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To: Lynn O'Shaughnessy, Bloomberg Wealth Manager

From: Mike Tripses, Chair

RE: Indexed Annuities: Too Good to be True?
      Penalties, caps and fees drive down income on equity-indexed annuities.

Last July you called NAFA and interviewed me. You also asked a series of questions to which we replied in a memo dated July 28th, 2006. NAFA was pleased to see that much of the information was included in your latest article titled “Indexed Annuities: Too Good to be True?” However, there are a few more clarifications and corrections we would like to offer you and your readers.

Your article quotes Chuck Newton, a financial adviser, as saying that "there are more than 500 of them [indexed annuities], but only about five are any good, if that many." As of November 27, 2006 there are 300 products approved for sale according to, Sheryl Moore, president. Mr. Newton is off by 200, but more importantly there is no source or support for his analysis recommending only 5 of these annuities and it must merely represent his unvarnished bias.

You are correct in saying that [people] “who believe that these annuities will match stock market returns in a bull market will be sorely disappointed.” Indexed Annuities differ from other fixed annuity insurance products in that part or all of the appreciation in benefits are determined by reference to independent indexes. Generally, the dollar value of benefits can vary up or down based on the increases and decreases in the performance of the indexes. However, the dollar value of benefits cannot fall below specified levels guaranteed by the insurance companies. With nearly all of today’s products, the dollar value of benefits cannot move downward, but only upward with interest credits.

In your article, you give the example of a product with a participation rate of 80% whereby if the index increases by 8%, the interest credited to your annuity will be 6.4%, but go on to say that “other calculations will also gnaw at your return.” Most fixed indexed annuities use a participation rate, caps and or fee as adjustments to a gain formula which measures the change of an independent index value. The purpose of the adjustment is to allow the insurance company to balance the amount it otherwise would have credited as a fixed rate with the cost of providing an indexed interest credit. All annuities must provide for guaranteed growth of principal over time. This means that the company must guarantee growth even if indexed interest is small or non-existent. Due to the normal relationship between bond interest and equity market volatility, bonds interest less required company spread will not normally yield enough to purchase an option to cover the full change in the index. Hence, the need for caps, participation rates or fees. This tradeoff is understood by most financially aware individuals. They understand that you cannot normally get “all of the upside of a volatile market and no downside”.

Just as there are “probably 100 different ways” to deduct fees and apply asset charges to mutual funds, stock portfolios, variable annuities etc., there are a number of ways to credit interest in today’s fixed annuities. No one insurance, savings, or investment product is right for all people, all of the time. The advantage of a competitive and evolving market in annuities is that many choices are available to consumers, allowing them to target their specific needs and meet their specific goals. There are numerous products with “simple” gain formulas and adjustments to choose from in the annuity market today, They include simple designs like the example you explain it in your article; designs which obviously don’t require a “degree in industry methodology” to understand as Scott Dauenhauer stated.

You also discuss the issue of minimum guarantees in your article and use an example of 3% on 80% of the original premium and a twelve year period to calculate. However, Jeffry Vodrie of Legacy Planning Group incorrectly concludes that the “effective annual return would be a paltry 1.1%.” Mr. Vodrie’s example is inappropriate since the new annuity standard non-forfeiture law has established a minimum percentage of premiums at 87.5%. In any case we don’t understand the disparaging tone for the reasons noted above. How much money do people have which would forgo a portion of upside interest credit based on an index for guaranteed growth? The truth is that most people have this profile of money somewhere in their assets and more so as they progress through retirement. The appropriate thing for an agent to do is help a client identify that money.

Minimum guarantees provide the greater of the actual interest credited or the minimum guarantee. Fixed annuities are a place to keep your money safe when safety is important. Some interest, any interest, is better than losing 20% of your savings for some people or for some savings as many did in the early part of this decade.

One final clarification for your readers, when Mr. McCann says that investors can do as well or better with a simple portfolio of Treasuries and a diversified stock mutual fund he is comparing annuities to U.S. Treasury securities and ignoring the indexed annuity’s potential for additional excess interest, which is one of its core benefits. Beyond that he presumes historical Treasury returns which include double digit returns of the 1980’s can be compared to Indexed Annuities issued today in a 4.75% 10-year treasury environment. Any such comparison is disingenuous. If one were to fund indexed annuity crediting today with the those outsized bond yields from the 1980’s the results would be comparable Mr. McCann’s suggestion also ignores the guaranteed protection of principal and guaranteed payout options provided by fixed annuities. The proposed U.S. Treasury securities do not guarantee principal if money is needed before maturity and the mutual funds have significant credit and market risk. The additional value of fixed annuities is the guarantee of no principal loss, locked in and accessible prior interest credits, guaranteed increases in annuity value and deferral of taxation on interest credited. Mr. McCann’s flippant and blanket conclusion does not serve your readers well.

We invite you to call us to discuss any statements made in this letter or as research for any future articles you do on fixed annuities.


Mike Tripses,

NAFA Chair

Mr. Tripses is a member of the Society of Actuaries and Executive Vice President and Chief Actuary of Creative Marketing Insurance Corporation in Overland Park, Kansas and can be reached at 800-992-2642.

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NAFA is the National Association for Fixed Annuities. NAFA was created to foster a better understanding of traditional, payout and indexed annuities. It is the only independent non-profit organization dedicated solely to the promotion and preservation of these unique products. Permission to distribute and/or reproduce this document for NAFA members may be given upon request. Any unauthorized distribution is strictly prohibited.

Last Updated: 12/20/2006 11:48:00 AM