Why Should Agents Sell Index Annuities?    1/98        
You have customers asking for the product. Although I have not conducted a formal survey I’m getting a lot of anecdotal evidence that customers are asking their agent or planner about buying index annuities. Why? They appeal to the risk averse prospect. If you don’t sell them an index annuity they’ll go down the street.

Protect clients from themselves. People have made a lot of money in the last few years. While I believe in the long term strength of the market I also believe it will go down. If you look at five year holding periods of the S&P 500 you find that roughly 20% of the time the index was lower at the end of five years than where it started - with an average loss of 25%. Clients should take some of today’s gain and place it in a vehicle without market risk.

It’s a simple concept with the right product. A point-to-point annuity structure is a simple story, "If the market is up at the end of the term you get part of the gain, if it’s down we’ll give you your money back and a little interest".

Protect the agent from clients. Some people should not be in the market, but they feel they’re missing out. Index annuities give them potential without market risk to principal.

To wrap this up, index annuities are a rapidly growing segment of the annuity market. Many of them offer a realistic chance of significantly beating the returns of traditional savings vehicles and we have consumers asking where to buy the product. 

1997 Equity Index Sales Over $3 Billion    2/98      
The Advantage Equity Index Sales Report shows that over $3 billion of index annuities was sold in1997. Thirty seven companies were surveyed with only Physicians Life and Safeco declining to participate.  Leaders in annual index sales were Keyport Life, Jackson National and Conseco. The combined market share of the top five carriers was 70.5% of total premium.

Annuities using annual reset structures captured the largest percentage of sales as did products with seven year surrender periods. Sales by distribution channel showed 77.3% of sales were contributed by independent agents with financial institutions accounting for 16.3% of sales and broker/dealers representing 6.5% of sales.

Index Annuity Performance - 1997    2/98       
For calendar year 1997 the S&P 500 posted a gain of 31.0%. The interest credited to an index annuity depends on the movement of the index, the crediting method, and the participation rate applied. Based on the average participation rates in effect one year ago, the following annuity structures would have realized these returns in 1997.

The annual reset structures locks in the interest once credited. The final interest credited to a term end point ignores index movements during the term, however, most index policies base the death benefit on the last anniversary index value.

1997 was a remarkable year for equity markets. If you compare the gain on the index annuities with the average yield on a certificate of deposit the innuities delivered the equivalent of three to four years CD interest in a single year.

Hypothetical Index Returns - Which Past Do You Use?    2/98       
Depending on the actual movements of the index, the crediting structure utilized and the participation rate applied any methodology may result in the highest return for any given period. Generally in a rising market the point-to-point, high point term or term yield spread structures result in higher returns than other structures. In choppy markets annual reset and averaged annual reset structures perform better. In a prolonged bear market no index annuity will produce a high return.

Our analysis applies current participation rates to past index movements. It cannot be used to predict future movements nor should it be used to state exact returns in the past. Actual participation rates are determined by option prices, the yields that can be earned on the insurance company’s investment portfolio, the composition of that portfolio, the net investment income and expenses of the insurance company, and management’s decision relating to the setting of the rate. Past participation rates would have been higher for some past periods and lower for others. Due to all of the variables involved, we do not believe you can predict what historical participation rates might have been.

Any hypothetical modeling has a bias, including ours. The returns for the periods are not truly independent because one period will include returns from a previous or subsequent period. Because there have been more rising periods than falling periods in the last fifty years, our analysis has higher hypothetical returns for structures that perform better in rising markets.  Finally, we calculate returns based on current participation rates. Many structures may change their rates yearly which would produce higher or lower returns than we have shown. While these hypothetical returns do not reflect actual returns, we believe they can aid in an examination of the relative hypothetical performance of the annuities.

We use a fifty calendar year period as a basis for examination. Would the specific hypothetical returns change if you use different days of the year or shorter timeframes? Absolutely. However, given a sufficient timeframe the relative returns and distributions should remain similar.

Let's examine three index annuity methodologies. We'll look at seven year periods, base crediting on calendar year movements of the S&P 500, base the minimum guaranteed return on 3% interest compounding on 90% of premium, and set the participation rates so that each methodology produces the same Mean return for the entire fifty year period.  This would require the term end point structure to use a 71% rate, the annual reset point-to-point would have a 75% rate with a 12% cap, and the monthly average would have a 92% rate.

First, we'll look at hypothetical distributions based on seven year periods for the last 50 years.

There are 45 seven year periods within the last 50 years. The term end point produced a 10% or higher annual return for 15.6% of the periods. In other words, for seven of the periods (45 x 15.6% = 7) the annual returns were 15.6%.  In nine of the periods (45 x 20% = 9) the term end point produced annual returns between 8% and 9.99%. The same calculations were conducted for all three crediting methods.  Now let's look apply the same participation rates to a thirty year period.

While the specific numbers changed, the overall distribution pattern of the returns for the 30 year period was similar to the 50 year period.  The point-to-point with cap still had the fewest periods producing a return under 5% a year; the term end point still generated more periods with returns over 10% a year.  Even though the individual percentages changed the overall relationships were relatively constant.

"Customized" periods with shorter time frames may not reflect realistic hypothetical performance.  These are the distributions if you plug in the rates over the last fifteen years.

Based on this example, you'd probably want the term end point structure. However, let's look at a different fifteen year period.

If you assume this timeframe will be representative of the future you'd probably select the annual reset methods. However, the data derived by "cherry picking" your periods may give a distorted view of the actual return parameters. If you look at hypothetical returns it's important to use a period that includes a variety of market conditions. 

Balancing Client Expectations    3/98       
Index annuities offer customers a long term savings vehicle with the potential for a higher return than they might realize from other conservative alternatives.  However, equity indexed annuities are not equity investments nor are they an index mutual fund. No index annuity realizes gains from reinvested dividends and capital gains.  But in a falling market, no index fund provides the protection of principal realized with an index annuity.

A balance picture of the strengths and weaknesses of an index annuity needs to be presented. You could say that an index annuity, unlike a mutual fund, preserves the principal if the market declines, but you should also say that the index annuity does not have the same upside potential of a fund.  You could say that an index annuity has the potential for higher interest than a CD, but you also need to state that the return could be as low as the minimum guarantee.

Balancing language needs to disclose the positives and negatives of both index annuities and the interest crediting structures and product features. For example, it is fair to say that averaging methodologies eliminate the risk of locking in a period's lowest value, however you also need to say that averaging prevents you from getting the highest value as well.  Index annuities can be a solution to a wide array of financial concerns, balancing language creates realistic customer expectations.

Consumers Want Index Annuities    3/98        
A financial writer for The Washington Post recently interviewed me for an article on index annuities and I received over fifty calls from consumers interested in index annuities. While I was somewhat surprised by the number of calls I was even more surprised by the comments of the callers.

 The callers told me that they were afraid of the stock market, but were unhappy about the return they were getting on fixed rate investments. They said they were willing to forgo some of the potential upside of the market if their principal was protected from market risk. What I found interesting was that none of these people had ever been approached about buying an index annuity.

The consumers told me that the reason they like index annuities is because they offer safety of principal from market risk. What consumers are saying to me is that they see index annuities as savings vehicles offering higher interest potential.

Every time I talk with agents about indexed annuities they want to know about the high return potential. They’ll talk about using index annuities as an alternative to mutual funds and focus on the possibility of double digit returns. The message that the agents are sending out to their customers is that index annuities are growth vehicles offering protection of principal.

There’s a breakdown in communication. It’s kind of like the customer is saying that they want a car with ABS brakes, air bags and reinforced bumpers, and the agent responds by showing them the turbo-charged engine and the speedometer that tops out at 140. Agents are missing most of the prospects for index annuities because they’re targeting cautious investors instead of risk averse savers and stressing performance over safety.

Index Annuities Instead Of Split-Funded Investing    3/98       
Split funded investing is a way to protect a principal sum while allocating funds to a potentially higher risk/higher return investment. A portion of the principal is placed in a fixed interest account and the remaining principal is invested in the higher risk vehicle. The premise is that the earnings on the fixed account will leave at least the original principal available regardless of the performance of the risky investment.

Say that you had $100,000 and found a vehicle that would guarantee a 6% return for seven years. An initial investment of $66,500 in this fixed investment would have an accumulated value equal to $100,000 at the end of seven years.  The remaining $33,500 could be placed in mutual funds, stocks or Mongolian oil futures. Even if the riskier investment went bust, the fixed account would still have a value equal to the original principal. If the risky investment doubled the investor would have $167,000 at the end of the period - $100,000 from the fixed account and $67,000 from the higher risk investment. Split-funded investing is for a cautious investor needing to preserve principal, but still desiring growth.

Index Annuity
The same need can be met with an index annuity. Say that the annuity guaranteed a minimum return on either 90% or 100% of the premium. The minimum guaranteed return would be either 110.69% or 122.99% of the premium by the end of the seventh year even if the index declined.  Unlike the split-funded strategy the entire index account participates in the index movement.  If the methodology of the index doubled and the annuity's participation rate was even 70% the original $100,000 is would grow to $170,000.

If the index goes up the index annuity provides a competitive return. If the market goes down the index annuity leaves the consumer with significantly more money than with the split-funded strategy.  

Banks Are Losing IRAs    4/98        
According to a study conducted by KPMG Peat Marwick in the last ten years ending in 1995 the financial institution share of the IRA market fell from 61% to 21%. The big winners were mutual funds and self-directed IRAs. The insurance industry's slice of the market remained at 8%.

The main reason for the banks' declining market share is the spectacular rise of the stock market, but it isn't the only reason. Consumers are becoming more sophisticated about their options. Banks need to quit selling IRAs and begin offering retirement solutions.

Index Annuity Buyer's Guide    4/98       
The NAIC Buyer's Guide To Equity Indexed Annuities does a satisfactory job of explaining what index annuities are, the different crediting methods and general features and benefits. The guide explains what the annuity is and provides a list of questions that a consumer should consider asking. A consumer reading the guide would gain a basic understanding of index annuities.

The guide is a good first step in working with a customer and should be followed up with a detailed presentation of the specific features of the annuity under consideration. The guide provides useful information that will be helpful in presenting a balanced picture.

Some Agents Still Confused Over Methodologies    5/98        
For a product that barely existed three years ago agents have done an excellent job of understanding, in general, how index annuities work. However, there is one area that still confuses some agents.

Some agents use participation rates to determine whether one annuity will provide a better return than another.  Participation rates are useful in comparing policies with identical crediting structures, but using these rates to compare annuities with different structures is misleading at best. Different structures perform differently in different markets.

A policy with a 50% participation rate using one structure could well produce a higher return than an annuity with a 90% rate and a different structure. The wide array of structures makes it impossible to compare index annuities solely by using the respective participation rates.

Awaiting The SEC Decision On Equity Index Products    5/98   
Last year the SEC issued a Request For Comments (Release No. 33-7438, File No. S7-22-97) to determine if indexed insurance products should be registered as securities.  The strongest response desiring the securities registration of these products came, not unexpectedly, from the NASD. The NASD position appears to be that unless regulations specifically say that something is not a security, it must be a security and a potential revenue source for the NASD.  You may remember NASD made a similar grab a decade ago to classify excess interest life insurance as securities - they failed.

Insurance products are not subject to SEC registration if they meet three "safe harbor" guidelines under Rule 151. The first requirement is that the product be issued by a corporation subject to the supervision of a state insurance commissioner. All index products are issued by companies subject to state insurance regulation and registration.

The second guideline is that the insurance company assumes the investment risk - not the customer. Unlike variable annuities and variable life contracts an index annuity guarantees a minimum annual return and guarantees that once interest is credited it cannot be lost, even if the index declines.

In addition to the minimum interest rate an index product may credit additional interest beyond the minimum guarantee. All fixed annuities may credit excess interest above the minimum guarantee. Whether this excess interest is derived from the net investment income of the insurer’s portfolio or from the net income attributed to an index is immaterial. The insurance company still assumes the investment risk.

The third requirement is that the annuity is not marketed primarily as an investment. Index products are not "index funds with principal protection". Index annuity buyers do not have any direct or indirect ownership of any security or index.

I believe the SEC will not require securities registration for index products.  Index annuities are fixed annuities.

The Cycle Of Hope, Fear & Greed    6/98       
There is an investor’s cycle of hope, fear and greed. All markets revolve around a circle. Over time a market will rise in value then fall in value, then rise and fall again. It is an ongoing cycle and the only variable is the amount of time needed to complete the circle. Ideally, one would buy and the bottom of the circle and sell at the top, but typical investors are guided by emotion and not facts when making investment decisions.

After the market has risen and is near the top the greed emotion takes over and investors begin to buy. After the market has peaked and begins to decline the investor continues to buy because they hope the market will rise again. After the market has bottomed out and started rising the typical investor sells out and sits on the sidelines because of the fear that the market will again fall.

This pattern is repeated in market cycle after market cycle. Index annuities appeal to the fear part of the psyche.  Equity index annuities can be used to overcome this aversion to risk by providing the potential for higher returns than traditional savings vehicles without market risk to principal. They’re an ideal bridge for a customer that has never invested in the stock market because of the fear of loss, but wants the potential for a higher return than they’re earning on other saving instruments.

Fixed Annuity Competitive Advantages    6/98  
It’s a difficult time for traditional fixed annuities. Falling interest rates and an inverted yield curve are putting many fixed annuity interest rates on a par with certificates of deposit. Even though many fixed annuities continue to offer initial and renewal rates that are above CD rates a strong argument can be made that if CD and fixed annuity rates are the same, people should buy the fixed annuity.

An Interest Free Loan
If someone loaned you $10,000 and said you didn’t have to pay it back for 10, 20, 30 years or even longer...and you wouldn’t have to pay any interest on the loan, but you could earn interest on the money in a very conservative instrument...would you be interested?

One of the greatest features of an annuity is tax-deferral; this means that the earnings of an annuity are not taxed until the money is withdrawn. So, not only do you earn interest on the principal (simple interest) and interest on the interest (compound interest), you also earn interest on the taxes that would have otherwise gone to Uncle Sam (tax advantaged interest). Over time the triple interest advantage of a tax-deferred annuity really adds up.

Say that you are saving money. Your intention is to use the interest from your savings to generate income when you retire. You have $50,000 to invest, are in a 33% combined tax bracket and could earn 5.5% interest in either a fixed annuity or certificates of deposit. Which vehicle will produce more retirement income? Here’s an example of the future interest you would receive if you deferred the taxes or paid taxes while your money was growing.

The annuity’s tax-deferred growth means more income is available for future needs. In only five years the annuity produces 9% more income than the CD; in thirty years the annuity’s income is 67% higher than the CD. However, someday someone will need to pay back this interest free loan when the annuity is paid out. What is the final outcome of your savings?

The annuity advantage is the money produced by tax-deferral. Tax-deferral permits the money to grow faster maximizing future interest income and the benefit begins as early as the end of the first year.

Say that you’ll earn $1,500 in interest this year and you plan to use the interest to go on vacation next year. If this interest is from a taxable account and you’re in the 33% tax bracket you’d pay $500 in taxes this year. If the interest was earned in a fixed annuity you’d withdraw the interest next year when you need it. By waiting until next year to take the interest you’d earn interest on that $500. At a 5% rate that’s an additional $25 you’d make from deferring your taxes - extra money you could use to pay for a lunch on your vacation.

And what if you didn’t need the full $1,500 for the vacation. In a CD you’d still pay taxes on all of the interest. In a fixed annuity you’d only pay taxes on the interest you withdrew; the balance would continue to earn tax-deferred interest.

Social Security Benefit Taxation
A decade ago Congress decided to tax the Social Security benefits of retirees with "substantial income"...‘substantial’ defined as people with as little as $25,000 in annual income. Interest income, pensions and Social Security benefits are included in the calculation which can result in as much as 85% of the Social Security Benefit subjected to taxes.

A fixed annuity may help minimize or avoid Social Security Benefit Taxation

No problem. I’ll just switch from CD’s to tax-free municipal bonds to lower the tax. Wrong. Municipal bond interest is included in the calculation (line 8b on Form 1040).

What if the CD interest that you’re letting compound - and paying taxes on, was transferred to a fixed annuity. The tax-deferred interest would avoid current taxes and is not included in the Social Security taxation calculation.

If total retirement income is close to the benefit taxation thresholds a fixed annuity may help avoid taxation. And, if you avoid benefit taxation this year you won’t ever have to go back in future years and pay the taxes you avoided.

Guarantees & Surrender Charges
Fixed annuities have a minimum interest rate guarantee, usually 3%. Certificates of deposit rates are reset at the end of each term and do not have a minimum guarantee.

One of the benefits of a fixed annuity is a specified surrender charge...yes, I said benefit. The surrender charge and the minimum guaranteed rate provide absolute certainty on the downside, and I’d like to thank Bill Harris of W.V.H., Inc. for this sales idea.  "Mr. & Mrs. Client, we know what is the worst case if you surrender the annuity down the road. So, I’d like to ask...Specifically, what is the lowest rate your CD will renew at in the future (rates were under 3% earlier in the ‘90s);  Specifically, what could you sell your municipal bonds for in three years;  Specifically, what could you sell your mutual fund for in four years."

With many other financial instruments there are no guarantees. A fixed annuity specifically tells you the worst you could do. If CD and fixed annuity rates are the same, there are many reasons to choose the annuity.

Where & When Is The Bottom    11/98        
In the last 30 days almost every index annuity has cut participation rates. Rates have been impacted by lower yields on fixed rate investments, at the same time option prices have sharply risen due to uncertainty over future market movements.  No one expects significant relief in option prices until the end of the year.

Should you wait and see if participation rates go up? The problem in waiting is that the index is still well below its high for the year. Option prices could fall which would increase participation rates, but waiting could mean missing out on a hundred or two hundred point gain in the index.

Investment Ads - Give Them "H"    11/98      
Although it is reported that the only certainties in life are death and taxes, a third rule might be that investment ads are boring. Look at a typical headline "To create long term wealth you need a consistent investment philosophy. At Dozer & Yawn we work side by side with you..." Boring!

The ad is trying to say that our people will help you make money. What if the ad instead showed a picture of a bulldozer with the lift full of moneybags and the caption "Not only does Dozer & Yawn help you make money, but we'll deliver it too".

The big "H" or Humor in advertising can be very effective, but its seldom used with investment products or services. One reason is that the SEC and NASD don't have a sense of humor (just try using a whoopee cushion during your next audit, I bet the examiner doesn't even crack a smile). The other reason is that investing is a serious business and we must present a sober and dignified image. The problem is we're so dignified that all of our ads look alike and the customer ignores them.

Humor can separate one from the pack and give prospects a reason to remember you. Which opener is more memorable "Protect your investment earnings from taxation" or "Keep Uncle Sam's hand in his own pocket". A drawing of Uncle Sam in a pair of Speedos will attract more attention than a tax rate table.

If you're trying to convey the need for retirement planning one firm used "You may know exactly what you want to do once you retire, but given the ever-changing financial markets you need to chart a course...", I'm not sure whether they want my retirement money or to sell me a compass. For two years our most successful retirement ad said "What is the question that will be most often asked by today's workers when they reach retirement...Do You Want Fries With That?" The graphic was a picture of a hamburger.

Humor can be effective in other areas. We had an investment counselor who draped her office in gauze and bandages while wearing surgical scrubs. She explained she was conducting financial check-ups. Another time she had a plate of ice cube encased pennies, nickels and dimes in front of her office. The sign above said "We specialize in unfreezing growth potential." Humor works, give it a try.

State EIA Approvals Are Like A Snowflake    12/98       
Most index products have been approved by a vast majority of the states. The states with the fewest index annuity approvals are New York, North Dakota, Oklahoma, Oregon and Washington. Other states with limited approvals include Maryland, New Jersey and Vermont.  

While New York is a special case, I wondered why the approval process was so difficult in these other states and so I called the insurance departments. I got the impression from some of these states that the reason for slow approvals was due to confusion over what index annuities are and what they're trying to do.

A common lament was that every index annuity seems to have a different excess interest crediting structure. Oklahoma say the main item delaying product approvals is inadequate customer disclosures. A recurring theme among regulators was that customer disclosures need to be strengthened to reflect the risks. A couple of states also voiced concern about requiring courses before agents can sell the product.