Balancing Expectations       Top   
Index annuities offer customers a long term savings vehicle with the potential for a higher return than they might realize from other conservative alternatives.  However,  indexed annuities are not equity investments nor are they an index mutual fund. No index annuity realizes gains from reinvested dividends and capital gains.  But in a falling market, no index fund provides the protection of principal realized with an index annuity.

A balance picture of the strengths and weaknesses of an index annuity needs to be presented. You could say that an index annuity, unlike a mutual fund, preserves the principal if the market declines, but you should also say that the index annuity does not have the same upside potential of a fund.  You could say that an index annuity has the potential for higher interest than a CD, but you also need to state that the return could be as low as the minimum guarantee.

Balancing language needs to disclose the positives and negatives of both index annuities and the interest crediting structures and product features. For example, it is fair to say that averaging methodologies eliminate the risk of locking in a period's lowest value, however you also need to say that averaging prevents you from getting the highest value as well.  Index annuities can be a solution to a wide array of financial concerns, balancing language creates realistic customer expectations.  The customer needs to be educated about how their index annuity will perform.

They're Not Mutual Funds
At current participation rates no index annuity will come close to matching average mutual fund returns over the long haul. This doesn't mean that index annuities won't produce double digit returns. If the stock market acts again as it did in the '90s many index annuities could generate 10% or higher annual gains, but they won't keep pace with the average stock fund. However, if we have a period of market turmoil as in the '00s, index annuities could realize substantially higher returns than mutual funds.  

Index annuities should be positioned as complements or alternatives to other savings vehicles that also protect principal from market risk. No customer should complain if their index annuity returns 4% or 5% when CD yields are around 3% if you've created realistic expectations of returns.

Minimum Guaranteed Returns
The vast majority of index annuities guarantee a minimum interest rate of 1%-3%. However, most annuities calculate this as a total minimum return. If a customer has only been told the minimum return is 1%-3% and the annuity credits less than 1%-3% they'll have questions.

When the minimum rate is calculated on less than the full premium you could explain the lower guarantee enables the company to channel more of the premium dollars to providing the potential for more excess interest. Tell the customer the purpose of the minimum guarantee is to ensure the accumulated value at the end of the surrender period will at least be equal to the original premium even if the market plunges.

The sizzle behind the guarantee side is not the minimum return; it’s the protection of premium from market risk. “Mrs. Smith, even if the market steadily falls for the next ten years the worst you will get back is your premium”. That’s the story; not earning a measly 3% interest. A low guaranteed return is a positive, it means that more money is available to enhance the index side of the equation

Averaging
I heard from a annuityowner who was unhappy because his index annuity credited 12% interest. The reason for his sadness was that hisr contract had a 100% participation rate and they knew the S&P 500 had gone up over 20%. They wondered why they didn't earn 20%.

Averaging produces a lower ending value when index values are rising. For calendar year 2006 the S&P 500 was up 13.6%. If you apply a 100% participation rate to a monthly average index value the gain for the same period is 5.6% - an effective participation rate of 41%.

Averaging produces a higher ending value when index values are falling. If you look at the one year period ending 8/31/98 the S&P 500 was up 6.4%. If you apply a 100% participation rate to a monthly average index value the gain for the same period is 14.3% - an effective participation rate of 222%.

Averaging always drives numbers to the middle. In a steadily rising period averaging produces half of the gain of an unaveraged line. In a steadily falling period averaging produces half of the loss of an unaveraged line The problem is customers won't complain if they receive more than they expected, but they're unhappy if they receive less than anticipated.

Many index products use averaging. However, if you merely told the customer that they had a 100% rate they might question why they receive less than the total index gain in a rising market. If you are presenting an annuity using averaging you need to explain that the annuity's return will probably not reflect the index return that appears in the newspaper. You need to illustrate the concept and not simply quote a rate.

Creating Expectations    Top   

The Millionaire    Top   
A successful television game show is Who Wants To Be A Millionaire. Through a demonstration of knowledge and nerves contestants can increase their monetary gains until they reach their ultimate goal. The game even provides ways to lower your risk - lifelines and insurance stages that lock in gains once certain levels are reached.

Some players quickly lose their lifelines and show that due to a lack of knowledge or nerves that they really shouldn’t have been in the game in the first place, but even the better players in the game develop a crisis of confidence as the stakes go up and they realize they risk losing much of what they have gained. Because of this, contestants often withdraw from the game before they reach their final goal - even when they know they should keep playing, due to the risk of loss.

The stock market is a lot like the game show. There are people that due to temperament or training probably shouldn’t be in the market and there are many other people with an unrealistic view of the risks of the stock market. Index annuities may be an answer for both because they provide unlimited lifelines if the market goes down. And, EIAs even let you bring in money from another game and protect any transferred gains from market declines. FIAs lock in gains and still let you play the game.

Tic Tac Dough        Top   
Financial vehicles are selected based on their “risk/reward” merits. Certificates of deposit are very low on the risk spectrum because the principal is protected from market risk, but the reward is limited.

Stock investments have an unlimited upside, but the possibility exists that one could lose all of their money. Index annuities protect the principal from market risk (they even provide at least a minimum return if the market goes down), and a potential return that is significantly higher than the CD.

FIA Hockey        Top   
An analogy of where index annuities fit in retirement planning might be to compare the investment world with a hockey game. Many people would agree that the most important player on the ice is the goalie. The goalie’s job is to protect the net; to safeguard the team. The goalie’s task is similar to the fixed rate investments in a portfolio. These fixed investments protect the portfolio from market risk. However, goalies very seldom score goals. Their job is protection, not performance.

There are other players on the ice like wingers. Their job is to take the offense and score goals. They’re flashier than the other players and they go for the big plays. They would be like the mutual funds or stocks in a portfolio. Their main job is performance, not protecting their goal.

But, there are other players on the ice - the defense and center. They skate up and down the rink. Sometimes they help in scoring points and other times they help protect their own goal. Index annuities are like these players. At times they’ll be helping the overall performance of the portfolio, but when they’re needed they’ll be there to help the goalie protect the goal.

FIA Blackjack        Top   

Blackjack is a simple game to play. If you win you get back double your money. If you don’t win you lose all of your money. FIA Blackjack is played a little differently. You can’t go bust playing FIA Blackjack. As long as you stay in the game long enough you’ll always get back what you started with, plus maybe a few extra pennies. Now, the house charges for this no loss provision; what percentage would you be willing to give up of your winnings if you knew you couldn’t lose? If you ask clients this question the most common answer is that they’d be willing to give up half of the potential gain to be protected against loss. Depending on the FIA you’ve chosen the “give up” could be less

FIA Potion    Top
Index annuities are the Viagra® of financial products because they never go down.

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.