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Advantage Compendium - An Index Annuity Resource |
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8.99% S&P 500 APP 3.15% Dow Jones Industrial APP 3.15% 17.00% Russell 2000
The Truth At Acute Angles 1/05 The preceding paragraph is accurate, as far as it goes, about index annuities. If a consumer read the whole thing they might walk away thinking an index annuity is a fixed annuity that might do better than their CD, but won’t perform like a stock market instrument, which is the balanced idea I wished to convey. But oftentimes when one is quoted the original intent is edited and slanted to reflect the angle and agenda of the editor. For example, if an aggressive index annuity marketer wanted to cite this with consumers the final quote might get parsed into something like ... Jack Marrion says “Index annuities...providing the potential for more interest...stock market gains without the risk...the index annuity is a safe money place ...protect both principal and credited interest and do not share in...index losses...providers of index annuities will make many consumers happy about their purchase.” On the other hand, a financial writer with a dislike for insurance companies might say it this way...Jack Marrion opined “Indexannuities are...incorrectly marketed as “stock market gains without the risk”, the reality is the index annuity...competes...with...other fixed annuities...does not include reinvested dividends...share in index losses...Current law state index annuities are...pseudo securities...In 2005...the providers of index annuities will make many consumers...purchase.” Or, if you are a public figure looking for headlines and planning on running for governor someday you might simply announce, Jack Marrion testified “Index annuities are...incorrectly marketed...possible...law...suits...I’m...happy...” What all of this means is you need to be clear about what you say and whom you say it to. If the marketing department wants to use your words, request final approval on your quote. If a regulator calls and wants to talk with you the only statement to remember is “Hold on while I conference in my lawyer on the speakerphone”. Dealing with the press is more difficult. Reporters from the general press are probably not going to report your comments in a favorable light. This is usually not because they hate annuities – although that is occasionally the case – but because of their background and their experience with financial industry spin. The background of financial reporters is not typically finance, nor have they usually ever worked in the insurance industry. Most of their financial industry knowledge and contacts are from the security side of the street, and the people they approach to learn more about index annuities are the security people selling against index annuities. As I once remarked, asking security folks about the merits of non-security instruments is like asking a Red Sox fan what he thinks the Yankees chances are this year. In addition, the reporter’s experience in talking with any financial industry interviewee is that the positive spin from the interviewee is so strong no wrong about any product is ever admitted, which tends to make the reporter a wee bit cynical about good news. So, the reporter is now writing about index annuities, a product of which they are not familiar, have only heard a sullied version of the facts whispered by direct competitors of the product, and all they expect to hear from proponents is a whitewashed version of very flattering partial truths. Then what is the best response when the media calls? Hang up. Even if the reporter does not intend to slam index annuities because “bad news sells” the probable bias of the reporter – and the general defensive reaction observed when people are asked hard probing questions about areas like surrender charges or commissions – will not result in a favorable story. When I talk with reporters and detect the usual bias my whole goal is to try to turn the story’s slant from “index annuities suck” into “index annuities don’t stink too much”, and I am seldom even this successful. If you do talk to a reporter and after publication feel your remarks were misrepresented, do nothing, hopefully you have learned your lesson and will keep quiet next time. Do not challenge or attempt to correct the reporter or complain to the editor because you will simply dig yourself in deeper. Whether the reporter is right or wrong one thing is for sure, they always get the last word. Index Annuity Myth #1
“You are going to earn an average 10% annual return” 1/05 The Stock Market For the decade of the ‘80s the overall annual market return was 17.3%; for the decade of the ‘90s the overall annual market return was 17.8%. Wonderful market years. However, the actual investment returns – earnings growth plus dividends – of the companies behind the stocks were respectively 9.6% and 10.6%.1 In other words, in the ‘80s the hard-real-dollar company returns were 9.6%, but investors bid up these companies to expect 17.3% returns. Why did investors value the future returns of the company stocks so much higher than the real company financial results? Much of it was taking into account the overlooked value of the past. The ‘50s and ‘90s experienced
similar oversized stock market returns; The ‘70s were a rotten decade with the stock market producing an annual market return of 5.9%. But when the decade ended and investors looked back at the actual company earnings performance they saw average annual dividends and earnings growth of 13.4%! From a performance standpoint corporations had their best decade since the war years of the 1940s, but the pessimism of the ‘70s obscured this reality. The ‘80s investor saw that a tremendous amount of value had been left on the table from the previous decade and bid up the price of stocks, and this optimism carried over to the ‘90s, even though actual corporate investment returns for these two decades were essentially only average. Investors tend to react when they perceive hidden value. The stock market return of last century’s ‘10s was roughly half that of actual corporate earnings for the decade; in reaction stock market returns of the roaring ‘20s were then 30% higher than corporate earnings. The same correlation is observed in the ‘40s where corporate earnings returned 14.9% but stock market returns were 8.6%; wherein investors in the ‘50s uncovered this value and bid up stock market returns to double that of actual corporate returns. And, as noted, the negative value relationship of the ‘70s was reversed in the ‘80s and ‘90s. Perhaps of greater importance today would be observing stock market performance after the “go-go” decades. The first decade of the last century had higher stock market returns than corporate performance would justify and stock market returns of the next decade were lower than actual corporate performance. The ‘50s stock market outperformed earnings by almost two to one, but we then witnessed a twenty year period where the stock market under-performed corporate returns. Finally, at the close of the last century we concluded a 20-year period of exceptional stock market performance in which stock market returns were nearly double those of the corporate earnings on which they are based. The question now is “will there be a stock market reckoning as in times past?” To assume that since the new millennium bear market is now behind us that the stock market will continue to outperform may be stretching the laws of probability. Carrier Behavior At anywhere near current rates index annuities won't average 10%+ returns Alas, not at current rates. If you take the ten dozen index annuities currently on the market, plug in current rates, caps or spreads, and see how these would have hypothetically performed for their respective surrender periods during these two decades you find only a half dozen of them ever average doubly digit returns for their surrender period, and these six products only break 10% average returns on one, two or three occasions. In general, index annuity rates would need to be much, much higher to give most products even a faint chance of ever averaging 10% returns even in great stock markets. This doesn’t mean you would never see a year with double-digit interest. Many crediting methods should observe double-digit return years, but the other years will drag the average below the 10% range. It might be supportable to say some index annuities may earn “a” 10% annual return, but using today’s index annuity rates and the recent stock market past to talk about averaging 10% index annuity returns is telling a fairy tale. Happily Ever After 1. “The Policy Portfolio in an Era of Subdued Returns” By John C. Bogle, June 5, 2003
Ethics Wars 2/05 A major index fund last year cut their already low management fee to 10 basis points because the industry leader offered a fee as low as 12 basis points for larger investors. Financial writers that had lionized the leader’s fund were now canonizing the new low-fee champ. The reality is the extra lift produced by saving 2 basis points in getting a consumer’s investment balloon off the ground over time is that of a popcorn fart ($10,000 earning 10% versus 10.02% the difference in 20 years is $245). Although low fees are better than high fees they are only one aspect of
returns, helping consumers find the right financial vehicle for their needs is
even more important over time. My feeling has always been if you can justify the
fee or commission to the consumer then all is well. The real question is not
whether the fee is high or low, but whether you have earned it. An NASD Fishing Trip 2/05
In August 1997 the SEC issued Concept Release No. 33-7438: File No. S7-22-97 requesting comments as to whether index annuities should be registered as securities. At that time NASD stated they felt index annuities were securities. However, after the comment period ended in 1998 SEC did not change their mind and let it stand that fixed index annuities were not securities. Now, seven years later, this demand by NASD for information on a product that the SEC has determined is not a security, and therefore not under NASD jurisdiction may surprise some people, but technically NASD is operating within their limits. Representatives must inform their broker/dealer of outside business activities so that the B/D may state any objections and exercise appropriate supervision. However, the scope and tone of the letter seems to me to be a mixture of intimidation, and a fishing trip for evidence of anything that may be twisted into a possible security violation. This isn’t the first time NASD has gone after index annuities. I heard they made similar requests a few years ago. However, targeting a fixed annuity that saved billions of consumer dollars from stock market loss in the midst of a bear market was bad timing, and NASD backed off. Today is different. I have been told member firms that do not offer index annuities are telling NASD of the sales they are losing to index annuities. You need to remember the revenue sources of NASD are fees and fines, and fixed index annuities generate neither. When I was president of a broker/dealer I used to tell my registered representatives that every morning they went into their office they were in violation of some NASD regulation and thus subject to fine, censure, license suspension or revocation. It was not because my reps were bad, it was because NASD has so many rules that they can almost always find something to nail you on if they want to. If NASD discovered that a representative’s client sold a mutual fund and used the money to purchase an index annuity it could very well have been the right thing for the client to do. But during their investigation of the transaction NASD might well discover some unrelated stock trades incorrectly posted, a few prospectuses on the literature stand printed 366 days before today, or the absence of a time stamp on an order in a customer file. Martha didn’t go to prison for trading on insider information. Although the NASD position is extremely one-sided they do have a legitimate concern. I have heard of agents that have essentially touted index annuities as “investments without risk”. Once I received a spamming email asking “whether my mutual fund returned 26% like their non-risk investment offered by XYZ insurance company did” (I forwarded this email to “XYZ” and they took action against the agent). The definition of “marketed primarily as investments” is open to interpretation, but NASD may be successful in having SEC reexamine index annuities because they will find some ignorant or unethical agents egregiously marketing an index annuity as an investment security. However, there are steps the industry can take to combat this. Quit calling them equity index annuities. They don’t perform like equities, they don’t look like equities, and under SEC Rule 151 they are not equities. They are fixed index annuities; FIAs not EIAs. Every time the press talks about EIAs or the annuity material uses “equity” in the description NASD’s case is strengthened. Free both carrier and submitted agent materials of investment wording and language. The annuity buyer is not earning “stock market-like returns” they are getting “index-linked interest”. An index annuity is not “no risk investing” it is “interest enhanced saving”. Fire the guilty. If a producer or agency markets index annuities as investments, overstates potential interest earnings, or fails to meet acceptable insurance department standards of market conduct, the carrier answer should be immediate termination. And lastly, defend index annuities. Index annuities are regulated by
state insurance commissioners, the insurance company assumes the investment
risk, and index annuities are sold as long-term savings vehicles. Index
annuities meet all the safe harbors to be deemed “not securities”. The
industry needs to proactively state this message publicly and loudly to
insurance regulators, security regulators, and the SEC. Index Annuity Myth #2 “A
Fixed Annuity Is For Old People” 2/05 The first is from folks saying that an annuity is designed to produce an income and therefore is better suited for retirement. However, anecdotal evidence suggests 98% of the annuities purchased are passed intact to the beneficiaries and never annuitized. An income you can never outlive is a wonderful annuity benefit, but the vast majority of annuity owners use the annuity as a means of preserving and growing wealth. The desire to grow richer is not limited to the old alone. The second reason has to do with the 10% penalty assessed by the IRS on annuity withdrawals under age 59 1/2, and some folks use this to say that you need to be in your 50s to think about buying an annuity because you don’t want the possibility of paying a penalty. However, qualified plans have the same penalty, and no one would suggest a 25 year old should not contribute to a 401(k) plan, or fund an IRA, because of this penalty. The decision to use a fixed rate or fixed index annuity should not be based on age, but rather on tolerance for risk. I believe a 30 year old should place their annual IRA contribution in the stock market because they have more than enough time to recover from bad times. But what if that 30 year old is so risk adverse that they keep putting that money in CDs? Switching to an index annuity should produce a better return over time than the bank. Conversely, if an octogenarian wants to take a portion of their assets and investigate the futures market, who is to tell them that they should buy. Consumers may use annuities for their risk averse dollars, regardless of their age. A fixed annuity is not just for old people, it is a place for money you wish to keep safe.
MVAs 2/05 Although many producers I’ve spoken with tend to believe the previous paragraph, the real reason behind Market Value Adjustments is the one found in the “Buyer’s Guide To Fixed Deferred Annuities” produced by the National Association of Insurance Commissioners which states “Since you and the insurance company share the risk, an annuity with an MVA feature may credit a higher rate than an annuity without that feature”. Carriers amortize the upfront costs associated with an annuity contract over a long period of time. Insurance companies typically buy bonds to back their annuities. Issued bonds decrease in value when rates are rising and increase in value in a falling interest rate environment. If an annuity owner gets out early the carrier needs to recapture the previous costs not yet paid for, and is affected by any changes in value of the assets backing the annuity. If the annuity owner shares in any future declines in asset values the carrier’s risk, and money set aside to cover possible asset losses, is reduced and the carrier should pass this savings on to the consumer in the form of a higher return. That is the theory. Is it reality? I don’t know. From a pricing standpoint having MVA does free up money. My problem is it is difficult to make comparisons on the returns of MVA and non-MVA annuities because often one carrier’s annuities all use or do not use MVA, and differences in returns between two carrier’s annuities may be due to some other factors. In the last few years MVAs reduced or even eliminated penalties if the annuity was surrendered early because interest rates were falling. In the current cycle of rising rates MVA could result in higher than listed surrender costs. MVAs are used in a minority of index annuities, so you do have a choice. However, the primary thing to remember about Market Value Adjustments is they do not come into play if the annuity is not surrendered early.
The market share of annuities offering a premium bonus rose to 61%, a 10% increase from the previous quarter. The average street-level commission paid rose modestly. Annual reset designs dominate representing roughly nine out of every ten sales, and insurance agents continue to be the catalyst behind nineteen out of every twenty annuities sold. I asked carriers what percentage of their sales were from 1035 exchanges, unfortunately, only a third of the carriers provided data and their individual numbers ranged from 13% to 85%. Based on conversations with carriers my opinion is 60% of the money going into index annuities is coming from another annuity. On the equity life side AmerUs Group continues to dominate atop both quarter and annual EIUL sales with a 60% market share. Index life 2004 sales were $123 million, a 23% increase over the previous year. The complete report will be publish later this month.
Why all the attention? Index annuities became successful.
The Best Wire Services articles came on the heels of an NASD request to members to send in damaging index annuity evidence (my phrase, not theirs), and two high profile California lawsuits against insurance companies that offer index annuities (although the main damage claims relate to annuity sales practices in general and not specifically to index annuities). Actual index-linked interest credited usually beats the minimum guarantee
Today there are a variety of minimum rates paid on premium amounts ranging from under 90% to 100%. However, the reality is under most crediting method assumptions the actual index-linked interest credited for a surrender period term will be higher than the minimum required benefit. If you look back over the last 50 calendar years, plug in current rates, caps and/or spreads, and calculate the returns based on product surrender period, you find that:
Honest Hype 4/05 If I could increase your income at
retirement 46% without increasing your risk would you be interested? Suppose we had $50,000 and were in a combined federal and state tax bracket of 33%. And say both a taxable account and an annuity are earning 6%. The annuity benefits from triple interest crediting and works with the full 6% interest. However, the taxable account produces an IRS Form 1099 every year that says part of the interest must be paid in taxes, whether it is being used or left for later, so we are left growing at only 4%. The annuity advantage means we would an amazing 46% more interest from the annuity than we would get from the taxable account in twenty years. An annuity could mean the difference between enjoying retirement or just getting by. If I could potentially double your interest income
without increasing
your risk would you be interested? If a consumer’s bank is paying 1.55% do you have a fixed rate annuity yielding 3.10% or better? If your top local bank is paying 3.15% can you find an index annuity with a cap of 6.3% or higher? You can offer consumers real or potential interests that is double what they are earning. My work with consumers implies they want 2% more interest to justify moving their money to an annuity – not hype of unsustainable double-digit returns – simply 2%. Although the rate differential between CDs and fixed rate annuities will continue to get squeezed this year, index annuities offer a viable way to get that 2%. If I could reduce or eliminate owing taxes on
your Social Security benefits without increasing your risk would you be
interested? If I could give you a friendlier minimum
guarantee than you get with a Savings Bond... If I could show you a safe money place that has
outperformed CDs would you be interested? If I could show you a way to possibly earn more
interest without subjecting your money to stock market risk of loss would you be
interested? If I could show you a way to end withdrawal
penalties but still earn competitive interest would you be interested? Fixed annuity surrender penalties – with a few exceptions – end at some point down the road. There comes a time when new annuity rates are declared without penalty. If I could show you marketing that didn’t hype
what it was selling would you be interested? Why Did CD Rates Climb & Annuity Rates
Stall? 4/05 By contrast, typical fixed annuity base interest rates were in the 3% to 3½% area last leap day and were in the same vicinity when February ended in 2005, and index annuity caps and rates were lower now than they were then. Why did CD rates go up while annuity rates stayed flat? CD yields tend to track short-term interest rates because of what they are backed by. The best known short-term interest indicator is probably the federal funds rate, which is the overnight rate charged between banks. The Federal Reserve raised this rate for the seventh time since last summer at their March meeting. Short-term CD rates have directly responded to these increases and risen accordingly. Fixed annuity rates are primarily determined by the yields earned on bonds owned by the insurer. To a great extent bond yields also drive index annuity participation as well. Bond yields remained flat to falling for the year in question, which is why annuity rates did not rise. Why did long-term bond yields stay flat when short-term rates rocketed? You will hear many different answers ranging from too much money (liquidity) in the hands of investors to a weak domestic economic recovery to China’s monetary policies. All or none of this may be why. Annuity rates tend to react more slowly to interest rate cycle changes because changes in the insurer’s bond portfolios are made gradually over time. This is why annuity rates seem much more competitive than CD rates when rates are falling and less competitive when rates are rising. The good news is that bond yields are finally going up and we are seeing both fixed rate and fixed index rates increase as well. How high will they go? Not even Mr. Greenspan knows.
The main reason I am ending publication is that my time may be more profitably spent on other aspects of index annuities. I will continue to conduct hypothetical testing on new methodologies because it is the quickest way to separate marketing hype from return realities, but these will be for myself. However, I would like to share a few return realities I believe I have generally found to be true. Hypotheticals Do Not Predict The Future Hypotheticals based on the past will not tell you what future results will be or the probability of certain results. Even results based on the finest computer models can only tell you the probability of certain outcomes if the model’s assumptions are correct. It is like spinning a roulette wheel based on the outcome of a roll of the dice. Hypotheticals Do Not Predict The Past But They Can Help Detect “Too Good” Rates If you plugged in last month’s current annual reset product participation rates, caps and spreads into 50 years of index movement and determined the annualized returns broken down by surrender period you found: 5-year products had an average annualized return of 4.33% and product average returns ranged from 3.08% to 5.03% 7-year products had an average annualized return of 4.53% and ranged from 3.58% to 5.31% 10-year products had an average annualized return of 5.12% and ranged from 3.98% to 6.15, but one annuity came in at 7.12% Basically the hypothetical returns of almost all of these products are within 1% of the average return for their surrender period and reflect similar pricing. There are two exceptions. One 5-year annuity has a 3.08% return, which is well below the others; one 10-year annuity has a 7.12% return; well above the others. Why? The carrier with the 5-year annuity is discouraging sales of this product by offering a less competitive rate because they are working on other products; it is a temporary situation. The carrier with the high 10-year index annuity is a bigger red flag. How can they offer a rate that results in a hypothetical return that is almost 40% higher than the average? The answer may very well be that they cannot and future renewal rates will be less competitive to make up for it. Hypothetical models may also be used to verify marketing claims. None of these annuities at current rates ever produce a 10% or greater return for their entire surrender period. So, if someone claims their annuity will give consumers “double-digit” returns you have reason to doubt the veracity of their message. These hypothetical returns do not mean if you buy an index annuity
today that you will earn 4.33% annualized over a 5-year period, 4.53% over a
7-year or 5.12% over 10-year period. For that to happen the future period would
have to exactly repeat as the past did, but in miniature, and the participation
rates or caps would never change. The hypothetical results have no bearing on
future returns, which is probably the most important reality to remember. Index Annuity Customer
Complaints 5/05 The National Association of Insurance Commissioners (NAIC) gathers data on customer complaints from all of the state insurance departments. This information is available on the Consumer Information Source (CIS) part of their web site http://www.naic.org/consumer/ on a company by company basis. I reviewed and totaled the number of closed customer complaints for 2004 relating to index annuities, variable annuities and annuities in general for the entire universe of all of the index annuity writers and the 25 largest sellers of variable annuities. Although I was able to find individual complaint statistics on each company, I did not want to turn this article into a “morality ranking”, and so I will only talk in terms of aggregates. The top 25 variable annuity issuers were responsible for $122,393 million in new VA sales in 2004. The top 25 VA writers accounted for over 95% of total VA business.1 The number of variable annuity specific closed customer complaints was culled from the CIS site on the top 25 VA carriers The entire universe of 35 index annuity carriers generated $23,324 million in 2004 index annuity premium. The number of index annuity coded closed customer complaints was determined for each carrier.
There were 181 closed customer complaints against the 25 top variable annuity writers, or an average of 7.24 complaints per VA carrier. The most complaints against a VA carrier were 55; one VA carriers had zero complaints. The median number of complaints was 5. There were 38 closed customer complaints against all 35 index annuity writers, or an average of 1.09 complaints per index carrier. The most complaints against an index annuity carrier were 9; 22 index carriers – or 63% of the total – had zero complaints. The median number of complaints was 0. On the VA side there were $676 million of sales for each complaint. On the index annuity side there were $614 million of sales for each complaint. The variable annuity side had fewer complaints per dollar of premium. In 2003 index annuity carriers had 30 complaints against $14,015 million of premium ($467 million for each complaint) and in 2002 index annuities had 16 closed complaints against $11,674 million of sales ($729 million for each complaint). I was unable to determine variable annuity complaints for the top players for these years. Although there were 38 index annuity complaints and 181 variable annuity complaints in 2004 there were 895 closed complaints against traditional fixed annuity insurers. What conclusions can be drawn? Based on closed consumer complaints there does not appear to be support for the contention that index annuities have more market conduct consumer problems than other type of annuities. 1. Carey, Rick. Variable Annuity Sales Reached A Record
$128.4 Billion In 2004. National Underwriter (v.109, No. 9 pp. 6-7) May Day –
Savings Bond Revolution 5/05 The Department of the Treasury will set the fixed rate administratively. The rate will be based on 10-year Treasury note yields and adjusted for features unique to savings bonds. What this means...If interest rates are higher in the future EE bond buyers will be locked into current low rates and could lose out on thousands of dollars of potential interest. The minimum guarantees, tax-deferral and safety of principal associated with
savings bonds can also be found in fixed annuities, but fixed annuities now have
the definitive edge over savings bonds in producing future competitive yields. Index-Link Power (How It’s
Done) 5/05 Another word for index-link is option. If you’ve ever given a car seller $50 to hold a car for you at a certain price you’ve participated in options. You put $50 on the table to hold a car, the car seller agrees to accept your $50, the seller is obligated to sell you the car at the agreed upon price. But as the option buyer you are not obligated to buy the car, you simply have a right to buy it at that price. You can walk away and the most you can lose is your $50. Equity options work the same way and I m going to use a real world example to show how the index annuity approach utilizes options to provide the potential for higher fixed annuity returns. To make this cleaner I am going to ignore transactions costs and will state this is not an inducement to sell or buy any security and is for purely educational purposes. Cheerios, Wheaties & Calls We know if we buy the CD it will return 2.8% in nine months. What will be the return on the share of General Mills over the same period? We don’t know. It could be greater than 2.8% or it could be loss. There is a third choice. At the end of April a stock exchange listed call option giving the right to buy General Mills at $50 at anytime within the next nine months last traded for $2.05. If we buy the call option – or equity-link – we have the right to buy General Mills at $50 a share and this right costs $2.05. Protection & Potential The Scenarios The CD is now worth $50. We add the $50 from the CD to the $4 realized from our equity-link and the result is $54, or an 8% return on our $50. What if the price of General Mills stock had been $50 or less at the end of the period? We wouldn’t use the option and the $1.37 spent on it is gone. However, because most of our money was placed in the CD we still have $50, and if we wanted to we could try this option/CD combo again for the next period. This is how an index annuity works. The primary differences are the insurer
uses bonds instead of CDs, index option instead of stock options, and an annual
period instead of nine months. Spring Holiday 5/05 I’ve tried to figure out why this is. I’ve theorized that perhaps the chance in tidal forces produced by the vernal equinox lowers the stimuli to my neural centers. Or, perhaps the flowering of new plants has triggered an allergic reaction causing my sinuses to swell and thus press against my frontal lobes. But I think the real answer is I get a good case of spring fever that brings out some buried urge to revert to my more primitive self.
I get up with the sun on these spring mornings, plop myself in front of the keyboard, and try to write articles and think deep thoughts, but something outside is calling me. Normally, a ringing phone is an intrusion on my writing, but today I’d welcome a call. “Hello...Yes, I’d be happy to speak at your conference next week...It’s in Salina?...I’ll be there and bring kites for everyone.” I find myself looking for excuses to get away, “Honey, we haven’t visited your mother in ages and I just have to know how her bunion surgery went.” Or, I will convince myself that I need to wax the car, weed the lawn, and clean out the gutters before I can possibly finish that story on market trends. By the time July rolls around I can think again and by September I’m back pounding on the laptop spewing out verbiage and concepts with abandon, but I really do resent losing my mind for part of a season every year. Perhaps I should simply accept the primitive urges and quit fighting it. Does anyone know of a vacant cave with wireless web connections?
First Quarter Index Annuity
Sales Dip 6/06
Allianz continues domination of the market with a 35% market share. To put that in perspective, Allianz sales equal those of the smallest 29 carriers in a market of 35 companies. Sales of the top three carriers continues to account for over half of all sales and the top ten make up 85% of sales. Annual reset designs dominate representing roughly nine out of every ten sales, and insurance agents continue to be the catalyst behind nineteen out of every twenty annuities sold. The new players are Aviva with Progressive Indexed, Great American with the
American Icon, Legend and Valor annuities, and West Coast Life with Index
Advantage. Two additional carriers are scheduled to launch index products within
30 days. New products include American National’s ValueLock 7 and 10,
Jefferson-Pilot’s Pro 7 and Pro 13, and Midland National Veridian 7. The Advantage
Index Product Sales Report is now available. Can Index Annuities and Variable Annuities
Complement Each Other? 6/06 Proponents of index annuities and variable annuities are typically mutually exclusive. Strongly held beliefs are found among distributors of each camp and these beliefs tend to migrate upwards to the insurance company manufacturers. The results are insurers that focus only on their particular world of variable annuities or carriers seeing only their own universe of index annuities. However, a look at possible synergies from a broad perspective and joint management of index annuities and variable annuities can create cost savings. On the one side you have carriers creating variable annuities. Variable annuities are being enhanced to offer additional guaranteed benefits such as guaranteed minimum death benefits, guaranteed minimum income benefits, and guaranteed minimum withdrawal benefits. All of these guaranteed benefits are “put-based” benefits, meaning they produce value if the underlying funds decline. Insurance companies typically use reinsurance or hedging strategies to manage the financial risks of these variable annuity guaranteed benefits. On the other side you have insurance companies manufacturing index annuities using “call-based” derivatives to manage the index participation formula. Call-based means they produce value if the index increases. I did some calculations of the expected cash flow to the insurance company of a put-based variable annuity guaranteed benefit, in this case a guaranteed minimum withdrawal benefit. The insurance company makes money through 95% of the stochastic scenarios generated, but can lose significant money ($30 million for each $1 billion of sales) the remaining 5% of the time.
Index annuities, being call-based, have the opposite effect. Benefit costs to the insurance company arise when the underlying index increases. When I calculated the expected cash flow to the insurance company with the index annuity under the same stochastic scenarios used previously the shape of the curve is reversed, indicating that indexed annuity participation is high when variable annuity benefits are low, and vice versa.
When VA and Index Annuity Hedging Strategies were combined the probability of a loss fell by 80%! What happens if an insurance company can combine the index annuity call-based participation formula and the variable annuity put-based guaranteed benefits? When I combined $5 billion of GMWB with $1 billion of index annuity the probability of a loss decreased by four-fifths, from 5% in in the GMWB only scenario to only 1% in the GMWB-Index Annuity combination. The worst case loss has declined 86%, from $350 million to only $50 million.
An insurance company that can create this type of combination should be able to significantly reduce hedging costs. Although there are not many companies that currently have significant blocks of both index annuities and variable annuities, this may change over time if companies evolve to create balanced product offerings of indexed annuities, variable annuities, and fixed annuities. Reinsurance can be a mechanism to create this balance immediately. Companies with a heavy concentration in indexed annuities could assume reinsurance of variable annuity benefits, or companies with a heavy concentration in variable annuities could assume reinsurance of index annuities. I have found that this powerful risk management technique is not being utilized by the insurance industry today and could provide a win-win scenario for both variable and index annuity manufacturers. I heard Mr. Tucker present this elegant and usable
concept and asked him if he would allow me to share it with my readers. I
encourage those involved in hedging on both sides of the annuity aisle to
contact Rich Tucker at 973-783-3168 or Rich@ruarkonline.com. – Jack Marrion Do You Like Me? 6/06 Being likeable could offset a competitor’s rate advantage We tell ourselves that given the two middle categories that we will usually take the competent jerk. After all, the point is getting the job at hand done and if the person working with us is likeable too, that is an added plus. However, the story says people don’t use jerks, regardless of how much they know, because they are jerks. A finding that means I will need to work harder on my interpersonal skills, and one that reinforces an old business adage – people do business with people they like. Psychology 101 taught that we like people who are similar to us and have an attractive personality. In a sales world it translates into consumers working with producers that are likeable. The article seems to hint that although we respect knowledge we would rather work with a likeable barely competent producer than a brilliant jerk. It may also mean being likeable could trump a competitor’s advantages if the competitor is perceived as less likable. Increasing likeability can mean both increasing sales and decreasing costs Multi-year fixed rate annuities and certificates of deposit are to a large part commodity, spreadsheet products. If two CDs or two fixed multi-year annuities have similar terms, but one has a higher rate than the other the one with the higher rate often wins. However, a recent study indicates that being likeable could be more important that rate. Likeability versus Rates Although the article used a different term, I think the reason for this bank’s success is it comes across as more likeable than other banks. What are the implications for producers? How you relate to others is more important than product knowledge, and if you are competing against a better rate you may still triumph by being more likeable. Consumers want to buy from people they are comfortable with, and knowing you are reachable and going to be there for them if they need you may well be worth more than a competitor’s extra half percentage of yield. What defines a more likeable carrier? Perhaps making it possible to talk to humans instead of phone trees when one calls for help or creating easy to understand customer account statements. Or if you are a marketing company you might increase your likeability by telling producers they will never have to deal with the poor service of a jerky insurer because one of the marketing company’s people will handle all of their needs. None of this means that one can succeed on “likes alone”. The producer, carrier, marketing company or bank still needs to meet the requirements of their job; incompetence will eventually run you out of business regardless of how nice you are. However, increasing likeability can mean both increasing sales and decreasing costs, and everyone likes that. 1. Casciaro, T. & Sousa Lobo, M. (June 2005) Competent Jerks, Lovable Fools, and the Formation of Social Networks, Harvard Business Review (pp 92-99) 2. Youngme Moon (May 2005) Break Free From The Product Life
Cycle, Harvard Business Review (pp 87-94) Autobiography (sung to the tune of When I Was A Lad from H.M.S. Pinafore a/k/a Captain Crunch Theme) 6/06 When I was a lad I
served a term CHORUS – He sold
so little, they rewarded he From stockbroker I
went into management CHORUS – He
taught so poorly, they rewarded he A bear market
caused a change in plans CHORUS – His
manager proposed a new career path for he An investment
dealer I then did own CHORUS – He
worked so little, a buyout rewarded he, And now I sit at
the peak of the pile CHORUS – Make
sure you sell very little and a poor teacher be ©Advantage Compendium
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| Copyright 1998-2009 Jack Marrion, Advantage Compendium Ltd., St. Louis, MO (314) 434-6030. webmaster at indexannuity.org. All information is for illustrative purposes only, does not provide investment or tax advice. No index sponsors, promotes, or makes any representation regarding any index product. Information is from sources believed accurate but is not warranted. Advantage Compendium neither markets nor endorses any financial product. |
