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My Response to a Comment on My Equity-Indexd Annuity Post

By JLP | September 29, 2007

Commenter Chris left this response to my post, A Look at an Equity-Indexed Annuity:

O.K. I’ve read through all of this and the fact is that we’re talking about several different things.

First of all we’re talking about investment vs. insurance. To everybody trying to compare an FIA (Fixed Indexed Annuity), it shouldn’t be done. An FIA is insurance. The risk is taken on by the insurance company. Hence the ability to guarantee that the there will be no loss in the value of the contract, as long as the individual follows the rules.

Secondly, nobody should have all of their money in one type of vehichle. There needs to be diversification. However, as an individual gets closer to retirement the “time horizon” reduces. This requires an individual to reposition their funds from an investment to insurance.

Third, as the individual is getting older and is needing to preserve more of their funds, or in retirement and decumulating their funds, we need to look at the type of vehicle the individual is in. One of the things that I feel everybody can agree upon is that we’re living longer. I feel that we’re going to be looking at many “boomers” needing to take a stream of income. There’s only one vehicle that will GUARANTEE that they can never outlive their funds, annuity.

Fourth, to all the people that state that FIAs are high commission products. I will agree that in the past there were some rogue companies that were paying outragous commissions. However that arguement is outdated. Side note, the MasterDex is not the highest paying FIA.

Fifth, and finally, what is the risk tolerance of the client? What are the goals for the clients funds? How soon do they need to get at the money? We need to look at suitability. We need to take care of the client. We can argue which is better, however no one vehicle can meet all the clients needs.

I’d like to look at some of Chris’ points.

“First of all we’re talking about investment vs. insurance. To everybody trying to compare an FIA (Fixed Indexed Annuity), it shouldn’t be done. An FIA is insurance. The risk is taken on by the insurance company. Hence the ability to guarantee that the there will be no loss in the value of the contract, as long as the individual follows the rules.”

If it is fair to compare the “risk” of the stock market with the “non risk” of the EIA then it is perfectly fair to compare the performance of the two. Also, if Chris’ argument were true then why the heck do all the annuity salespeople start their presentations off by talking about the S&P 500 Index? If it’s not fair to compare an EIA with its underlying index, then salespeople shouldn’t be allowed to even MENTION the index! Once they (the salespeople) mention the index then I think it is fair game to compare the two.

I’ll stop comparing the two as soon as salespeople stop representing their product as a risk-free way to invest in the market.

“Secondly, nobody should have all of their money in one type of vehichle. There needs to be diversification. However, as an individual gets closer to retirement the “time horizon” reduces. This requires an individual to reposition their funds from an investment to insurance.

“Third, as the individual is getting older and is needing to preserve more of their funds, or in retirement and decumulating their funds, we need to look at the type of vehicle the individual is in. One of the things that I feel everybody can agree upon is that we’re living longer. I feel that we’re going to be looking at many “boomers” needing to take a stream of income. There’s only one vehicle that will GUARANTEE that they can never outlive their funds, annuity.”

Notice in the second point Chris states that as a person approaches retirement, their “time horizon” reduces and then in the very next paragraph he talks about how people are living longer. I think the insurance and brokerage industry wants people to look at an approaching retirement as a reduction in your time horizon so that they can justify selling you an annuity. If you retire at 65, there’s a pretty good chance you could still be around at 85, which is twenty years. That’s a long-term time horizon in my book.

Oh, and that GUARANTEE that Chris speaks of is only as good as the insurance company. If the insurance company goes under, guess what happens to that annuity. No, it’s not likely to happen but there’s always a chance that it could.

“Fourth, to all the people that state that EIAs are high commission products. I will agree that in the past there were some rogue companies that were paying outragous commissions. However that arguement is outdated. Side note, the MasterDex is not the highest paying EIA.”

I still say that if annuities are as great as everyone says they are, reduce the commission payout to EXACTLY the same payout as mutual funds. Seriously, why should a salesperson earn a bigger commission from an annuity sale than they earn from a mutual fund sale?

“Fifth, and finally, what is the risk tolerance of the client? What are the goals for the clients funds? How soon do they need to get at the money? We need to look at suitability. We need to take care of the client. We can argue which is better, however no one vehicle can meet all the clients needs.”

Some annuity salespeople scare people into buying an annuity. I would be willing to bet that most (notice I didn’t say ALL) annuity salespeople fail to properly explain market risk to prospect. Instead they get a prospect who is close to retirement, who has saved his money for 30-40 years, built up a nice nest egg and then ask him how much of his nest egg he can afford to lose? When the prospect naturally says, “NONE,” the salesperson is more than happy to point him to a product with a guarantee (and lots of extra fees).

Finally, I wonder how many annuity salesmen on the verge of making a big sale would actually tell a client that the annuity isn’t suitable for them? More likely, they make the sale and justify it later. No, not ALL salespeople would do this but there are those who do.

This is going to sound like a blanket statement, but most people would be better served by avoiding equity-indexed annuities. The only people I have found who even like EIAs are those who sell them.

Topics: Retirement Planning | 11 Comments »


11 Responses to “My Response to a Comment on My Equity-Indexd Annuity Post”

  1. Judknow.Com » My Response to a Comment on My Equity-Indexd Annuity Post Says:
    September 29th, 2007 at 10:24 pm

    [...] unknown wrote an interesting post today on My Response to a Comment on My Equity-Indexd Annuity PostHere’s a quick excerpt [...]

  2. TJ Says:
    September 30th, 2007 at 2:04 pm

    I think the point that Chris was trying to make is that FIA’s SHOULD NOT be compared to (or represented as) an actual investment in the index–by consumers or salespeople. Granted, many an indexed annuity salesperson does just that, thereby perpetuating the idea that an indexed annuity is something that it isn’t. Bad agents, no doubt about it.

    I don’t agree with Chris’s point that as a person approaching retirement needs to “reposition their funds from an investment to insurance” as he says. Certainly, the ‘pre-retiree’ likely needs a more ‘protective’ asset allocation, and this might include the use of annuity products, but that isn’t necessarily the case. And I’d argue that if it is the case, an indexed annuity is very often not the best choice. Side note: people are living longer, and outliving one’s income is becoming more and more of a possibility–thus a very good use of annuity products.

    The question of guarantees isn’t something I worry about, by the way. I can’t point to a single case off the top of my head where an annuity holder lost there money, at least to a highly-rated carrier.

    Regarding the commissions, yes, there are still some carriers that pay huge (by comparison) commissions, but there are also quite a few where the comp is, in fact, in line with mutual fund commissions.

    Finally, you are right–some annuity salespeople do use “scare tactics” to sell. Truth is, I have mixed feeling about this. Some people NEED to be scared a little bit. I have a retired client who, before he became my client, lost a considerable chunk of his retirement portfolio during the market downturn in ’01. His prior advisor had him fully invested in the market with no downside protection. Guess what? That means he got to retire on about 65% of what he was planning on. I can think of some annuity products (as well as some investment strategies!) that would have provided some protection from this.

    In any case, not to ramble, I tend to agree with the idea that FIA’s are not generally the best tool for any job. I’ve said it before, but I still think that the FIA was cooked up in the back room of an insurance company as a way to give non-securities-registered reps an “investment-like” product to sell (mis-sell?).

    Perhaps a future post on annuities in general would be beneficial? An unbiased look at the use of annuities for investment/retirement planning might be a helpful topic.

  3. Dateline NBC Investigates Equity-Indexed Annuities | AllFinancialMatters Says:
    April 15th, 2008 at 12:42 pm

    [...] My Response to a Comment on My Equity-Indexd Annuity Post [...]

  4. David D Says:
    April 23rd, 2008 at 8:19 am

    A couple of comments: many EIAs have no fees at all. If there is a chance that the EIA could get a better return than another no market risk vehicle, such as cash, CD’s, money market funds, why would it not be appropriate?

    I agree, I think EIA’s have been missold, and many of the EIA products are too confusing. But there are some very simple EIAs available.
    Remember many people do not want to invest in the stock market, period.
    Comment on your comparison to mutual fund commissions: people who invest in mutual funds often pay, in addition to upfront sales charges of 5%, annual management fees of greater than 1% (in addition to normal mutual fund expenses, and I’ve seen people with mutual fund wrap accounts with annual management fees of 1% (again in addition to mutual fund expenses) that have not had good performance. No matter the financial product or service unless you are a do-it-yourselfer you’re going to pay fees, with VA’s or mutual funds (in my experience their are plenty of fixed annuities with NO fees). Also did you know that B share mutual funds have very high expenses and usually 7 year surrender charge (although called contingent deferred sales charge). 10% of the people in any walk of life or industry or profession, including doctors, lawyers, judges, politicians, writers, priests, etc.. are not honest.

  5. JLP Says:
    April 23rd, 2008 at 8:49 am

    David D said:

    “…many EIAs have no fees at all.”

    That’s not true. They HAVE TO HAVE fees (or expenses) of some sort or they won’t stay in business. You are flat out lying to people if you tell them that EIAs have no fees.

  6. Stock Market » Blog Archive » Comment on My Response to a Comment on My Equity-Indexd Annuity Post… Says:
    April 23rd, 2008 at 10:29 am

    [...] Deal Journal – WSJ.com wrote an interesting post today on Comment on My Response to a Comment on My Equity-Indexd Annuity Post…Here’s a quick excerptBut there are some very simple EIAs available. Remember many people do not want to invest in the stock market, period. [...]

  7. Jon Says:
    April 25th, 2008 at 2:24 pm

    I did a similar comparison prior to finding this article and my S&P data is quite different. Can you please provide your source for your S&P data?

  8. Mike C Says:
    May 26th, 2008 at 7:06 pm

    All I have to say to the gentleman who thinks Fixed Indexed Annuities are a poor retirement vehicle is:

    Sequence of Returns — Google it!

  9. Steve Hansen Says:
    June 8th, 2008 at 3:08 am

    I think you missed something in your calculations with the index annuity.

    You forgot the annual re-set lock in. I’ll try to illustrate.

    First I want to identify that I am a financial planner I hold securities licenses as well as insurance licenses. I use many financial tools, all tools can be good or bad if used incorrectly.

    Starting with $100,000 in both the market (I’ll use the S&P 500 Index) and in an index annuity.

    Let’s set the S&P 500 Index at 1,000.

    We’ll use your dad’s annuity with a cap of 10% and a participation rate of 100%.

    Market Investment:

    At the end of year one let’s assume a 10% drop in the S&P 500 index. If you were invested in the S&P 500 Index through an exchange traded fund (EFT) that had zero cost (non-existent) The S&P 500 Index would be at 900 and your investment would be worth $90,000.

    At the end of year two let’s assume a 10% gain in the index and the index would now be at 990 and your account would be worth $99,000.

    At the end of year three let’s assume a gain of 20%. The S&P would be at 1038.5 and your account would be worth $113,850.

    Fixed Index Annuity:

    At the end of year one you would still have $100,000 in your annuity (no losses)and your new starting point to track gains would be 900 on the S&P 500 index.

    AT the end of year two the index went up 10% (990) and your dad’s gain would be 10% and his annuity would be worth $110,000.

    At the end of year three the index went up 15% (1,038.5) and your dad’s gained would be capped at 10% ($11,000, $110,000 X 10% = $11,000) and his annuity would be worth $121,000.

    Year 3 values:

    S&P 500 EFT (no costs) $113,850

    Fixed Index Annuity $121,000

    Additional Comments..

    Return Sequence Risk is a huge issue for retirees.
    Contact me for additional info on RSR.

    The picture above does not address many issues: mis-representation of FIAs by bad advisors, ignorance of RSR by equity advisors.

    Both equities and FIAs are good tools when used correctly. The rule of 100 says that an investor should subtract his/her age from 100 the difference is the approximate amount that should be at risk in equities. So a 60-yr old should have 40% in equities, but in order to avoid RSR this money must not be used for income draw down. Success in the market no matter what system is used (asset allocation, sector rotation, seasonal trend) requires time. Equities need to be left to grow for a minimum of 10-yrs preferably 15. Income draw down should come from safe money accounts. What I call the income for life model, which is made up of 6 stages; stage 1-3 must be safe money and 4-6 should be market based.

    Go to my website; http://www.coloradoirahelp.com and click on the red print “Income for Life Model”

    To view the only FINRA (formerly NASD) reviewed presentation of Index annuity go to click on the retirement plans tab on the top of the home page and the view presentation.

    Lastly, I applaud your effort and understand your concerns. I hope that someday soon Fixed Index Annuities become regulated by FINRA as I believe there are far too many insurance salesman claiming to be financial advisors and unfortunately most of them do not have a clue and most likely are only in the business for the money.

    Ask you dad this one question; How much of your retirement assets can you afford to lose due to a market correction? If he answers none, then he should not have any of his assets exposed to market risk and that includes bond funds, because bond funds can lose value if interest rates go up.

    So he needs to have his money in safe money accounts such as CDs, individual bonds that can be held to maturity, passbook savings, money market or Fixed Annuitis (both traditional and Index)

    Warmest Regards

    Steve Hansen

  10. Kirk Mickelson Says:
    December 30th, 2008 at 11:18 am

    Why no reply to Steve Hansen’s comments? Probably because they are pretty compelling. Thanks Steve.

    Regards,

    Kirk Mickelson

  11. Ken Juen Says:
    April 1st, 2010 at 1:11 pm

    I see good arguements on both sides. The annual reset is what makes annuities out shine Mutual Funds. When the market recovers I would much rather make 10% on my original investment than 25% of half of my original investment. Also timing can be everything, losing 50% of my income in 2007 would not be good. An annuity payment would stay the same and have the opportunity for growth during the recovery. Did you notice during the crash of “07″ no fund managers went to cash, no commisions or fees in cash, they rode the market to the bottom with your money and they get large salaries and bonuses.

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