The mechanics of fixed indexed annuities, Pt. 1: The history and current industry status
By Randy Timm
This article is the first in a series that will describe fixed indexed annuities and how they work. This article (and each consecutive article in the series) assumes that the reader has a general understanding of annuities.
History of fixed indexed annuities
The first annuity of this type was issued February 1995 in the U.S. by Keyport Life, now part of SunLife of Canada. When first introduced, the industry referred to these products as equity index annuities. However, within the last five to six years, the industry has stopped calling these annuities equity index annuities in favor of fixed indexed annuities (FIA). This terminology is a more appropriate descriptor of these products and their core attributes.
Since 1997, sales of fixed indexed annuities have grown ten-fold, with over $30 billion dollars in sales in 2009. In fact, almost 28 percent of all fixed annuity sales in 2009 were fixed indexed annuities. The chart below illustrates this growth. Source: LIMRA and AnnuitySpecs.com
The lost decade
In simple terms, the "lost decade" is the time period between December 31, 1999 and December 31, 2009 in which the U.S. stock markets experienced a negative return. This "lost decade" created an issue for many Americans who experienced a substantial decline of their principal.
Now, many Americans are more concerned about the preservation of their retirement dollars, not just their retirement dollars' growth. This preservation is increasingly important as Americans approach retirement age, or the time when they need to start taking income from those dollars.
The hypothetical chart below illustrates the difference in accumulation between $100,000 in premium invested in the stock market and $100,000 in premium deposited in a fixed indexed annuity on December 31, 1999. Each account is assumed to accumulate for 10 years and is compared using the most popular index for fixed indexed annuities, the S&P 500. Please note: The index does not include the value of any dividends paid.
As the chart shows, the index was down four out of 10 years in the past decade. The ending balance for the money invested in the stock market is $75,893, while the ending balance for the fixed indexed annuity (with a 6 percent annual cap) is nearly 80 percent higher, at $134,627. The fixed indexed annuity was not affected by the negative dips in the index. Instead, these dollars were protected because in the negative years, zero interest was credited.
FIA values assume a 6% annual cap for period 12/31/1999 - 12/31/2009
Taking income from an account that is not protected from market loss can have adverse side effects at the time the income is needed most. To help protect the income potential of an annuity, many consumers add optional income riders. For more information about income riders, please refer to my earlier article series entitled "Anatomy of a Fixed Annuity Income Rider". Current industry status of fixed indexed annuities
As I am sure many of you know, fixed indexed annuities have been the topic of recent national debate. Approximately two years ago, the Securities and Exchange Commission (SEC) proposed Rule 151A, which classified fixed indexed annuities as securities. Within hours of the Rule becoming final, certain insurance carriers and marketing organizations filed an action against the SEC seeking to nullify Rule 151A. On July 12, 2010 the United States Court of Appeals for the District of Columbia Circuit vacated the Rule. Later that week, the Senate voted in favor of the new Financial Services Regulation Bill that contained the Restoring American Financial Stability Conference Amendment which, so long as certain requirements are met, provides that fixed indexed annuities are insurance products to be regulated by the state. This Bill was signed into law by the President on July 21, 2010.
Fixed indexed annuities remain classified as a fixed insurance product and do not require a securities license for sale. However, if the potential sale involves transferring money from a security, the recommendation could be classified as "investment advice." A producer is required to hold a securities license to make such recommendations. Producers should continue to seek competent legal advice on what constitutes "investment advice" in all states they do business in, and to seek competent legal advice on the licenses or registrations required to conduct that business.
Stay tuned for the next part of this series, "Mechanics of Fixed Indexed Annuities." If you need help finding the appropriate product solution for your next client, please contact me using the forum below. Sign up as a fan and you'll automatically receive future articles from my Annuity Notebook.
This article is not intended to give tax or legal advice and is for general educational purposes only. It does not give investment advice. This article is for agent use only. Features and/or riders may not be available in all states or with all insurance carriers and may vary from state to state. Please check the product/rider disclosures and policy for actual terms and conditions. You are encouraged to seek independent legal and/or professional tax advice depending on your client's individual circumstances.
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