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2000 Year In Review 1/01
2000 ended a lot of records. As a string of five positive return years
for the S&P 500 was snapped the Dow’s longer parade of nine consecutive up
years also came to an end. The Dow’s 2000 decline was the largest since 1981,
while you had to return to President Carter’s inaugural year to find a worse
time for the Standard & Poor’s 500. And, after posting the highest annual
percentage gain in its history in 1999 the NASDAQ 100 then generated the biggest
loss. Before we review the returns of 2000 I think it would be worth mentioning
that the S&P 500 and Dow Jones Industrial Average have only posted
back-to-back negative performance years once in the last half century. Index
returns for the final year of the twentieth century were as follows:
|
2000 Calendar Year Return
|
|
|
|
| |
Point-to-Point |
Monthly Averaged |
Daily Averaged |
| Standard & Poor's 500 |
(10.14%) |
(3.37%) |
(2.86%) |
| Dow Jones Industrial Average |
(6.18%) |
(7.04%) |
(6.68%) |
| NASDAQ 100 |
(36.84%) |
(4.52%) |
(2.93%) |
| Russell 2000 |
(4.20%) |
0.71% |
1.08% |
The S&P 500 began the year at a level of 1469.25 and ended the year at
1320.28. The highest point was reached on 24 March when the index hit 1527.46;
the lowest point was 1264.74 on 20 December. The index closed lower that its
starting point on 187 days and higher on 65 days.
From a high of 6.75% last January the 30 year US Treasury bond yield trended
down - with the exception of a second quarter burp, ending the year at 5.46%.
Option volatility was nasty with the option volatility (VIX) index averaging
25.947 during the year. Volatility was exceptionally high last April reaching an
average value of 31 during the technology stock rumbles, falling back to under
20 by the dog days of Summer, and then closing the year at levels that brought
back memories of the Asian crisis of 1998.
Sales Success Story of the year - Midland National Life
Product Innovation of the year -
Conseco Annuity
Assurance’s Simple Index
The players stayed pretty much the same. BMA, Life Investors and Monumental
entered the market and SAFECO came back. Pekin Life left the arena. Two trends
developed in 2000. A minor trend was carriers adding absolute or annual
point-to-point crediting products to their portfolios of averaging structured
offerings. A more significant trend was a number of carriers adding products
with multiple indexes. The most significant sales success story of the year was
Midland National Life. Midland National began selling index annuities in the
fourth quarter of last year and was one of the top five sellers of product by
the second quarter of this year. Conseco Annuity Assurance had the most
significant product innovation with the introduction of their Conseco Simple
Index annuity.
2000 began with a record $1.5 billion in first quarter index annuity sales.
Sales dropped in the second and third quarters, and will undoubtedly be down in
the fourth quarter resulting in estimated sales of around $5 billion for the
year - in line with 1999. The decrease in sales was primarily due to very
competitive fixed annuity rates coupled with an extremely volatile stock market.
With the exception of a few bond indexed products, and one monthly averaged
Russell 2000 product, index annuity returns were zero for the calendar year. If
you had purchased an index annuity in 1999 and ended your first contract year in
2000 your credited rate ranged from zero to as high as 15.48% depending upon the
date you bought.
A consensus forecast of the nation’s leading economists, reported in
Fortune’s 12/18/00 issue, said that short term interest rates will remain
basically flat for most of the year and begin rising in the fourth quarter as
growth increases. My crystal ball sees rates softening through the second
quarter.
Index annuity sales are not going to increase until fixed rates retreat under
6%. Agents are correctly perceiving that fixed interest rates are very
attractive from a historical perspective and are selling traditional fixed
annuities. Although it would help index annuity sales if the stock market
resumed an upward course, even this effect would be minimal as long as rates
remain high.
The 2000 stock market should open the eyes of many investors and make them
more aware of the risk of stock investments. After the stock shock has
dissipated, and fixed rate alternatives are less attractive, these people may
decide that an equity linked vehicle that protects their principal from market
risk makes sense. However, index annuity sales will not advance until fixed
rates go down a point from their high and I see this happening in the Spring of
the year.
Annual Reset Index Annuities Reset
Annually 1/01
Most of the index annuities on the market calculate index movement for a
one year period and then credit interest to the index annuity contract applying
a crediting formula to any recognized gain. If there isn’t a gain the contract
simply credits zero for the year, but previous interest credited is unaffected.
The process then begins again using the actual end of the year index value as
the starting point for the coming year. This is the basic structure for annual
reset index annuity products and it is easy to understand. However, the
simplicity of the index annuity structure doesn’t portray the real power of
the index annuity story.
The index annuity locks in the annual gain. The gain cannot be lost even if
the index subsequently goes down. This is a very important feature. Equity
investments have produced significantly higher returns over time than fixed rate
vehicles. Based on the past performance of equity investments why doesn’t
everyone buy stocks? The reason is that stocks can go down and you can lose
money. Index annuities are designed to give the potential for higher returns
than other savings vehicles, but without the market risk to principal associated
with stocks. In today’s financial markets annual reset index annuities are
crediting effective net rates of around 50% to 60% of the actual index gain. At
first glance, participating in only around half of an index yearly gain seems
low and unappealing - especially when compared to pure equity investments.
However, you need to remember that these annuities ignore the bad years.
Suppose we had a five year period where the index acted like this:
|
Index Gains |
Participation Rate |
Annuity Gains |
|
| Year 1 |
+20% |
x 50% |
10% |
|
| Year 2 |
+16% |
x 50% |
8% |
|
| Year 3 |
+12% |
x 50% |
6% |
|
| Year 4 |
-20% |
x 50% |
0% |
|
| Year 5 |
+14% |
x 100% |
14% |
|
Suppose during this same period the index annuity was only able to
participate in 50% of the index gains for the first four years and then was able
to offer a 100% effective participation rate in the fifth year. The credited
rates would look like the Annuity Gains posted above:
If we placed $10,000 in the index and $10,000 in the index annuity, here is
what the accumulated values would be at the end of five years:
| |
|
Index Value |
Annuity Value |
|
| |
Year 1 |
$12,000 |
$11,000 |
|
| |
Year 2 |
$13,920 |
$11,880 |
|
| |
Year 3 |
$15,590 |
$12,593 |
|
| |
Year 4 |
$12,472 |
$12,593 |
|
| |
Year 5 |
$14,218 |
$14,356 |
|
Even though the annuity only offered a 100% rate in one year it still
performed comparably. The reason is because the index investment fully
participated in the fourth year loss; the index annuity was not affected.
My example was designed to show comparable results. In reality, equity
investments should produce higher returns over time than index annuities because
in today’s markets an annual reset index annuity cannot provide full index
participation, but the difference in performance between the two might be closer
than we would think because of the “no market loss” feature of index
annuities.
In 1999 the S&P 500 generated a 19.53% gain. In 1999 annual reset index
annuities produced returns of 8.11% to 12.43% depending upon the crediting
method. In 2000 the S&P 500 lost 10.14% producing a total gain of 7.41% for
the two year period. The index nnuities retained their 8.11% to 12.43% gains for
the same period.
Another amazing feature of these annuities is that they reset. The S&P
500 fell from 1469.25 at the end of 1999 to 1320.28 at the end of 2000. If you
had purchased the index a year ago you would need it to increase 11.3% simply to
be back where you started. But, the index annuity uses the lower ending value as
a new beginning. Instead of merely struggling back to ground zero the index
annuity is sharing in the increase. I’ve read articles from a few doomsayers
stating that we’re in a long term bear market and any future gains will be
from short lived bear rallies rather than long term bull forces. Annual reset
index annuities can capitalize on choppy markets by using slides to their
advantage. At the end of 1972 the S&P 500 closed at 118 - a year end index
level it would not again reach until 1980. If you could have purchased the index
in 1972 you were under water for the rest of the ‘70s. However, an annual
reset structure over the same period would have recognized a 77.9% gain.
Index annuities are an extremely powerful financial tool. Index annuities
provide the protection of other fixed rate vehicles, but with potential for
significantly higher returns. Although they are not designed to compete with
equity investments index annuities may, over time, provide more competitive
returns than expected and with a lot less stress to the nerves.
Day In Not Time In Determined 2000
Returns 1/01
He was too polite to call me a liar, but when I told the caller that the typical
index annuity averaged a return of 5% to 6% for 2000 he was a little
incredulous. Understandably. The client statements he was looking at showed
returns of zero, two or three percent - his top index annuity returned 4.5% and
I’m telling him that the typical index annuity credited about the same rate as
CDs or traditional fixed annuities overall. Indeed, there were many index
annuity owners receiving double digit returns month after month.
Last year the anniversary date of your index annuity was more important than
the crediting method in determining whether you had a good or bad return. As an
example, if you bought the annuity on the “best” day each month in 1999 your
returns in 2000 averaged 6% to 9% depending upon the index annuity you
purchased. However, if you picked the “worst” day each month in 1999 to buy
the same annuity your return averaged 2% to 4% last year. And even though
the peaks were moderate the market was still extremely volatile, so averaging
formulas didn’t have a lot of high days to offset the low ones.
The best performing structures were those with higher participation rates and
lower caps followed by annuities using lower participation rates and high cap
point-to-point structures. Yield spread or asset fee structures tended to be
hardest hit because the gross gains weren’t that high to begin with.
The chart at the bottom of the page assumes that you had purchased different
index annuities on every day of last year and shows what your return would have
been on the 2000 contract anniversary date. One line is a monthly averaging
structure with a 100% participation rate and the other is a point-to-point
structure that also has 100% participation rate, but with a 10% cap. Even though
the capped version would have struck out for the final six weeks of the year and
delivered zero returns, the capped Mean return was 7.5% versus 5.5% for the
averaging product.
Even with a troubled year index annuities in general have a very strong story
to tell. During a time when many equity investments lost money the typical index
annuity produced a return that was at least in the same vicinity as CD rates.
Many index annuity owners also earned a zero return. But you know, if the worst
news you ever have to tell your client is that they didn’t lose any
money, maybe an index annuity is all right.

A Winter Opportunity 2/01
There are a few opportunities I wish I hadn’t missed. I wish I’d
traded Billy my dessert for that Mickey Mantle rookie baseball card of his a few
decades ago, I should probably have bought that Florida ocean front home in 1980
for $27,000 and I ought to have bought Microsoft when my broker called in
1986. As I write this article the S&P 500 is hanging around the mid
1300’s. Less than one year ago the index closed at 1527. The point of all this
is if you lock in the S&P 500 value today you could be up 10% to 15% when
the masses sitting on the sidelines discover their missed opportunity and
finally buy.
If you stepped in after the crash in October of 1987 and bought when the
index was 248 you missed the lower point of 233, but you were ahead of those
that waited until January to buy at 261. If you moved when the S&P 500 was
at 311 in September of 1990 you missed the 295 low in October, but you were well
ahead of those folks buying at the 330 level in December.
Now, I don’t know if this is the bottom of the market. However, I do
believe that the market will continue to advance in the years to come well pass
last year’s high point. Locking in an index value today means your starting
point for calculating future gains is on the low end and you’re getting a head
start on the next move upward. Sure, you may miss the absolute bottom but you
should still be ahead of the game when all is said and done.
Participation Rates Will Be Heading Down 2/01
2000 was a wonderful year for traditional fixed annuities with interest
rates not seen since the mid ‘90s. However, interest rates have been heading
lower and will continue to move down for at least the next six months. At the
end of last year the yield on thirty year US treasuries was 5.50% with 6 month
T- bills are at 5.92%.. My crystal ball says short term interest rates will be
5.25% by Summer with long term rates slightly higher. Bottom line for at least
the first half of 2001 is falling fixed annuity rates and falling CD rates. It
also means downward pressure on index annuity rates.
All index annuities promise an accumulated value at least equal to the
original principal by the end of the
surrender period. To provide this minimum guaranteed return the insurance
company invests in bonds or other instruments. After paying expenses and
ensuring that the guaranteed value is protected any remaining funds are used to
buy options which provide the potential for additional interest from index
gains.
When interest rates go down it takes more bonds to guarantee the minimum rate
leaving less money to buy the options. Therefore participation rates go down
or/and yields spread go up or/and caps get lower.
While interest rates were falling option prices were rising. The option
volatility or VIX index is a way to check general option volatility, although it
reflects the S&P 100 and not the S&P 500.
The VIX averaged a value of 26 last year and in January skirted over 30. To
give that some perspective, VIX values were around 16 to 18 in 1996 and 1997.
Higher volatility means higher prices and index option volatility is higher than
it has been.
The combination of falling rates and higher option prices means a double
whammy for index annuity rates. Index annuity rates will slide. However, falling
interest rates should help the stock market find its legs again so stock prices
and stock index values will head up.
Which leads me to the fire sale thinking. The stock market could be near a
bottom. Index annuity rates - even after a couple of chops, will still be
competitive. So, there’s an opportunity to lock in a low index starting value
at a competitive participation rate.
At some point participation rates will stabilize and start increasing again -
even with low interest rates, because option prices will decline due to lower
volatility resulting from renewed optimism about the direction of the market.
However, by the time participation rates starting heading back up the market
could be a lot higher than it is today. Which means this is probably a good time
to lock in long rate guarantee products.
The Rule of 72-50-2 2/01
You are familiar with the Rule of 72 which tells you approximately how
many years it takes a sum to double at a given rate. It’s handy to be able to
figure out, without using a calculator, that when, say, you’re earning a 6%
return, that by dividing 6% into 72 you’ll find out it takes about 12 years
for money to double. But you know, the Rule of 72 can also be expanded to
illustrate the potential earnings power of index annuities.
Rule of 72 - 72 / 6%
= 12 Years
The Rule of 72-50-2 says that if you can increase the return 50% you’ll
wind up with twice as much by the end of the second lower rate term. Let’s say
that a fixed annuity is paying 6% and we put in $10,000 today. Using the Rule of
72 our $10,000 would grow to $20,000 in 12 years and $40,000 in 24 years.
$10,000 becomes $20,000 in 12 years
and $40,000 in 24 years
$10,000 > $20,0000 > $40,0000
Now let’s say that we believe the index annuity will average a
9% annual return - 50% more than the traditional fixed annuity. Again
using the Rule of 72 our $10,000 grows to $20,000 in 8 years, to $40,000 in 16
years, and to $80,000 in 24 years - double the total return of the other
annuity.
$10,000 becomes $20,000 in 8 years,
$40,000 in 16 years and $80,000 in 24 years
$10,000 > $20,0000 > $40,0000 > $80,000
Even though the index annuity only earned 3% more than the fixed rate
instrument we wound up with double the money.
| |
Start |
Year 8 |
Year 12 |
Year 16 |
Year 24 |
| at 6% |
$10,000 |
|
$20,000 |
|
$40,000 |
| at 9% |
$10,000 |
$20,000 |
|
$40,000 |
$80,000 |
The Rule of 72-50-2 illustrates that even a modest increase in your return
can reap big rewards over time.
A corollary to the Rule of 72-50-2 is the Rule of 72-1/2-2/3. It again talks
about increasing the return 50% (the 1/2 figure), but says that when we increase
the rate of return by one half we can achieve the same final goal of the lower
return vehicle in two thirds of the time. Our goal is $40,000 and we have
$10,000 today. If we can earn 8% the Rule of 72 says our money will double every
9 years and we’ll reach our goal in 18 years.
$10,000 becomes $20,000 in 9 years and $40,000 in 18
years
However, if we can increase our return by 1/2 it takes less time for the
money to double.
8% times 1 1/2 = 12%
72/12% = 6 Years
and we reach the same goal in two thirds of the time.
|
72-1/2-1/3 |
Start |
Year 6 |
Year 9 |
Year 12 |
Year 18 |
| at 12% |
$10,000 |
$20,000 |
|
$40,000 |
|
| at 8% |
$10,000 |
|
$20,000 |
|
$40,000 |
The Rule of 72-1/3-1/2 is useful for showing the power of tax deferral. Say
that you’re earning 6%. If you’re in a combined 33% federal and state tax
bracket it takes 50% longer for your money to double if it isn’t tax-deferred.
Rule of 72-1/2-2/3 72/6% = 12 Years
6% minus 1/3 = 4% 72/4% = 18 years
The Rule of 72 is a powerful financial tool. It gives us the
ability to illustrate many of the benefits of index annuities simply and shows
that if you can earn just a little bit more your goals will be reached faster.
Tomorrow I Will Begin To...
2/01
1. Contact each client every 90 days - It doesn’t have to be a sales call.
2. Review 10 client files a day to see if changes should be made and set an
appointment with the client.
3. Ask for 2 referrals a day.
4. Schedule a “How To Cope With Falling Interest Rates” seminar. Use a
local library or school, notify the newspaper of this service event and call
existing clients and prospects.
5. Schedule a “Supercharge Your IRA” meeting with prospects, clients and
their guests. Talk about IRA strategies in a turbulent market and how the new
rules on distribution will affect them.
6. Plan a campaign. Pick a product you really like, learn all about it, and
tell everyone you meet about the product for the next 30 days.
7. Schedule a 2 hour weekly planning appointment. Sit down and determine the
10 things you most want to accomplish for the week.
8. Start a newsletter. There are several sources that provide customer
newsletters that can be personalized. Send them to your clients and prospects
each quarter. They’re an effective prospecting tool.
9. Send a handwritten note to each client that purchased a fixed annuity from
you last year. Tell them that they’re doing well and current interest rates
are still holding at X%.
10. Send handwritten letters to prospects that didn’t buy from you last
year. Thank them for their consideration and tell them you hope you may be of
service at some time.
11. Call your tax-free municipal bond mutual fund clients. Congratulate them
on choosing an investment that pays tax-free dividends (and probably generated a
gain in value as well).
12. Join an organization that will expand your horizons. It could be a
professional association to increase your knowledge or a business club to
increase your centers of influence.
13. Ask your best clients “If there was just one thing you could change
about doing business with me what would it be?” Your clients will help you
improve your business if you ask them for input.
14. Read or reread “The Sale Begins When The Customer Says NO” by Elmer
Leterman and “How I Raised Myself From Failure to Success in Selling” by
Frank Bettger.
15. Give time or money to a charity you’ve always wanted to help.
Economic Superlatives Of The Last Half
Century 2/01
Greatest Calendar Year
Advances
Dow 43.96% (1954)
S&P 500 45.02% (1954)
NASDAQ 100 101.95% (1999)
Greatest Calendar Year Declines
Dow -27.57% (1974)
S&P 500 -29.72% (1974)
NASDAQ 100 -36.84% (2000)
Most Consecutive Up Years
Dow 9 Years 1991-1999
S&P 500 5 Years 1995-1999
Most Consecutive Down Years
Dow 2 Years 1973-1974
S&P 500 2 Years 1973-1974
Periods With Multiple Consecutive Down Years
Dow One
S&P 500 One
Highest Value
Dow 11723.00 (1/14/00)
S&P 500 1527.46 (3/24/00)
Lowest Value
Dow 196.80 (1/13/50)
S&P 500 16.66 (1/03/50)
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Yields - 6 Month Certificates
of Deposit
High 17.98% (8/81)
Low 3.16% (4/93)
Yields - 3 Month T-bills
High 16.30% (5/81)
Low 0.64% (6/54)
Yields -10 Year T-Notes
High 15.32% (9/81)
Low 2.29% (4/54)
Yields -Moody’s Aaa Corporate Bond
High 15.49% (9/81)
Low 2.57% (1/50)
Seasonably Adjusted Unemployment Rate
High 10.8% (12/82)
Low 2.5% (5/53)
Prime Lending Rate
High 20.50% (8/81)
Low 2.00% (8/50)
CBOE Option Volatility (VIX) Index
Highest Value 150.19 (10/19/87)
Lowest Value 9.04 (12/23/93) |
Index Annuity Superlatives
2/01
Oldest Carrier In The Market
Keyport Life Insurance Company
Newest Carrier In The Market
Oxford Life Insurance Company
Greatest Number of Available Products
American Equity Investment Life
Lazarus Carriers
North American Company
SAFECO
Highest Agent Commission
ING USG Regency
Midland National Direct 16
Conseco Choice EIA
National Western Confidence Select III
North American Market Choice III
Conseco FPDA 500
American Equity Performance
Highest Issue Age - 90
Americo/Great Southern Equiflex
Columbus Life EIA
IDS (American Express) Index 500
ING AmeriBest AmeriLink One
Monumental Future Enhancer
Longest Surrender Period - 18 Years
Standard Life (IN) Equity Income Plus
Shortest Surrender Period - 1 Year
GPM EquiMark II 1 Year
Jackson National ELI 1 Year
Keyport KeyIndex 1 Year
Lafayette Life Marquis Flex 01
Equity Index Annuity Sales Leaders
1996 Keyport Life
1997 Keyport Life
1998 Conseco (American Life & Casualty)
1999 Jackson National Life
2000 Allianz (LifeUSA)
|
Smallest Initial Premium
& Ongoing Premium
Union Central Flex Index
Conseco Choice
Conseco FPDA 500
Great American EquiLink Choice Plus
ING USG GenFlex
ING USG Regency
Lincoln Benefit Savers Index III
LSW Secure Plus FPIA
LSW Secure Plus Select
LSW Secure Plus TSA
Midland National Direct/APP 10
Midland National Direct/APP 16
North American Market Choice
Northern Life FutureLink v1.0
Standard Life (IN) Equity Income Plus
Standard Life (IN) Equity Master Plus
Standard Life (IN) 5 Star
Highest Initial Premium
Jackson National
SAFECO
Greatest Number of Index Account Choices
Midland National Life Direct (6)
North American Market Choice (6)
Freest Withdrawal - 15%/year
Western United Horizon II
Most Innovative Add-On
Midland National Future Earnings Tax Rider
Longest Published Renewal Histories
LSW
Lincoln Benefit Life |
2000 Index Annuity Sales Set New Record
(Barely) 3/01
Index annuity sales for 2000 were over $5.25 billion, up slightly from
the $5.15 billion sold in 1999. The top five index annuity carriers for calendar
year 2000 are:
1. Allianz Life
2. American Equity
3. Jackson National Life
4. Midland National Life
5. Conseco Assurance Company
Sales hit $1.5 billion in the first quarter of 2000, dropped to $1.4 billion
in the second quarter, dropped another 7% to $1.2 billion for the third quarter,
and remained in that territory for the fourth quarter.
The increase in traditional fixed annuity sales directly challenged index
annuity sales. Traditional fixed annuity sales increased due to historically
high interest rates pushing first year rates over 8% and longer term guaranteed
rates over 7%. Nineteen out of twenty index annuity sales are made by
independent insurance agents. Fixed annuities offered returns 1% to 3% higher
than bank instruments; the stock market story was scary; agents returned to
selling traditional fixed products.
In spite of attractive interest rates on other vehicles and a rocky stock
market, fourth quarter sales held their own. Several companies, led by Allianz
Life, posted strong gains in sales when compared with the previous quarter.
The players stayed pretty much the same. BMA, Aegon and Monumental entered
the market and SAFECO returned. Pekin Life left the arena. Two trends developed
in 2000. A minor trend was carriers adding absolute or annual point-to-point
crediting products to their portfolios of averaging structured offerings. A more
significant trend was a number of carriers adding products with multiple
indexes.
Although the top five carriers have always been responsible for at least half
of total sales, it’s a very fluid group. Allianz was the top selling index
provider for 2000, Jackson National was number one in 1999, Conseco in 1998,
Keyport in ‘96 and ‘97. Midland National was not even in the market with an
index product in the Summer of 1999 and yet became the fourth highest seller in
2000.
A comprehensive analysis of fourth quarter and calendar year 2000 index
product sales is available in the Advantage 2000 Equity Index Sales &
Market Report. The report includes information on all index annuity and
index life products currently available as well as data on the typical index
annuity buyer and sources of premium.
It’s Not A Surrender Charge It’s A
Liquidity Cost 3/01
In an article in the December 2000 issue I introduced the concept of
defined liquidity. The idea extends the definition of cash instruments beyond
the standards of protection from market risk and general liquidity, to include
instruments which offer these standards, but may deduct a known and definitive
cost to provide them. Cash instruments with defined liquidity include vehicles
that offer a very high likelihood that the instrument will be around at the end
of the holding period and a similar likelihood that there won’t be protracted
delays in receiving the cash unless there were truly exceptional circumstances.
Using this definition certificates of deposit would be a defined liquidity
cash vehicle. CDs protect principal from market risk and liquidity is generally
available. CDs charge penalties for early withdrawal, but the amount of the
penalty is known from the onset. The penalty could dip into the principal in the
early part of the holding period, but again the maximum cost is known to provide
the liquidity.
Bonds, on the other hand, are not a cash vehicle because the cost of future
liquidity is an unknown. If one holds a bond until maturity the owner receives
the stated par value. However, if one wishes to liquidate the bond prior to
maturity the value received is dependent upon undefined external factors -
including the interest rate environment.
Bonds are very liquid, but their value is not protected from market risk.
Stocks and other equity instruments would also not qualify as cash vehicles
because although they generally are liquid at some price that price cannot be
forecasted with certainty.
Traditional fixed and fixed indexed annuities can meet the cash definition if
they don’t use some type of market value adjustment feature or require
annuitization, but simply deduct a measurable cost if liquidated. Fixed
annuities are liquid. Although they usually have contract provisions that enable
the carrier to delay payment at their discretion this maximum period is also
defined, and in the past it has taken calamities for insurers to materially
delay payment.
Over time, equity investments have generated higher returns than bond
investments and bond investments have generated higher returns than cash
investments. The reasons we shouldn’t keep all of our money in only stocks, or
only stocks and bonds, are due to the risks mentioned previously. An advantage
of defined liquidity instruments is that they tend to pay higher returns than
pure cash instruments while offering protection from market risk . If we adjust
our cash needs to reflect the liquidity costs of these defined liquidity
instruments our cash returns dramatically increase.
Pure cash instruments would include savings and money market accounts. These
have historically produced lower returns than other vessels and currently yield
in the 2% to 5%. As I write this, you can find certificates of deposit yielding
5% to 6% and fixed annuities paying 6% to almost 7%. Say that a fixed annuity
had a liquidity cost of 7% for the first seven years and also an interest rate
of 7%. If you had to liquidate the annuity at the end of the first year the
interest earned would roughly offset the liquidity cost and you’d merely get
back your original principal. However, let’s say the cash instrument
alternative is earning 3%.
Defined Liquidity vs. Cash - Net Returns
| |
Yr 1 |
Yr 2 |
Yr 3 |
| Cash @ 3% |
3% |
6% |
9% |
| Annuity @ 7% (less 7% cost) |
0% |
7% |
14% |
| True Liquidity Cost |
-3% |
+1% |
+5% |
Your true liquidity cost isn’t 7% - the amount assessed by the annuity
contract, but 3% - the difference between what you would have earned in the cash
vehicle and would earn if you liquidated the annuity.
At the end of the second year the return from your cash instrument would be
about 6%, but even after paying the annuity’s liquidity cost the annuity would
have a higher net return. The true liquidity cost of the fixed annuity is not
7%. It’s 3% at the first anniversary and 0% by the second anniversary.
The cost of liquidity - be it a surrender charge
or
a early withdrawal penalty or a “b” fee - isn’t the nominal charge, but
the net return after the cost when compared with the alternative instrument.
The ultimate liquidity cost isn’t as easy to predict with an indexed
annuity because future earnings beyond the minimum guarantee are unknown;
instead we’re comparing finite liquidity costs with probabilities of higher
earnings. However, the worse case actual costs can be computed and at some point
the indexed annuity will make the owner whole.
The defined liquidity aspects of term end point-to-point indexed annuities
which measure index movement over a period of several years may be more
appealing to the risk averse investor than a direct investment in an indexed
fund. Granted, an index annuity owner doesn’t participate in the reinvested
dividends as with an indexed fund nor does one currently receive all of the
upside, but the index annuity owner knows that principal cannot be lost if the
annuity is held to the end of the measuring period.
In addition, the owner always knows the annuity’s liquidity cost and may
liquidate the annuity if a better opportunity presented itself. As an example,
suppose you purchased an index annuity today with an initial liquidity cost of
7% and the index dropped 20% over the next few months. The indexed fund investor
is down 20% and can either wait and hope for future growth or liquidate and
receive 80 cents on the dollar. The indexed annuity owner has the option of
staying put and waiting for the index to climb again, the minimum guarantee to
make him whole, or liquidating the annuity and receiving 93 cents on the dollar.
Liquidating the annuity and taking the loss may seem extreme, but this
example illustrates that the annuity owner always knows the maximum liquidity
cost of the vehicle. There were individuals at the end of 1999 that purchased
NASDAQ 100 indexed funds and NASDAQ 100 based indexed annuities. If the most the
indexed annuity owner can lose is 7%, today, which would you have rather owned?
People keep too many dollars in cash instruments because they want liquidity.
Unfortunately, cash instruments offer lower yields than most financial vehicles.
Over time these people may drown in a sea of liquidity because their returns
haven’t kept them afloat with the rising tide of inflation.
Vehicles with defined liquidity have higher returns than these cash
instruments. The main difference is the higher returns come with a known cost.
People should determine their cash needs and then allocate these directed
dollars within the time and cost constraints of the defined liquidity vehicles
to increase their overall returns.
Annuities Have Temporary Liquidity Costs
A fixed annuity typically deducts a
surrender charge if the contract is liquidated
prior to the end of a predetermined period. However, it may be more accurate to
replace the term
“surrender charge” with temporary and voluntary liquidity cost. Surrender
charge implies an ongoing expense and has resulted in agents referring to
annuity products as having a “seven year term” or being a “ten year
product “
with the stated years representing the period during which liquidity costs are
assessed. In fact, the expense associated with liquidating the contract usually
disappears after an agreed upon duration and the “term” of
an annuity is from date of purchase until the maturity date.
Indeed, a forty year
old owner’s annuity may have a fifty year “term”
and may also have a seven percent cost, but only if
the contract is voluntarily liquidated in the next
eight years. There are indexed annuities that measure index movement over a
multiple of years whose ending point coincides with the last year of the
temporary liquidity cost, but the annuities typically don’t require the
annuity balance to be distributed at
this measuring point.
Quotations for the Insurance
Industry 3/01
On Selling
“The most important secret of salesmanship is to find out what the other
fellow wants, then help him find the best way to get it. When you show a
man what he wants, he will move heaven and earth to get it”
-Frank Bettger
How I Raised Myself From Failure to Success In Selling, Chapter 6
On Overcoming Objections
“There is no excuse for an excuse, but there is
always a reason for it. Nothing is as objectionable as an excuse
masquerading as an objection! Let’s make it an objective to meet every
objection.”
- Elmer G. Leterman
The Sales Begins When The Customer Says “No”, Chapter 8
For an Actuary’s Resume
“I’m very well acquainted too with matters mathematical, I understand
equations, both the simple and quadratical, About binomial theorem I’m teeming with a
lot o’ news -With many cheerful facts about the square of the
hypotenuse.
- Major-General Stanley
Gilbert & Sullivan, The Pirates of Penzance, Act I,
For www.NAIP.org
“Happy is the man who finds
wisdom and the man who gets understanding, for the gain from it is better
than gain from silver and its profit
better than gold.”
- Bible, Proverbs verse 3
For the Marketing Director to Compliance
“The first thing we do, let’s kill all the lawyers”
- Dick Butcher
King Henry VI - Second Part, Act IV, Scene II
|
On Selling Ideas
“I can remember when a guy once told me that he bought insurance from a
particular agent because he was told that if he became disabled, that
particular company would pay the premiums on his policy for him. He didn’t
tell him that 1,854 other companies will do the same thing...An idea was
sold.”
- Joe M. Gandolfo
Robert Shook, Ten Greatest Salespersons
For a Sales Manager to the Field
“It isn’t enough! See! You’ve got to get more money out of our
customers. See! I want you to go to the butchers, the tailors, laundrys
and the rest and milk ‘em dry. See!”
- Boss Zucco
Detective Comics No. 38
On Time Management
“Remember that TIME is Money. He that can earn Ten Shillings a Day by
his Labour and...sits idle one half of that Day...has really spent or
thrown away Five Shillings.”
- Benjamin Franklin
On The Effects Of Compounding
“Remember that Money is of a prolific generating Nature, Money can beget
Money, and its Offspring can beget more”
- Benjamin Franklin
On Taxes
“Neighbors, the Taxes are indeed very heavy, and if those laid on by the
Government were the only Ones we had to pay, we might more easily
discharge them (but) we are taxed twice as much by our Idleness,
three times as much by our Pride, and four times as much by our Folly”.
- Benjamin Franklin
On the Need For Market Research
“Do you hear something?”
- General George Armstrong Custer |
New IRA Minimum Distribution
Guidelines 3/01
On January 11, 2001 the Internal Revenue Service issued new proposals that
simplify mandatory retirement plan distributions. The regulations apply to
distributions taken on or after January 1, 2002 but may be used now.
The Old Way
This area has been governed by complex distribution regulations proposed in
1987. The 1987 proposal required the IRA owner to mandate a distribution pattern
that could not be slowed after the owner became 70 1/2. The previous year’s
balance was used to determine the minimum required distribution based on the age
of the owner and primary beneficiary, and different methods could be used to
calculate life expectancy. When a surviving spouse beneficiary died before the
owner it often caused an acceleration of the taxes owed at both deaths.
The IRS recognized this and explains in the new regulations that “In
general, the need to make decisions at age 70 1/2, which under the 1987 proposed
regulations would bind an individual in future years during which financial
circumstances could change significantly, was perceived as unreasonably
restrictive. In addition, the determination of life expectancy and designated
beneficiary and the resulting required minimum distribution calculation for
individual accounts were viewed as too complex.”
New Proposal
Beneficiary selection at the Required Beginning Date (RBD) is no longer
irrevocable; you can change beneficiaries as often as you like.
Normally, your required minimum distribution calculation will be unaffected
by the selection of beneficiary. With one exception, all calculations will be
based on the account owner’s age less ten years as published in the IRS
tables. An exception is made for a spousal beneficiary that is more than ten
years younger than the account owner - the couple can use a joint life
expectancy table that uses the younger age.
Upon death of the account owner non-spousal beneficiaries will be required to
take the required minimum distribution over their life expectancy.
The new rules let the surviving spouse keep the proceeds and rollover the IRA
to their own IRA or disclaim the IRA to their children or others.
Kind & Simple
No longer will most distribution amounts need to be calculated on the age of the
account owner and beneficiary. The recalculation/no recalculation decision is
eliminated. No longer can the death of a beneficiary after the RBD cause an
acceleration of taxes. The need to satisfy the separate incidental death benefit
rule is eliminated. The IRS predicts that minimum distributions for most people
will be reduced.
|
IRA Minimum Distribution Proposal Highlights
Required Minimum Distributions should be reduced.
The beneficiary’s age is irrelevant. Minimum
Distributions will be
based on the account
owner’s age less 10 years.
No Recalculation decisions.
Proposed Rules may be used now.
No acceleration of taxes upon
premature
death of a beneficiary.
Beneficiaries may be named after death of the account
owner
providing opportunities for disclaimer and “stretching” IRAs.
Surviving spouses have much greater flexibility.
|
Beneficiary
The proposal allows the beneficiary to be determined as late as the end of
the year following the year of the account owner’s death. This permits after
death estate planning and grants a high degree of flexibility. People will be
able to use their own life expectancy to calculate distributions from inherited
IRA’s.
All in all, the proposals are a win for taxpayers and will enable people to
pass along a greater portion of their qualified plans to family and others. The
freedom to change beneficiaries at anytime is a great benefit.
Information obtained from sources believed accurate but not
warranted and is not tax or legal advice.
Consult an advisor for your personal situation.
Prepare For A Nasty Spring
4/01
 |
Falling
traditional fixed annuity rates, a stock market that may not have bottomed, and
nervous consumers - the perfect environment for indexed annuities. From a rational economic point of view indexed annuities are the correct answer for
today. However, current psychological condition of the
consumer may mean a rough few months ahead for indexed annuity sales. |
Newton’s Fourth Law -
A Prospect At Rest Will Stay That Way Unless Shoved
Index annuities offer the potential for higher returns than other savings
vehicles without stock market risk to principal and credited earnings. They are
ideal for consumers that do not have the temperament or time horizon for pure
equity investments and are an alternative for savers that have seen interest rates
drop 1% to 2% in the last year. But, people are in denial.
I’ve heard from investors that can’t bring themselves to admit their
losses. I’ve heard from savers who have cash sitting in low interest money
market accounts because they didn’t lock in the higher rates of a few months
ago. Consumers are traumatized and it will take time for them to heal and be
receptive. In the meantime, when faced with an unpleasant reality many people
choose to do nothing.
Index annuity sales will take off as confidence about an upward direction of
the market builds and low interest rates force people towards alternatives, but
it could take a while until the economy, media and psyches are
all in alignment.
Renewal Rate Integrity
4/01 Almost
two-thirds of the index annuities on the market may change the participation
rate and/or yield spread and/or cap on each contract anniversary. If you further
include annuities that may change some aspect of the interest crediting formula
prior to the end of the surrender period the total percentage of index annuities
with an element of “trust me” in receiving future interest rises to over
70%.
We asked indexed annuity carriers to provide us with their renewal rates. To
date, four carriers have furnished us with their renewal rate histories. As we
anticipated, market conditions at certain renewal periods forced some caps to be
lowered or yield spreads to be increased. However, all four insurers have at
some point in time improved renewal rates, by either raising the participation
rate or lowering the yield spread or raising the cap, when compared with their
initial contract rates.
Carriers That Have Raised Renewal Rates American Equity Investment Life Life Insurance Company of the Southwest Lincoln Benefit Life Midland National Life
The integrity of the insurance company
is more important than the crediting method used in determining which index annuities ultimately credit the most interest to
their contracts. Our analysis has found that although the nominal or stated rate
of index annuities is quite broad, the net effective participation in index
movements is tightly grouped - everyone is buying options in the same market. Even though index annuity returns will not be
identical because products have different loads and other variables, the
treatment of customers at renewal is of supreme importance.
The listing of these carriers doesn’t mean that the other insurers offering
indexed annuities haven’t raised renewal rates. We’ve only
received renewal rate histories from these four companies and everyone of
them had gone back to at least some of the time to their policy owners with a
better deal at renewal.
Why Stocks Go Up & Down
4/01 Mary
has decided that an ice cream shop at the edge of Yourtowne would be a good
business. It would take $10,000 to start the business, but she only has $1,000.
Mary forms a corporation and issues ten shares of stock. Mary invests her $1,000
to buy one share and finds nine other people willing to invest $1,000 each for a
share. The corporation now has $10,000 in capital and Mary’s Ice Cream, Inc.
opens.
At the end of the first year, after paying all operating expenses and taxes,
Mary’s Ice Cream, Inc. has $2,000 left over in profits. The investors decide
to pay out $1,000 in dividends to shareholders and retain $1,000 in the business
to spend on a new freezer.
Corporations issue stock in the form of certificates in exchange for money,
property or services. Each certificate represents a share in the ownership of
the corporation. In the investment world total profits (or losses) are divided
by the numbers of shares of ownership to reflect the proportionate financial
interest of the investors.
To determine the income or loss that each share represents the net income ($2,000) is divided
by the outstanding number of shares (10) which produces a number known as the
earnings per share ($200).
A corporation may also pay out some of the profits as dividends to the
shareholders. To determine the dividend that each share receives the total
dividend ($1,000) is divided by the number of shares (10) and thus is known the
dividend per share ($100).
| For the first year Mary’s Ice Cream, Inc. generated net earnings of $200
per share and paid out a dividend of $100 per share. To figure out how Mary’s
Ice Cream, Inc. is doing we need to use a couple of financial measuring tools. |
Earnings Per Share Net Corporate Income/ #
Outstanding Shares = EPS |
The Price/Earnings or P/E Ratio tells us how many year’s worth of earnings
a share of stock is selling for. The investors paid $1,000 for a share. The
earnings per share are $200. If we divide the share price
by the earnings per share we see that a share of stock sold at five times
earnings. Another way to say this is that the P/E Ratio is 5.
|
P/E Ratio Current Share Price/EPS= Price
Earnings Ratio
|
The P/E Ratio for stocks vary greatly depending upon the industry the
corporation is in and the outlook for the particular company. A higher P/E Ratio
means that investors anticipate that company’s earnings will grow at a
faster rate than a stock with a low P/E Ratio. |
The higher the P/E Ratio, the
more confident or bullish investors are that earnings will continue to grow; the
lower the ratio, the more pessimistic investors are about future earnings
growth.
P/E Ratios indicate optimism about future earnings growth. A
high P/E Ratio says investors are very
confident
that earnings will increase
A high or low P/E Ratio by itself doesn’t mean a stock is better or worse
than another. You need to compare the stock against other stocks in the same
industry.
Mary’s Ice Cream, Inc has a P/E Ratio of 5. To get an idea as to whether
the current share price reflects the true value of the company we’d need to
compare this stock with the shares of other ice cream companies.
Dividends represent a portion of the total return that you get from stock
ownership, but they are not automatically paid when a company has a profit.
Companies in mature industries - utilities would be an example, tend to pay out
more of their earnings in dividends.
| Industries in expanding markets typically retain most or all of the earnings
to finance future growth and pay little or no dividends. Mary’s Ice Cream, Inc. paid a dividend of $100 a share. To figure out the
dividend yield divide the dividend ($100) by the share price ($1,000). Mary’s
has a dividend yield of 10%. |
Dividend Yield Share Dividend/Share Price= Yield
|
Mary’s Ice Cream, Inc. continues to do well. By the end of the fifth year
the corporation’s earnings per share are $800 and the dividend is $400.
One of the investors wants to sell his share. What is a share of stock in Mary’s
Ice Cream, Inc. worth?
|
Mary's Ice Cream, Inc.
Dividend = $400 EPS = $800 Industry P/E Ratio = 6 What Is
Stock Worth? |
Would you pay $2,000 for that share of stock? At $2,000 the stock has a
dividend yield of 20% ($400/$2000) and would sell at a P/E Ratio of 2.5 when
shares of other ice cream industry stocks are selling at a price earnings ratio
of 6!
Would you pay $4,000 for that share of stock? At $4,000 the stock has a
dividend yield of 10% ($400/$2000) and sells at a P/E Ratio of 5 which is still
below the industry average. Lets’s look at the track record. The company has
steadily increased earnings each year and the future looks promising.
|
The price of a share of stock depends upon what someone is willing to sell it
at and another is willing to pay. The price is based on the current and
potential earnings of the company.
Day-to-Day stock prices are affected by emotions and changes
in assumptions of future earnings.
The long term performance of individual stocks, and the stock market overall,
is based on actual earnings. If earnings continue to grow the price of a stock -
or value of a stock index, will trend upward reflecting the economic facts.
However, on any given day the price of the stock may be higher or lower than its
long term value based on emotions and assumptions.
What would happen to the share price if I told you that a new municipal
swimming pool is being built right across the street from Mary’s Ice Cream,
Inc. Hundreds of hot, hungry, thirsty children will cross the sidewalk in front
of the store every day. An investor might pay a little more for a share of the
corporation because their assumptions about future earnings would have
increased.
What if I told you that another ice cream shop was thinking of opening up
right next door to Mary’s. An investor might offer a little less for a share
of stock than they normally would have because if the rumor’s true, future
earnings could be harmed. But, if the rumor wasn’t true the price of the stock
would return to near its long term value.
The daily movements of the stock market react the same way. A rumor or
announcement of events that could increase earnings - like the possibility of
lower interest rates on business loans, causes stock prices to move up. Negative
rumors or events - like recession fears, cause stock prices to move down.
In the final analysis, stock prices and returns are based on actual earnings
over time. If the earnings of a company grows over time the price of the company’s
shares will grow. If you believe that the nation’s economy will continue to
expand, stock indexes will increase in value.
Quarterly Index Annuity
Sales 4/01

Bear Markets - It’s Now or Later 5/01
It’s official. However you define it we’ve met a bear market. Now
the question is when do you get back in?
Interest in equity index annuities is increasing due to the protection from
market risk benefit. Consumers realize that an index annuity will provide at
least a minimum guaranteed return, but minimizing loss is only one consideration
in financial planning. The other half of the equation is maximizing gain.
Unfortunately, the market doesn’t announce its low point
| People tend to sit on the market sideline waiting until they’re absolutely
sure that the bottom has been reached before they buy. The problem is that the
market doesn’t announce when its reached its low point, so you risk missing
the bottom and missing potential profits by not diving in, or diving in and
getting caught in a bear rally whereby the market sinks even further. |

|
I went back and looked at the last three S&P 500 bear markets. The
question I asked was what would the ultimate gain be if we could have purchased
the index on the day the S&P 500 dropped 20% from its previous high, if we
held the index until nine years after that point. Or, what would have happened
if we bought the index six months after it reached the low point of that
particular bear market and held it to the end of the same nine year point.
Bear #1
The S&P 500 closed with a value of 140.52 on November 28, 1980. It didn’t
close above that level until November 3, 1982 spending almost two years in the
financial wilderness. The first time the index closed down more than 20% from
the initial high was on March 3, 1982 with a value of 110.92. If we could have
purchased the index on March 3, 1982 we would have realized a gain of 234% if
held until nine years had passed.
The low point was set on August 12, 1982 when the index closed at 102.42. To
be certain that the bear market was over we would have waited until Lincoln’s
birthday in 1983 to get in. At the market close on March 3, 1991 we would have
been up 151%
Bear #2
The 1987 correction was rapid. The S&P 500 peaked at 336.77 on August
25, 1987 and the first day the index closed down 20% was October 19; the nadir
was hit in December. If you could have purchased the index on October 19, 1987
you would have been up 212% on October 19, 1996. However, if you waited until
June 3, 1988 to buy you were up 163% by that October day in 1996.
Bear #3
The 1990 market was a “bear lite” kind of correction. The October low
point was reached the same day the index closed down almost 20% from its July
high point. If you could have purchased the index when it was down 20% you
would have seen it increase 352% by October of 1999. If you’d waited six
months your gain was 254%.
In these instances you would have been far ahead if you had simply decided to
ignore intuition, hunches and market experts and bought the index when it first
closed 20% below the previous high. Waiting until everyone was sure that the
bear market was over reduced ultimate returns.
S&P 500 Bear Markets - Buy or Wait?
Previous
High Value |
Low
Value |
Buy
on 20%
Decline |
Wait
6
Months |
Final
End Point |
Ultimate
Buy At 20% |
Gain
Wait |
|
08/02/56
49.64 |
10/22/57
38.98 |
10/21/57
39.15 |
04/22/58
42.80 |
10/21/66
78.19 |
99.7% |
82.7% |
|
12/21/61
72.64 |
06/26/62
52.32 |
05/29/62
58.08 |
12/26/62
63.02 |
05/28/71
99.63 |
71.5% |
58.1% |
|
02/09/66
94.06 |
10/07/66
73.20 |
08/29/66
74.53 |
04/07/67
89.36 |
08/29/75
86.88 |
16.6% |
(2.8%) |
|
11/29/68
108.37 |
05/26/70
69.29 |
01/29/70
85.69 |
11/25/70
85.09 |
01/29/79
101.55 |
18.5% |
19.3% |
|
01/11/73
120.24 |
10/03/74
62.28 |
11/27/73
95.70 |
04/03/75
81.51 |
11/26/82
134.88 |
40.9% |
65.5% |
|
09/21/76
107.83 |
03/06/78
86.90 |
03/06/78
86.90 |
09/06/78
105.38 |
03/06/87
290.66 |
234.5% |
175.8% |
|
11/28/80
140.52 |
08/12/82
102.42 |
03/03/82
110.92 |
02/12/83
147.76 |
03/03/91
370.47 |
234.0% |
150.7% |
|
08/25/87
336.77 |
12/04/87
223.92 |
10/19/87
224.84 |
06/03/88
266.45 |
10/19/96
700.66 |
211.6% |
163.0% |
|
07/16/90
368.95 |
10/11/90
295.46 |
10/11/90
295.46 |
04/11/90
377.63 |
10/11/99
1335.21 |
351.9% |
253.6% |
Since 1956 the S&P 500 has experienced nine periods when values declined
more than 20% - or very close to it, from a previous high. The following graph
shows values of the index at each previous high and bear market low, the values
when the index first declined 20% from the previous high, the value six months
after the market low, and the final index gain or loss using an end point nine
years after the day of the 20% decline
The buy on the 20% decline strategy versus waiting 6 months
would have produced higher returns in seven of the nine markets. Even after
including the horrendous 1973-1974 bear market, the buy on the decline method
resulted in a 28% higher average return than if you waited six months after the
ultimate low to enter.
In all but one of the bear markets the buy on the 20% decline method
means you would have watched the index sink further before it bottomed out, but in all but two corrections
buying early generated higher gains than waiting until the next bull market had
been formally announced.
A year from now we will know when the next bull market began and the bear
market ended. Perhaps it’s already happened, or maybe it’s yet to be. This
bear market has lasted over thirteen months which is near the median length of
previous hibernations. By the way, the S&P 500 first closed 20% below its
previous high in March.
All information is for illustrative purposes only and is not investment
advice. "S&P 500" is a trademark of The McGraw-Hill Companies
Inc., and must be licensed for use. S&P Index-linked products are not
sponsored, endorsed, sold or promoted by Standard & Poor's and Standard
& Poor's makes no representation regarding the advisability of purchasing
these Products. Information is from sources believed accurate but is not
warranted.
Most Company Web Sites Have Uninviting
Front Doors 5/01
The Advantage Group did the first study on insurance company web
sites in 1999. Our conclusion then was that most of the sites weren’t worth
the time it would take an agent or consumer to access them.
I recently revisited the sites of the insurance companies offering index
annuities. Almost every site requires agents to obtain password access to gain
deeper entry into the portal. Many of the carriers provided me with a password
and let me explore.
|

|
I’m delighted to report that the information
available to agents in the sites is, on the whole, useful and up to date.
Almost every site I visited provided current rates, product
specifications, forms, customer policy data and even marketing and sales
help. Once you are an appointed agent the company opens its web site and
permits you to enter the vault. |
However, if you don’t have a password the first impression of almost every
index annuity carrier web site is that of a six inch thick steel door with a
sign posted above the doorbell that says “entry denied”.
The front page of a typical company site has a couple of general “who we
are” paragraphs, an agent login button and links to a few generic pages that
offer information like “we’re an insurance company and we sell insurance”.
If you click the products link the site will usually connect you to a page that
may list a few products and provide extremely brief summaries; although there
was one site that regardless of the page linked to always responded with ”call
us for details”. In short, most company web sites convey absolutely no
marketing or recruiting value.
Web sites are 24 hour marketing portals. A prospective agent may hear about a
company and in this browser based age their first look at the company will be
through the carrier’s web site. However, most of the time the web site won’t
provide any useful information about the company or the products. There are a
few exceptions.
The sites for ING USG Annuity and Integrity Life provide “demo rides”
showing the kind of web information agents will receive after they are
appointed. Conseco, Jackson National and SunAmerica also provide a hint of the
treasures that await new agents. But, the best first impression is made by the
web site of Standard Life of Indiana.
The Web Site with the best front door is
www.standardagents.com
StandardAgents.com provides complete product descriptions, sales ideas,
product interest rates, real industry news, financial market information, and
forms and supplies, all without requiring a password. It is an inviting site
with useful information. The site made me want to talk with Standard Life of
Indiana to see what else they offered. Take a look, it shows how a first
impression should be made.
The Bear Market Ended April 4, 2001 5/01
A year from now it may very well be determined that the low point of
the 2000-2001 bear market was reached during the first week of April. This isn’t
a guarantee. Recent positive stock market momentum could be a bear rally with
further hardships yet to come. However, I would not be surprised if the market,
by fits and starts, eventually pushes past the previous highs.
If we are now in the next bull market, what did the millennium bear
ultimately look like?
2000-2001 Millennium Bear Market
|
Index |
Previous
High |
Low |
%
Decline |
| S&P
500 |
3/10/00
1527.46 |
04/04/01
1103.25 |
(27.77%) |
| DJIA |
01/14/00
11722.98 |
04/03/01
9485.71 |
(19.08%) |
| Russell
2000 |
03/09/00
606.05 |
04/04/01
425.74 |
(29.75%) |
| Nasdaq
Composite |
03/10/00
5048.62 |
04/04/01
1638.80 |
(67.54%) |
The bear market was terrible for the NASDAQ, moderate for the Dow Jones
Industrial Average and typical for the Standard & Poor’s 500.
This is the tenth bear market for the S&P 500 in the last fifty years. If
early April was the end, the millennium bear had a duration of almost thirteen
months placing it in fifth place on the list. The decline from the previous high
was 27.77% making it the sixth hardest bear market. All in all, the millennium
bear didn’t cause the long term pain felt with the bear markets of the ‘70s
and early ‘80s, nor was it as gentle as the 1990 expanded correction.
The Millennium Bull
In the last few weeks the S&P 500 has moved up from the low. How long will
it take to blow past the previous high?
If we ignore the awe inspiring 73-74 bear market which took 90 months before
the level of the previous high was regained, previous markets averaged twelve
months after the low to enter record territory with recovery time ranging from
three to twenty one months. If past times are any indication, the S&P
500 could be back over 1500 as early as this Fall and probably not later than
next May.
Most Index Annuities Posting Zero Returns 5/01
Annual reset point-to-point index annuities have yet to post a
positive index related return for 2001. In fact, the last time an annual
point-to-point structure would have credited a positive index return was during
the second week of last November.
Annual reset structures using averaging are faring a little better with some
contracts eking out 2%, 3% and even 4% returns for brief periods in February.
But, the bear has proved too powerful and these structures have also been
smitten.
Term end point annuities have seen any paper gains achieved since late 1998 -
early 1999 erased.
It won’t get any better very soon. The S&P 500 has increased from 1103
at the start of April to around 1250 by the end of the month. However, even if
this rally continues the index was at the 1400 to 1500 level last year pretty
much through December. At best, some index annuity structures may hit passbook
savings or money market equivalent rates this year even if we are now entering
the next bull market.
Where’s The Pony?
The good news is that nobody died. Term end point annuities should have
sufficient time remaining in their periods to overcome this adversity and still
post respectable returns. Annual reset structures are calculating tomorrow’s
new index gains from today’s lower initial points.
This market highlighted the principal protection benefit of index annuities.
A zero return doesn’t sound quite as bad when compared with the alternative of
a 27% or 67% loss.
Consumers now understand the concept of market loss and may not want to
continue using the postman as their financial advisor. In tough times people
look for guidance, safety and a hand to hold. This is an excellent time for
agents to tell the index annuity story.

1st Quarter EIA Sales
Level 6/01
In spite of a miserable stock market and fire sale interest rates on
traditional fixed annuities index annuity sales remained level with the previous
quarter.
First quarter sales were $1258 million compared with sales of $1258 million
in the fourth quarter of 2000. Sales were down sharply when contrasted with the
record $1500 million sold in the first quarter of 2000.
The EIA Sales Leader for the first quarter was once again Allianz.
| Allianz Life |
$236,050,000 |
| Midland National |
$172,400,000 |
| American Equity |
$151,893,840 |
| Jackson National |
$108,551,575 |
| Conseco Assurance |
$84,212,494 |
| AmerUS Group |
$79,407,405 |
| ING USG |
$71,572,331 |
| Fidelity & Guaranty |
$66,000,000 |
| Americo |
$37,124,392 |
| LSW |
$33,704,162 |
The quarter was marked by the departure of one of the pioneers in the
arena when GE Capital withdrew their index annuity from the market. American
General also pulled their index annuity off the shelf. These departures were
balanced with the entry of Oxford Life onto the field and the reentry of Delta
Life.
Bonus products were introduced by LSW and Midland National; Clarica added an
averaging product. ING USG quit the Choice Index. Jackson National added a seven
year version of their ELITE 90 annuity and is closing the ten year product.
ReliaStar pulled the Series I version of their EIA.
In the first quarter products with a surrender period of more than ten years
represented over half of the market. Index annuities with surrender periods of
ten years or longer represented 76% of first quarter sales versus 64% for the
same period last year. There were more sales of annuities with surrender periods
of twelve years or longer than all annuities with surrender periods of less than
ten years combined.
In the previous two quarters products with an agent commission of 11% or more
represented over 40% of sales, but in the first quarter this segment dropped to
31% of total sales. One year ago 42% of the annuities sold had an agent
commission of under 8%; in the first quarter only 25% of the policies sold paid
a commission of under 8%.
Insurance agents continue to dominate distribution. capturing over 96% of
index annuity sales. Annual reset methodologies represented 86% of total sales
and crediting structures using some type of averaging have similar market
penetration. Although ten carriers have introduced multiple index products, the
S&P 500 is still the index used for 96% of index annuity sales.
The average index annuity sales premium reported was $33,116; average premium
ranged from $11,306 to $53,7000. The average fixed annuity premium was $33,452;
average premium ranged from $10,675 to $52,116. The average index sales premium
was similar to that reported in the previous quarter.
Source: Advantage 2001 Equity Index Sales & Market Report
Index Life
Insurance 6/01
Equity Index life insurance sales have reported over $60 million in
premium for each of the last three years. Total EIUL premium for the first
quarter of 2001 was $18.8 million with AmerUS as the leader .
We identified twelve companies that offer equity index life insurance. The
current companies and life products are:
| Allstate |
Equity-Indexed
Universal Life |
| American
General |
Platinum
Accumulator 500
Platinum Provider 500
Platinum Survivor 500 |
| Americo/Great
Southern |
Great
Index UL |
| AmerUS |
Foundation
Builder Plus |
| Bankers
Life & Casualty |
Innovative
Life |
| Conseco
Life Insurance |
Conseco
Indexed UL
Conseco Indexed UL 2 |
| Lafayette
Life |
Marquis
UL |
| Life
of the Southwest |
Secure
Plus Life |
| Lincoln
Benefit Life |
Savers
Index UL |
| ING
Southland |
Legacy
Index
Legacy Pro Index
Legacy Index IE
Legacy Index Survivor |
| Transamerica
Occidental |
Transdex
500 |
| Union
Central |
Excel
500 |
Equity Index Universal Life is for people that need life insurance and desire
permanent protection. They want greater flexibility and greater control than is
available with traditional insurance. In addition EIUL owners: Like the
opportunity for higher potential interest with equity linked returns; Don’t
like the volatility and risks of VUL; Want the certainty of knowing they’ll
earn at least a minimum return in both good times and bad.
EIUL is available as a flexible premium personal insurance plan with premiums
paid monthly, quarterly or yearly. EIUL is available for estate planning
purposes as survivorship life and as a single premium insurance instrument
CDs Also Have Bearish
Moments 6/01
You would have been better off over the last couple of years if you’d
kept your money in certificates of deposit. Over the last two years CDs would
have generated over an 11% total positive return; contrast this with the losses
of the stock market over the same term.
Every time a bear appears in the stock market CD buyers come out and smile
and smugly remark that “while they may not earn as much in their bank accounts
at least they’re protected from that nasty volatility affecting stocks.”
Although it is true that certificate of deposit principal is protected from
market risk the interest earnings can wildly fluctuate.
Since 1970 there have been eight times when CD interest rates fell more than
20% from the previous high in the cycle. On average, the lowest rate in these
cycles was 50% of the previous high.
|
6 Month Certificate of
Deposit Rates -
Decline From Previous Cycle High |
| Cycle
High |
Cycle
Low |
%
Decline |
| 1/70 |
3/71 |
(55.41%) |
| 8/74 |
12/76 |
(60.53%) |
| 3/80 |
6/80 |
(53.04%) |
| 8/81 |
1/83 |
(52.98%) |
| 7/84 |
10/86 |
(52.81%) |
| 3/87 |
4/93 |
(69.61%) |
| 1/95 |
1/99 |
(21.73%) |
| 5/00 |
4/01 |
(36.36) |
If you’d been retired and using CD interest to help pay the bills you saw
your income cut in half on eight separate occasions - once as early as by the
time of next renewal. Bank instruments do provide stability of principal, but
the trade-off is return volatility.
From 1991-2000 the S&P 500 annual gain was 14.86%; CDs
averaged a 5.26% return
Equity index annuities provide protection of principal from market risk.
Because the additional interest beyond the minimum guarantee is linked to the
movements of a stock index, index annuity returns also fluctuate. However, over
time equity markets have produced significantly higher average returns than
fixed rate instruments.
In the ‘90s the S&P 500 index had an annual return of 14.86% - and this
includes the 150 point drop in the final year of the decade. During the ‘90s
six month certificate of deposit rates averaged 5.26%. - the interest rate on
the final CD at the end of the decade was 24% less than the rate earned on the
first.
Today, CD interest rates are 4% to 5% and the stock market is lower than its
been in over a year. Both bank instruments and equity instruments will continue
to be volatile. However, it may make sense to have volatility work for you over
the long term while protecting the principal with an index annuity.
Overall Index Annuity Returns Are
Strong 6/01
The chart below pretends that every month since 1997 you had
purchased: the annual reset point-to-point annuity with the best first year
return, the annual reset point-to-point annuity with the worst first year
return, and annual reset annuities averaging index values generating the best
and worst first year returns.

You can see that the interest credited to these annuities is all over the
board. In general, actual credited interest was in the double digit area when
the index was heading up and at or near zero during the millennium bear market.
What is interesting is that if you add up all of the returns and average them
out you find that these index annuities delivered actual annual first year
interest of 7.3% to about 9.5%.
Depending upon the point-to-point annual reset annuity you owned, and whether
it had a maximum cap on interest and what that cap may have been, your mean
first year returns ranged from 7.50% to 9.35% for the period. Depending upon
which annual reset annuity you bought and the averaging method and rate used,
your mean first year returns ranged from 7.32% to 9.45%.
If you had consistently picked the worst performing index annuities month
after month - and the names of the annuities with the lowest returns changed
depending on the month you’re looking at, you still received an average
interest rate significantly higher than certificates of deposit yielded over the
same period.
Point-to-Point Returns Ranged From 7.50% to 9.35%
Averaging Returns Ranged From 7.32% to 9.45%
Another point is that these returns are after the effects of the worst bear
market in a generation. For the final six months of the chart the stock indices
produced negative annual returns, and yet overall, annual reset index annuities
still credited interest that was, on average, 50% to almost 100% higher than
other traditional savings vehicles.
A final point is even though some crediting methods didn’t average values
and may have had caps, and others averaged index values, the end result is that
the range of first year returns during an extremely volatile market period is
the same for both point-to-point and averaging methods.
Selected
Highlights Of The 2001 Tax Act 6/01
Containing a mind numbing 444 pages of tax law changes and
explanations the Economic Growth and Tax Relief Reconciliation Act of 2001
(HR 1836) was passed by Congress May 26, 2001 and signed by President Bush June
7, 2001. The Act greatly increases the ability of Americans to save for
retirement by increasing contribution limits on qualified plans, eliminates the
estate tax, and provides significant financial incentives for education.
However, most of the individual tax breaks aren’t fully realized for a few
years.
This summary addresses a few of the highlights of the Act. It is not intended
to be comprehensive in any subject area and although the information is believed
to be accurate as far as it goes, it is not guaranteed or warranted. One should
always contact their tax advisor for their individual situation.
Christmas in September
| In 2000 if your taxable income was in excess
of: $6,000 - single individuals, $10,000 - heads of households, $12,000 -
joint filers, you will receive a one-time check of : $300 - single, $500 -
heads of households, $600 - joint filers, probably in September. This
special credit reflects the effect of the new 10% tax bracket carved out
of the old 15% one. |
 |
Even if your taxable income was a million dollars last year the most you’re
going to get is $300, $500, or $600, depending on your filing status. If you
made under these amounts last year your check is reduced by 5% for every dollar
below the thresholds. You won’t get anything if you didn’t have a taxable
income last year or if you were claimed as a dependent on someone else’s
return. The tax credit is not taxable; you will not report the check on
your Form 1040 as taxable income. Of course, if you live in a state that
gives you a deduction for federal taxes paid they will probably want an
adjustment on this tax rebate.
Income Tax Bracket Changes
The most significant delayed benefit will be realized by those filers with
incomes over $300,000 as the maximum tax rate goes from the current 39.6% to 35%
in 2006. In addition, the higher income taxpayers that currently have lost the
deductibility of personal exemptions and up to 3% of their itemized deductions
eventually are treated like everyone else regaining full deductibility by 2010
and getting back a third of the deductibility beginning in 2006.
|
Tax Rate Schedule |
| Now |
10% |
15% |
28% |
31% |
36% |
39.6% |
| 2002 |
10% |
15% |
27% |
30% |
35% |
38.6% |
| 2004 |
10% |
15% |
26% |
29% |
34% |
37.6% |
| 2006 |
10% |
15% |
25% |
28% |
33% |
35% |
The new 10% bracket applies to the first $6,000 of income for single
taxpayers and $12,000 for joint filers. All of the rate tables are adjusted for
inflation (the 10% table won’t be adjusted for inflation until 2009). The
bottom line is the Act means sizable tax reduction for big income earners and
big tax payers; modest benefits for the little people.
No Change In Capital Gain Tax
The current capital gain rates were unaffected, although there will probably
an attempt to adjust these rates as well. However, striving for long term
capital gains tax treatment should become less meaningful for most people as
ordinary tax rates fall. By 2006, the difference between ordinary income rates
and long term capital gains rates for folks with a taxable income of $160,000 or
less will be 5% or 8%. Even people in the highest brackets will have less of an
incentive for coveting long-term capital gain rates.
One effect of the Act is the old argument that “mutual funds
are better from a tax viewpoint
because variable annuity withdrawals are taxed as ordinary income”
becomes weaker.
Now, not only do variable annuities permit you to enjoy realized portfolio
gains without generating an end of year Form 1099, and permit you to sell, buy,
and adjust portfolio positions without fear of immediate tax consequences, and
watch money inside the annuity grow on a tax-deferred basis, but the ordinary
income taxation of these variable annuity benefits has been reduced.
Annuities & Life Insurance
What didn’t happen - taxation of the inside build-up of
annuity and life insurance cash values.
The annuity benefit of tax deferral became (pick one) less important or
more important. You could argue that a general reduction in rates lessens the
importance of tax deferral, or you could say that with lower effective taxes in
the lower income brackets, tax deferral today means deferring higher taxed
dollars for use at retirement when you’re at a lower tax rate.
Kiddy Kredit
The child tax credit gradually doubles over the next ten years increasing to
$600 this year, $700 in 2005, $800 in 2009 and $1,000 in 2010. The Act also
increases the credit for adoptions.
Marriage Relief
The tax “penalty” against married filers almost goes away by 2009, but
nothing happens until 2005. The relief is accomplished by gradually increasing
the married standard deduction to be double that of a single taxpayer and
gradually expanding the 15% tax rate income levels to double those of a single
taxpayer. The schedule is as follows:
|
Marriage Penalty Relief |
| |
The standard deduction increases to |
The 15% tax level
increases to |
| 2005 |
174% of singles |
180% of singles |
| 2006 |
184%
" " |
187%
" " |
| 2007 |
187%
" " |
193%
" " |
| 2008 |
190%
" " |
200%
" " |
| 2009 |
200%
" " |
200%
" " |
Education
Education is a big winner under the Act with expanded contribution
limits, expanded tax breaks and an expanded list of tax-favored
educational institutions.
College Tuition Deduction & Tax
Credits
The Act provides for an above-the-line deduction for qualified higher
education costs. In 2002, taxpayers meeting adjusted gross income
thresholds (below $65,000 - single, $130,000 - joint) will be entitled to
a tuition deduction of $3,000. In 2004 the deduction increases to
$4,000. After 2005 the deduction is scheduled to go away. |

|
HOPE and Lifetime Learning tax credits remain the same. A taxpayer may take
either the deduction or the credit, but not both. It appears to make more
sense to take the HOPE tax credit, rather than the deduction, if your taxable
income is under $80,000. The Lifetime Learning Credit is probably better than
the deduction if you’re under $60,000 to $70,000 in income.
Education IRAs
The Act
-quadruples the contribution ceiling for Education IRAs from $500 to $2,000
beginning in 2002.
- the AGI limits for joint filers wishing to fund Education IRAs will jump to
$190,000 - $220,000
- contributions may also be made by corporations and tax-exempt entities
- permits Education IRA distributions to be paid for elementary and secondary
school educational expenses
as well as colleges
The expanded Education IRA legislation is anincredible
opportunity for financial service providers. Programs, products, seminars and
marketing campaigns will be designed to create annual contribution plans
targeting parents, grandparents, corporations, churches, schools and
organizations.
The estate tax is entirely repealed for one year...so schedule deaths for
2010. Sunset provisions require all aspects of the Act to go away for years
beginning after December 31, 2010. This means some future Congress will need to
deal with estate tax and other issues. However, estates taxes are scheduled to
be phased out.
| Estate
Tax Phase-Out |
| |
Top
Rate |
Exemption |
| 2002 |
50% |
$1.0
million |
| 2003 |
49% |
$1.0
million |
| 2004 |
48% |
$1.5
million |
| 2005 |
47% |
$1.5
million |
| 2006 |
46% |
$2.0
million |
| 2007 |
45% |
$2.0
million |
| 2008 |
45% |
$2.0
million |
| 2009 |
45% |
$3.5
million |
| 2010 |
No
Estate Tax |
| 2011 |
55% |
$1.0
million |
When the estate tax is fully repealed in 2010 the use of stepped-up basis of
estate assets is reduced. Today, the heirs’ tax basis is the fair market
value at death. Under the new law only the first $1.3 million of the estate is
entitled to a stepped-up basis. However, an additional $3.0 million going to a
surviving spouse receives fair market value at death.
This means that the first $5.6 million ($1.3 - husband, $1.3 - wife, $3.0 -
surviving spouse) of a couple’s estate will be taxed at some basis other than
original cost. It also means that record retention requirements could be a
century or more. Imagine a man buying a piece of property at age 21, leaving
that property at his death at age 81 to his age 21 grandchild, and the
grandchild finally sells the property at age 91. To contest an inaccurate tax
basis presented by the IRS, you’d need to produce a 130 year old bill of sale.
IRAs
If the 1982 $2,000 IRA contribution limit had been indexed for inflation,
the current contribution ceiling would be $3,720. While the Act isn’t quite as
generous, IRA limits do increase next year and older taxpayers will be able to
contribute a little more.
| IRA Contribution Limits |
| 2002 -2004 |
$3,000 |
| 2005 - 2007 |
$4,000 |
| 2008 |
$5,000 |
The contribution limits will be adjusted for inflation beginning in 2009 in
$500 increments.
A taxpayer age 50 or older by year-end may contribute an additional $500
above these limits from 2002 through 2005 and a $1,000 more in and after 2006. This
amounts to a potential 50% to 75% increase in IRA sales revenues next year from
a representative’s existing client base.
Low Income IRAs
Single taxpayers with an AGI of $15,000 or less and joint filers under
$30,000 will receive a 50% tax credit for up to $2,000 in contributions to an
IRA or qualified retirement plan. Single taxpayers with an AGI of $25,000 or
joint filers with a $50,000 income will get a 10% tax credit in 2002.
|
Low Income Credit |
| Joint Return |
Head of Household |
All Others |
Credit |
| $30,000 or less |
$22,500 or less |
$15,000 or less |
50% |
| $30,001-$32,500 |
$22,501-$24,375 |
$15,001-$16,250 |
20% |
| $32,501-$50,000 |
$24,376-$37,500 |
$16,251-$25,000 |
10% |
Rollovers
Today, IRA distributions may only be rolled over to another IRA (unless the
IRA is funded entirely from a pension plan distribution). In 2002, eligible
rollovers from IRAs, 403(b) annuities, qualified retirement plans can be rolled
to any qualified plan accepting the rollover. This greatly simplifies
retirement planning and could be a windfall for 401(k) and 403(b) plan sponsors
enabling them to gather more qualified assets under one roof.
Under current regulations, if you don’t complete a qualified rollover
within sixty days the amount cannot be rolled over. The new law says you can
petition the Secretary of the Treasury to waive the sixty day requirement
for good cause.
Congress has also instructed the IRS to update the mortality tables used to
calculate minimum required distributions to reflect current life expectancies.
Qualified Plans
The Act devotes a large number of pages to pension reform, and all for the
better. Some of the highlights going into effect after December 31, 2001 are:
-Annual Compensation limits increase from $170,000 to $200,000
-Maximum Defined Benefit Limit increases from $140,000 to $160,000
-Contribution limit goes from $35,000 to $40,000
-25% contribution limitation goes to 100% of compensation
-Deferral limits on 401(k) and 403(b) plans increases from
$10,500 to $11,000 in 2002
and $1,000 a year thereafter to a top of $15,000 in 2006.
-SIMPLE plan limits increase from $6,500 to $7,000 in 2002 and $1,000 a year
thereafter to a top of $10,000
-Cliff vesting reduces from five to three years, graded
vesting reduces from seven to six years
-Congress provides tax credits for small employers wishing to
start a plan
Elective Deferral Limits
The maximum deferral limits for 401(k), 403(b) and SIMPLE plans start
increasing next year. After the last scheduled increase limits will be indexed
for inflation in $500 increments.
| New
Contribution Limits |
| |
401(k),
403)(b) |
SIMPLE |
| 2002 |
$11,000 |
$7,000 |
| 2003 |
$12,000 |
$8,000 |
| 2004 |
$13,000 |
$9,000 |
| 2005 |
$14,000 |
$10,000 |
| 2006 |
$15,000 |
$10,000 |
Catch-Up Contributions
401(k) and 403(b) participants age 50 and older may contribute an additional
$1,000 over the limit in 2002. The catch-up amount increases by $1,000 a year
until it reaches $5,000 a year by 2006. For SIMPLE plans the catch-up amount is
$500 a year increasing until it reaches $2,500.
Plans will not be required to permit catch-up contributions if they don’t
want to. However, these extra contributions are not subject to nondiscrimination
rules, so it makes sense to offer the benefit.
Small Employer Tax
Credit
If an employer with 100 or fewer employees elects to start offering a
retirement plan in 2002 or later, they can receive a $500 tax credit to help
offset administrative and retirement education expenses each year for up to
three years.
The tax credit is only for employers that haven’t offered a plan for the
last three years and is available for new plans starting after December 31,
2001. The credit is 50% of the first $1,000 of administrative and employee
education expenses for the first three years of the plan.
Beginning next year, the IRS will no longer charge small employers fees for
determination letters.
Summary
The Act is complicated and wide ranging. It provides modest tax relief for
most taxpayers and more significant relief for Americans earning six figures or
more.
The Act does kill the federal estate tax. However, due to Sunset provisions
the tax will reappear in 2011 if a future Congress doesn’t act. In addition,
the potential loss of stepped-up tax basis for some assets could replace today’s
estate tax liability with tomorrow’s capital gains tax expense. The bottom
line is unless estate planners want to rely on the generosity of a future
Congress, the purchase of life insurance to cover estate cash needs remains a
prudent course of action for many people.
Education is a big winner under the Act. The threshold income limits
permitting the deduction of student loan interest were substantially raised.
Private colleges may begin to offer pre-pay tuition plans just like state
sponsored programs. The raising of Education IRA limits (and the list of
potential contributors) makes these accounts a worthwhile market.
IRA purveyors will realize a 50% to 75% increase in their potential revenue
base without adding new clients. Financial consultants should begin booking
space for January IRA seminars today.
Qualified plans will become even bigger and attract more assets with raised
contribution limits and the easing of rollover restrictions. Small businesses
are better pension prospects than ever.
The Economic Growth and Tax Relief Reconciliation Act of 2001 offers
incredible opportunities for financial service providers.
Index Annuity Returns Are A Matter Of Degrees
6/01
The last twenty years were a robust time for the stock market, even with the
inclusion of four bear markets. If you look at seven year periods from 1981
until the end of the century - 1/1/81 to 1/1/88 through 1/1/94 to 1/1/01, you
see that the average S&P 500 return, without reinvested dividends, for all
of the calendar year periods was 12.95%. The way this is measured is the final
value of the index is compared with the initial value seven years prior and a
gross percentage gain is computed. From this total gain, the annual compounded
rate can be determined.
Most index annuities measure index movements on an annual basis. A
participation rate/yield spread/cap is applied each year, positive gains are
credited as interest, negative years are treated as zeros. Because an annual
reset index annuity doesn’t lose ground in down years, it doesn’t need to
participate in all of the index movement to produce competitive returns. Over
this twenty year era an annual reset point-to-point index annuity with a 93%
participation rate would have produced the same average return as using 100% of
the S&P 500.
However, there aren’t any annual reset point-to-point index annuities
around with a 93% participation rate. Today, the typical unaveraged annual reset
annuity, without a cap, has a participation rate of 50%. You can find index
annuities averaging annual values with higher rates, but averaging always drives
values to the middle. In this twenty year period an averaging index annuity with
a 75% rate generated about the same overall return as a 50% annual
point-to-point design.
At current rates no annual reset index annuity will produce
sustained double digit returns
What does this mean? If the next twenty years duplicates the previous score,
the typical annual reset index annuity will not average a 12% return, nor a 10%
return, nor even an 8% return. At today’s rates, annual reset index annuity
returns would average around 7%.
But, rates should go up
In the grand scheme of things a 7% interest rate isn’t bad for an
instrument that protects principal and credited interest from market risk.
Current bank rates are 4% to 6% and a 7% index annuity return would be
competitive. However, what if you feel a potential average return of 7% isn’t
enough?
One alternative is using an index annuity with a different crediting method.
Term end point index annuities, measuring gain over multiple year terms, would
have periods with double digit gains even at current rates, but interest is not
usually credited until the end of the period. The other alternative is to select
a good carrier and wait.
Most annual reset index annuities can change the participation rate and/or
yield spread and/or cap prior to the end of the period, and usually on an annual
basis. This flexibility means that future rates could be lower, but they could
also be higher. One of the major costs in determining the degree to which the
consumer participates in the index is the cost of the options providing the
potential index-linked interest. From a long term point of view the current
prices on these options are high. When option prices decrease insurance
companies can buy more of them and participation rates and/or caps would go up
and yield spreads would go down. It doesn’t take much a change in rates to
increase returns.
Looking at these seven year periods over the last twenty years the average
annuity annual return increases about 1% for each: 7% increase in a
point-to-point crediting method rate, 11% increase in the rate when using
monthly averaging, or 2% increase in a cap with an annual point-to-point design.
A point-to-point design at a 60% rate or a monthly averaging design with a 90%
rate generates average returns of over 8%; an additional 10% increase in rate
pushes average returns over 9%.
The chart shows the hypothetical yearly returns for an annual reset index
annuity, averaging monthly index values, using seven year periods. The numbers
at the bottom of the chart represent the first year of the seven year periods
(the first number represents 1/1/81 to 1/1/88 and the last 1/1/94 to 1/1/01).

Annual reset index annuities probably won’t get you long term double digit
returns even if the stock market does a repeat of the last twenty years.
However, because option prices are at relatively high levels today, future index
annuity renewal rates can benefit when option prices fall. Higher renewal rates
could push returns into the 8% and 9% range for some periods, which is pretty
good for a savings vehicle which protects principal and credited interest from
market risk.
What if the bottom drops out of the stock market?
Index annuity interest is linked to an equity index. If the market does poorly,
so will the index annuity. But, annual reset annuities have two features that
help when the index declines. First, every index annuity has a minimum guarantee
saying you’ll get back at least your premium at the end of the period. Second,
annual reset annuities reset annually meaning they can take advantage of bad
times. If you look at seven year periods ending in the ‘70s the average annual
S&P 500 return was 0.77%, but an annual reset point-to-point index annuity
with only a 60% rate would have averaged a return during the same time frame of
over 5% a year.
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