FIA Market        Top  

Index annuities were designed to cope with the fear of loss. They either locked in gains every contract year, or they locked in the highest anniversary index value for the term. These designs played to consumer fears of recurring negative market years.

FIAs were then designed to attract risk averse investors that wanted protection of principal and maximum potential gain

The stock market did very well in 1996 and some companies questioned whether consumers would rather have an index annuity that simply tracked the index movement from start to finish - and participated in more of the index growth, than a higher cost crediting structure that locked in the high point, but had lower participation. 1996 witnessed the introduction of several point-to-point crediting products.

FIAs were then directed toward the risk averse savers promising annual locked in returns

1998 was a scary year for the stock market. Although the final returns were very positive, many indexes dipped in late Summer lower than they were when the year began. To answer the consumers’ concerns insurance carriers responded by adding more index annuities which locked in annual returns and increasing the number of annuities with averaging structures that capitalize on choppy markets.

discovered that 18% returns were not a birthright. The protection from market risk offered by index annuities together with the potential for higher interest than traditional fixed vehicles attracted an entirely new group of consumers to the products.

Sales Growth        Top  
Index annuity sales were $400 million in 1995 and have steadily increased. For 2010 total sales were over $30 billion and over $210 billion of index annuities have been sold since inception.

Who Buys This Stuff        Top   
Index annuities are designed for people that are averse to risk. The type of person whom, if given a choice between an investment that has an equal chance of doubling in a year or losing 20% of its value versus an investment that will make 6%, will always choose the low risk/low return alternative. Certificate of deposit and traditional fixed annuity buyers fit this profile. However, the message agents communicate to consumers doesn’t always reflect the consumers’ aversion to risk.

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

Due to the volatility of the market there will be years when the index annuity performs poorly and times of exceptional performance, but indexed annuities are designed to generate long term competitive returns that fall in the middle, between those of equity and fixed instruments. The good news is that consumers are satisfied with this potential because their key reason for buying an index annuity is protection of principal.

The Wheel        Top  
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.  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 consumer 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.

Index annuities are also attractive for stock market investors that want to take their profits, don’t want to lose principal, but want the potential for a higher return than they might get from a money market account.

Index annuities can provide solutions for specific financial concerns. Say that an individual has taken early retirement and received a lump sum pension plan distribution. The person will start drawing on these funds to provide income in a few years. The money could be invested in mutual funds. Over time, equity investments have produced high returns, but the stock market is fickle in the short term and could go down. An index annuity guards against risk to principal if the market goes down while providing higher upside potential than certificates of deposit.

Or, a retired couple already owns traditional fixed annuities and are planning to leave the money in the annuities to their children. An index annuity assures them of earning at least a minimum return while giving them the possibility of bequeathing an even greater legacy.

Or, many people invest their retirement funds in fixed rate instruments. This may be prudent for a worker in their fifties, but it’s a costly strategy for a thirty year old. An index annuity gives these workers guarantees and higher potential growth.

Index annuities are an attractive tool for SEP, SIMPLE and 403(b) retirement plans. They are attractive to the no-load investor and they may be an alternative to bonds.

Potential Returns        Top  
Although the excess interest in an index annuity is linked to the performance of an equity index, index annuities are not equity investments or mutual funds. Mutual fund returns include reinvested dividends and subject the principal to market risk. Index annuities do not include reinvested dividends, but the principal is protected from market risk.

At current rates, no index annuity will provide the same returns as equity mutual funds in a rising stock market. However, many index annuities could provide a substantially higher return than bank instruments or traditional fixed annuities. And, if the market falls index annuities provide the protection of a minimum guaranteed return.

Indexes & Indexing    Top  
The S&P 500 index is the external equity-linked index used in the vast majority of the index annuities purchased today. The S&P 500 Index includes a representative sample of 500 common stocks from companies trading on the New York Stock Exchange, American Stock Exchange and NASDAQ National Market System. The objective of the index is to be a benchmark for U.S. stock market performance and represents over 70% of the domestic equity market capitalization.

Although the S&P 500 index is the dominant external index utilized, other indices are used. Today, several carriers offer equity indices beyond the S&P 500. These indices include the Dow Jones Industrial Average, S&P MidCap 400, NASDAQ 100, Russel 2000, and bond and international indices.  No index sponsors, endorses or sells any index annuity.

Why Indexing?
The intent of indexing is to match the performance of a certain group of investments. The idea is not to try to “beat the market” but to be the market because over time the stock market has gone up. Indexing benefits from diversification which reduces the volatility and risk associated with owning only one or a few securities.

Indexed Funds versus Indexed Annuities
The benefits of indexing - diversification and simplicity, apply to both index mutual funds and index annuities, but they are different animals. Indexed mutual funds include reinvested dividends in their return calculations, but they charge management fees and offer no protection to principal or previous returns from market drops. Index annuity interest calculations do not include reinvested dividends, but principal and credited interest is protected from market risk. No index sponsors, endorses or sells any indexed fund or annuity and indexes make no representation regarding the advisability of purchasing these Products.

Summary        Top  
Index annuities are now in their sixteenth year and they are delivering competitive actual returns. Index annuity sales have grown. The story is a simple one. FIAs may be used to preserve market gains, prevent market losses and give consumers a chance to earn higher returns than they might earn on other savings instruments. Index annuities can provide solutions for specific financial concerns

All information is for illustrative and educational purposes only,  does not provide investment or tax advice, and is not an inducement to buy or sell anything.  Information is from sources believed accurate but is not warranted. Advantage Compendium neither markets nor endorses any financial product.