since 2000. The media pundits like to point out we are hitting all-time highs, but when inflation is considered, we are nowhere near an all-time high when inflation's bite is considered. It took investors during the Great Depression of the 1930s until 1954 to break even on price and until the 1990s when taxes and inflation are considered. Most folks don't have 60 years to break even, unless you're 115-year-old Misao Okawa in Japan and can afford to sit out a massive rebound.
A great number of suckers involved the indexed annuity's most popular product this past year that is down 12 percent in its first year and requires greater than a 15 percent return net of fees to break even. The sad part of the equation is that this indexed product is being used as a core holding in a clients' safe money portfolio to replace CD money, rather than as a supplement to improve diversification in a laddered-income annuity portfolio.
With a multiple of 15.8, the market has only performed at a 6 percent average annual return in the subsequent 10-year party. Put the confetti away, as the party has been crashed already.
4. Smart Money advocates who have been very accurate in past downturns are turning the alarm sirens on with a vengeance, like Nouriel Roubini, who sees an increased risk of economic civil war in Europe between rich Northern European countries like German and the austere, entitlement-ridden southern countries like Greece and Spain.
So in conclusion, the opportunities for indexed annuities and income riders is bright, but with the market at an all-time high in nominal terms, keeping maturities short and expectations modest should rule an advisor's plans as their ladder or bucket annuities, regardless of whether they are variable or fixed.
It's an excellent time right now to encourage caution, communicate with clients and go over the reasons why their stock- or bond-linked indexed annuities are up and why the commodity-driven indexed product is way down. The seesaw is working, but clients will always pay attention to the down side of the saw and what they see on their statements. Be proactive in your reviews, and keep it short, simple, safe and stable.