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NAFA Testifies at California Hearing on proposed annuity bill!

TO: Assemblyman Coto, Chair, Department of Insurance

FROM: Kim O’Brien, Executive Director of NAFA

RE: October 30th Hearing Senior Annuity Regulations

Thank you again for your time and consideration on the very important issue of the marketing and sales of annuities in California. The National Association for Fixed Annuities believes in the importance of suitability and that full disclosure is an important part of the sales process. Only customers who fully understand the insurance benefits and limitations of their fixed annuity will be satisfied with their selection. Accordingly, NAFA strongly opposes any inconsistent marketing or sales of a fixed annuity.

That said, there is still a persistent misunderstanding on the suitability of fixed deferred annuities. Fixed deferred annuities offer lifetime guarantees and various benefits That set them apart from other financial products. The tax treatment of deferred annuities is different. This memo will help to explain these differences so that you will see how these features are attractive to seniors, and, more importantly, why fixed deferred annuities can be a suitable part of some seniors’ financial plans.

NAFA also disagrees with any generalization that annuities are unsuitable for seniors with modest means. This generalization takes an entire group of people -- each with their own unique income, savings, family, and retirement circumstances -- and precludes them from purchasing a product that offers the insurance guarantees of fixed annuities. Instead, this group would be limited to market risk options or the limited interest of money-market type products. Fixed annuity insurance products offer guaranteed preservation of purchase payments coupled with guaranteed minimum interest, even when that interest is small or non-existent, regardless of whether the interest is declared in advance or is based on positive changes in a financial market’s index. Fixed annuities can be suitable and necessary for some individuals, including those over age 65. NAFA would like to take advantage of the committee’s offer to submit follow-up information. Specifically, NAFA will clarify:

1. The use and purpose of surrender charges,

2. The insurance company’s assumption of risk, and

3. The benefits of fixed annuities that make them suitable for some seniors.

1. The purpose and use of Surrender Charges

Committee Member Assemblyman Calderon questioned the “high” surrender charges and made the suggestion to “regulate them to be no higher than, say, 3%.” You are no doubt aware that penalties for early withdrawal are common among financial products, and annuities are no different. Longer surrender-charge durations afford the insurance carrier the ability to invest longer–term, which generally offers higher interest returns to the client. This means that those who surrender early are not being subsidized by those who “stay the course”. No other financial instrument offers the ability to avoid surrender charges under so many circumstances and market risks as well.

Most annuities include a variety of withdrawal provisions, some of which provide substantial withdrawal rights without penalty…..and without exposure to loss of principal through market risk. Among the circumstances that commonly allow for early withdrawal of the entire proceeds without penalty are death, terminal illness, nursing home confinement, Required Minimum Distributions, and unemployment. Furthermore, most fixed annuities also allow for a specified annual withdrawal amount without penalty. Most common is a 10%-of-accumulated-value penalty-free annual withdrawal, but other options may include interest (often cumulative) or a specified annual percentage amount that accumulates annually. No other accumulation vehicle allows the owner to make withdrawals prior to the end of the penalty period without penalty fees or market risk to the asset. Surrender penalties are clearly spelled out in the disclosure materials and the contract.

Statistically, the higher first year surrender charges are accompanied by a 7% - 12% bonus or other interest crediting benefits. 80% of all the indexed annuities available (which tend to have longer surrender charges than declared rate annuities) are for 10 years of less. About 10% (or 30-some products) have 11 or 12 years, with the remaining having 13 – 16 years, and one product having 18 years. Source:

2. Fixed Annuities and Assumption of Risk

Under fixed annuities, the insurance company credits the owner with a rate of interest that the company declares in advance and guarantees for a period of usually one year (declared rate), or the insurance company credits the owner with a rate of interest that the company calculates by reference to a formula that includes a factor for changes in an independent index specified by the company (indexed). The owner bears no investment risk whereby the insurance company fails to credit the declared interest rate. The company credits the owner with a rate of interest that the company may be said to bear the risk that subsequent declared rates may be reduced, but never below a minimum rate. The dollar amount of annuity payments is set in advance and remains the same during the pay-out period. The owner bears no investment risk that the insurance company will fail to continue making annuity payments in that dollar amount.

Under variable annuities, the owner earns a rate of return that the insurance company derives from the investment performance of a pool of assets invested by the company and managed by an investment adviser. The dollar amount of annuity payments also varies up and down with the performance of a pool of assets. The owner bears all of the investment risk that the pool will earn less than the owner could earn elsewhere and that the owner’s accumulated value or dollar amount of annuity payments will drop. However, the owner bears no investment risk that the insurance company will fail to continue making annuity payments of some dollar amount.

3. The benefits of fixed annuities

As we testified at the hearing, the fixed annuity profile is someone who needs:

- GUARANTEED lifetime payouts

- GUARANTEED principal protection

- GUARANTEED prior earnings protection

- GUARANTEED minimum interest

The guarantees of fixed annuities are the primary appeal to an older population, a dynamic that has been universally recognized across the financial services industry. Given their capability to safeguard and insure principal and previously credited returns, insurance companies are again in the unequivocal position of meeting the needs of seniors who are concerned about having their principal exposed to market risk. It is the convergence of this age group’s needs with the unique ability of insurance carriers to satisfy them that has created the substantial interest in fixed annuity products among seniors.

The capability to elect an income that cannot be outlived at guaranteed rates sometime in the distant future is a feature unique to annuities for those who require certainty in the income portion of their portfolio. Insurance companies are “stepping up to the plate” to fill an apparent need simply because of this exclusive ability to insure longevity risk. Moreover, in addition to specified guaranteed rates, the carriers also generally offer to turn the deferred annuity into an income stream at the customer’s discretion, guaranteed for a specific time frame, even life, based on current factors that are commonly even more favorable than the guaranteed rates.

Another benefit of annuities is their tax-deferred nature. Accumulating and holding retirement funds in tax-deferred vehicles allows the asset to grow more quickly than would otherwise be the case in a similar, but taxable, vehicle. Because of this significant advantage, Congress has imposed a 10% penalty for taxable amounts withdrawn before age 59 ½ in recognition of the public good of holding these products into retirement years. Insurance companies have designed products in conformity with the tax laws and in response to the market demand for the product by those who have the most to gain from the benefits of them.

.Some casual observers may indicate that already-tax-favored funds such as IRA money and pension funds should not be held in an annuity because they are already tax-favored and, therefore, there is no benefit to the use of annuity. However, they forget that it is the guarantees and longevity insurance that drive the use of the annuity in these situations.

The maturity date of the contract is also commonly misunderstood. A maturity date is a term of the contract required by state law, and it is often the last date by which the funds must be dispersed. This legal requirement also ensures that the annuity complies with federal tax laws. Generally, surrender charges will be over before the maturity date is reached — in many cases long before the maturity date is reached. As indicated earlier, in most situations there is liquidity each year, and often the client is able to convert the proceeds to a stream of income before the maturity date without penalty.

In addition to tax-deferral, there is another significant tax benefit to recipients of Social Security benefits that causes the annuity to be particularly beneficial to older individuals. Social Security benefits can be taxed on up to 85% of the benefit amount at the client’s marginal tax rate if his or her income is above a certain provisional level. This is true even if the income is left to accumulate in a vehicle such as a CD or is generally considered to be tax-free as with municipal bond interest. Not only do returns left to accumulate in a deferred annuity escape current taxation, they do not count in determining whether, and to what level, Social Security provisional benefits will be taxed. This is a significant benefit to customers, and especially middle-class retirees who derive a significant percentage of their income from Social Security not currently consuming all of their assets for living expenses.

Finally, because an annuity is a contract, it generally passes to heirs through beneficiary provisions rather than through the probate process. For those without a will, this is one way in which assets can be left to a named beneficiary not subject to the intestacy provisions of the state and without the delays and costs associated with state probate. Since the cost of probating assets for a decedent can be significant, again, especially for middle-class retirees, this is another benefit to a senior wise enough to have some of his or her assets in a fixed deferred annuity.

In the end the two most important maxims for suitability are:

1. Target safe money needs, not age or demographic.

2. Diversify products as well as risk by putting savings or investments into more than one financial product.

As with any insurance product, an annuity must be selected to fit the particular needs of the person buying it. As with any financial product, an annuity will be suitable for some, but not all, people and for some, but not all, of their financial assets.

Suitability is always a matter for individual determination. Only a well-informed client can make an appropriate decision. Therefore, it is important that all the features and benefits of the fixed annuity be fairly and accurately communicated to a prospective buyer.

Declared rate and indexed fixed annuities are responsible for protecting billions of dollars worth of retirement assets and have saved many a contract owner from losses in riskier vehicles. The benefits offered through fixed annuities fulfill the conservative promises of safety and minimum guarantees for which many people are looking. In fact, fixed annuities can be the ideal foundation for a sound retirement portfolio or savings plan, regardless of the retiree’s or saver’s age!

FIA Performance

We thought the committee would be interested in this report by Jack Marrion, President, The Advantage Compendium which was posted at November 2007. NAFA does not believe that past performance is any indication of future performance, but believes the information is instructional in the mechanics of these products.

5 Year Index Annuity Returns
There were 25 carriers active in the index annuity market in September 2002. Farmers, IDS, SunAmerica and Transamerica marketed term end point designs that have not yet reached the end of their index period and they cannot be included in the study. I asked the remaining 21 carriers for copies of customer statements with customer information whited-out for contracts issued closest to 30 September 2002 for a five year period ending 30 September 2007. Nineteen companies responded with details about 23 different products. This is the fifth year I have collected 5-year return data and I deeply appreciate the cooperation and support of the carriers, representing almost 90% of the industry, that were open in sharing what some of their policyowners earned in their index annuities. This carriers are:


American Equity

American Investors




Jackson National Life

Lafayette Life

Lincoln Benefit Life

Lincoln Financial Group


Midland National Life/NACOLAH

National Western



Sun Life

Standard Life of Indiana

Union Central

What Is Important
Index annuities are designed to be competitive with stated-rate annuities and to the best of my knowledge they are demonstrating that competitiveness. Half a dozen products credited annualized interest of 7% to 8% and almost all the rest credited interest in the 5% to 6% range.

FIAs credited from 27% to 254% more interest than the average CD over the last 5 years

The S&P 500 was running at an annualized return rate of 13.4% for the period and the average U.S. stock mutual fund hit 16.1% a year, a strong statement demonstrating that index annuities are not designed to compete against equity investments. However, the average annualized index annuity yield of 6.12% compares very favorably to the 5.0% attained yearly by the average taxable bond fund return, blew the socks off the 3.5% that was earned by a U.S. Savings Bond issued in September 2002, and pole-vaulted over the 2.5% achieved by the average CD over the same 5 years.

cc: Committee Members, Attendees

If you are interested in learning more facts about fixed indexed products, NAFA encourages you to read our White Paper available at


Kim O'Brien
Executive Director
2300 E Kensington Blvd
Milwaukee, WI 53211
415-946-3532 (fax)

Last Updated: 11/14/2007 4:10:00 PM