2004 - A Better Year    1/04
Congratulations, you survived. You survived the worst bear market since the Great Depression. You lived through a year that saw annuity minimum interest guarantees return to the levels of the 1940s. You kept selling in an ever changing marketplace of pulled products, lowered commissions, falling caps and shell shocked prospects. You did it and you’re still here. Although 2004 won’t be an easy year, it will be better than 2003.

Rising interest rates will make fixed rate and fixed index annuities more competitive, and although CD rates will rise as well, annuities will still enjoy a competitive advantage.

Index annuity statements finally show meaningful results after three years of zero returns or thereabout. The index annuity story for 2004 is real returns, better index participation, and protection against the next bear market.

The Advantage Group is now Advantage Compendium. A compendium is defined as a short, complete summary of the subject covered, something I have strived to do in the index annuity world. The new year will see Advantage Compendium offer new tools and explore new topics.

Last year I wrote of Annus Horribilis. 2004 will be Tempus Opportunitas (a time of opportunity). Enjoy.

Situation Realization Prospecting...   1/04
targets the situation that causes awareness of the need for your product and creates an opening for a marketing arrow to reach the target. 2004 presents certain prospecting opportunities; here are five.

The Bond Fund Plunge
Say a ten-year bond has a 6% coupon rate and pays $60 a year interest. If bonds with similar maturity dates and creditworthiness also had 6% coupon rates the bond would sell for $1000. But what if new ten-year bonds were paying 7% coupon rates?

No one is going to give us $1000 for a bond paying $60 when they can get $70 on a new one. They’d give us less than $1000 for our bond. Now multiply that one example by a zillion and you have a future glimpse into 2005 for many bond mutual fund owners.

Interest rates should go up in 2005. When interest rates go up bond values go down, unfortunately many bond mutual fund owners don’t realize this.

Endangered Series HH Savings Bonds
Unlike Series EE Savings Bonds and I Bonds, which are savings instruments, Series HH Savings Bonds are income vehicles. Every six months an interest payment is directed deposited in the checking or savings account of the owner. When you redeem Series HH Bonds you receive the face value – no more, no less.

You cannot buy Series HH Savings Bonds for cash. You can get them only in exchange for other savings bonds like eligible Series E Savings Bonds and Series EE Savings Bonds. Series HH Savings Bonds pay miserly rates – the current yield is 1.5% – but they do offer one significant benefit.

Series E and EE bonds share with annuities the ability to defer the payment of income taxes on interest earned as long as the money remains inside the vehicle. However, these reach final maturity 30 years after issue at which time all of the deferred interest becomes taxable, unless the savings bonds are exchanged for Series HH bonds. If you exchange growth savings bonds for Series HH bonds you can continue to defer the taxes due on the original savings bond interest build-up for another 20 years.

A lot of people own savings bonds, and I am surprised by the number of consumers out there that both own savings bonds and are aware of the Series HH swap feature, but they may not be aware the Treasury has announced its intention of discontinuing issuance of HH Bonds in mid-2004.

So what does this mean for producers?
During the qualification process the consumer should be asked if they own savings bonds, and if yes, ask if they are aware that the Series HH swap window will close this year. Savings bond buyers are conservative, understand the power of tax-deferral, understand the benefits of tax-free exchanges, and they don’t need current income. This is a portrait of a fixed annuity buyer.

Unfortunately, you can’t do a 1035 exchange between a savings bond and an annuity. Informing the consumer that they still have time to do the saving bond shuffle is a good deed, not a moneymaker, but asking the questions identifies the strong annuity prospects. What if their experience with savings bonds has turned them against tax-deferral and the eventual tax payback? Well, there’s always single premium life.

Show Me The Returns
For the first quarter of 2003 the S&P 500 average index value was 861. Going into 2004 the S&P 500 is at 1111. This means most index annuities will be crediting interest in at least the first few months of 7%, 9%, or more. At the same time CD rates are between 1% and 3%. Show your prospects a current index annuity statement and ask if they would like to learn more. Bragging ain’t bragging if it’s true and it’s hard to turn away from a good story.

Go Back To The Well
When your customer bought that index annuity in the first quarter of 2003 the S&P 500 average index value was 861. Going into 2004 the S&P 500 is at 1111. This means the customer’s index annuity will be crediting interest in at least the first few months of 7%, 9%, or more. At the same time CD rates are between 1% and 3% and bond funds may have lost money. It’s time to call all of those people that purchased an index annuity from you, congratulate them on their decision, and ask which lower yielding assets would they like to transfer to index annuities.

IRS Form 1040 Lines 8a, 8b & 9
This prospecting opening is not unique to 2004, but an annual rite of spring. Remind folks of the wonderful tax benefits of all deferred annuities by pulling out a yellow highlighter and marking up Tax Form 1040. Ask how much interest income they are reporting on Line 8a (Taxable interest) and describe how annuity interest left inside the contract is not subject to current taxation and thus reduces current tax bills. If interest is listed on line 8b (Tax-exempt interest) ask if they knew that tax-deferred annuity interest, unlike municipal bond interest, does not contribute to Social Security Benefit Taxation (SSBT). If there are figures on line 9 (dividends) inquire whether they are comfortable with the risk to principal found in stocks and funds and would they be interested in learning about a vehicle that protected principal and credited returns from stock market risk (and might reduce their current taxes too).

Guest Commentary by Ray Ohlson    1/04
Deficit Spending - This term is being bantered about, almost daily, in the press. Is it always bad? This isn’t meant to be a political discussion. I’m proposing “good” deficit spending as we enter 2004. “Good” deficit spending is an investment that will reap a profitable return. It will help to grow an organization or an entity.

Today, we are facing challenges to our businesses. We have do not call lists, anti-spam legislation, anti-faxing rules and new California laws that threaten to change the way that we do business. These challenges also bring about great opportunities. We must invest in new methods of marketing that may, I emphasize may, turn into tremendous opportunities. We have to invest in ourselves. Financial service representatives that do this will, in time, reap greater market share. But, there must be experimentation. There must be some risk taking. There may even be times when you risk your capital, or borrow money, to try these new ventures. Hence, deficit spending. Spending money earmarked for other means is risked in a new trial and error enterprise.

Here are some examples:

1. Put aside some money for a new direct mail program. Be straightforward in your approach (no hooks, tell them you are selling an annuity or simplified issue life) so you get qualified prospects responding.

2. Try something that will appeal to the consumer mass media. What about newspaper, television or radio? What about a regular column or radio show?

3. Develop, or redesign your website. It’s your electronic brochure. More and more seniors are going to the web to check you out. What are they seeing? Are you putting your best foot forward?

4. Sponsor client appreciation coffees, luncheons, dinners or even a wine tasting. Admission charge? Ask them to bring another couple. Give a short presentation on a general topic that should be of interest and ask them to fill out an interest form to determine future topics, and then contact the viable prospects.

5. Advertise on senior websites.

6. Give a presentation at a senior organization’s regularly sponsored meeting. Bring in the coffee and cookies.

7. Think about hiring a resource concierge. This person will be available to assist your clients in “non-product and non-planning” situations. In other words, be the source directing clients to all the information they need.

8. Write, or purchase, a newsletter to be sent to clients and prospects. Place your picture and biography on the piece and watch how you are perceived to be “the expert” in your area.

WHEW! And this is just a short list. Where do you get the money for this if you don’t have the money? How about borrowing? Would that be deficit spending? You betcha. But, it’s good deficit spending. It will produce revenues that will pay off the loans, allow you to hire, expand and prosper. Business and governments do this everyday. Did you ever have a student loan? Why? Because the degree put you in a position to potentially earn more money and be more successful. This is still being done today and is worth every penny!

Now, before you get out your checkbooks, look at your marketing/business plan. Here are some marketing plan components you should analyze:

Market Review – Trends Overview, Market Segments, Target Market (both primary & secondary),

Product Review – What will you present? Annuities, Single Premium Life, LTC, Med Supp, etc.

Develop Strategies For Positioning your products & services – Communications and Promotions

Create An Action Plan and Implementation – Media Plan, Budget, Schedule        And

Develop How To Evaluate Results – Lead Tracking and Sales Reviews

So, how will you do in 2004? You must keep growing. You do need to take risks. Make them calculated risks. Determine which ideas fit your business and dive in. Spend or borrow….invest in yourself. Your clients believe in you…believe in yourself!

Protect Consumers From Themselves   1/04
Last year DALBAR reported the results of a study showing that for the years from 1984 through 2002 the S&P 500 averaged an annual return of 12.22%, while the average investor earned 2.57% ⁽The Economist 7/5/03 “The law of averages” p.7⁾. How could investors generate passbook savings returns during the greatest bull market period in history?

The main reasons investors earn lousy returns and continue to make the same mistakes over and over again are a lack of understanding about the realities of risk, and even when they do understand, their decisions are usually driven by their heart instead of their head.

Risk/Return Realities
I am sure you have heard that the longer you stay in the stock market the less likely you are to lose principal. And it’s true. If you look at performance of the S&P 500 over the last 50 years 17.0% of the five year holding periods resulted in a loss of principal compared to 9.5% of the ten year periods. But that’s not the whole story. Even though only one in ten ten-year stock market periods would have resulted in a loss, one in three would have produced a return of under 5% a year.

Think about that. You’ve endured the ups and downs of the stock market for ten years, but based on historical performance there’s a one in three shot that you probably could have done just about as well nestled in a bed of bonds or fixed annuities. One out of three times you were not rewarded for the extra risk you took – that risk being the one in ten chance of losing your original dollars.

I’m not denying the odds of getting better than a 5% annual return are in your favor if you play the market for longer periods, what I’m saying is if consumers understood the realities of stock market risk and return, many of them might conclude that the risk of loss is too great even given the better than even odds of success. And even when the head understands the risk and the odds, the heart takes over and screws everything up.

When bull markets are raging greed takes over and we buy at cycle tops because we don’t want to miss out, when bear markets begin we don’t sell after our gains have slipped by 4% (on their way down to 20% or more) because we hope good times will quickly return, and when the cycle has bottomed and is poised to rise again we sell, because we extrapolate the bad times out in time forever. None of these actions are logical; they are all driven by emotion.

Fixed index annuities can get people off the emotional roller coaster of always buying high and selling low by removing the risk of market loss from the decision process, and they can improve the odds of the consumer at least receiving a competitive return. The tradeoff for improving the odds of getting a competitive return is lessening the chances of double digit returns.

Fixed index annuities, with the possible exception of some term end point designs, are not currently priced to deliver sustained ten percent plus returns if the stock market really takes off.

Although an index annuity could deliver an occasional double digit year, current caps or other index participation limits means sustained high returns are unlikely. But that’s okay. Even if the index averaged a 12% annual return over the next 20 years and the index annuity averaged 8%, this doesn’t mean the index annuity failed because it only realized two-thirds of the index return. It means the index annuity succeeded because the consumer realized three times what they might have without the index annuity.

2003 – A Mixed Bag of FIA Returns   2/04
In calendar year 2003 the stock indices closed higher for the first time in four years. The S&P 500 and Dow Industrials were up over 25%, Nasdaq rose over 50% and the Russell 2000 grew 45%. All in all, it was a very good year for the market.

Index annuity returns for 2003 ranged from feast to famine depending on the crediting method used, with biennial structured annuities crediting zero and an index annuity linked to the Russell 2000 crediting almost 14%. The wide range of returns was due to the poor pricing environment a year ago and the scattered way the indexes closed day by day.

A year ago option prices were higher than they are today and interest rates were lower than they had been. This placed limits on potential index-linked interest earned resulting in lowered caps, larger spreads and lower participation rates. The lower caps translated into annual point-to-point returns in the 7.0% to 11.5% range, even though the actual indices rose 25% to 26%. The highest annual point-to-point based interest was produced by an annuity using a combination participation rate and spread method that resulted in a 13.1% return.

However, spread designs generally resulted in the worst performance for averaging based crediting. This was due to gross averaging returns that represented about a third of the unaveraged index gains. Spreads have greater impact when returns are low, and thus a combination of single digit averaging gains and higher spreads resulted in yield spread averaging annuities crediting interest rates of 1.0% to 8.1%.

Other averaging designs did better. Capped averaging methods generated returns ranging from 3.6% to as high as 13.9% with many vehicles crediting 6% to 8% interest for the year. The cap philosophy of “most of less” was the winning strategy for averaging products in 2003.

Although point-to-point designs usually credited more interest than averaging structures for 2003, it was not universal. Two of the annuities crediting over 12% for the year were point-to-point designs and two featured monthly averaging. The year did not decide which crediting method is best, but merely emphasized the fact that different methods react differently to different markets.

My crystal ball shows the pricing environment for index annuities will improve in 2004. If the indices cooperate it could be a very nice year.

And So The Greed Resurfaces...  2/04
I get emails from consumers. I don’t know how they track me down – I don’t like dealing with real people – but I still get a steady stream of queries from the public. Last week I received an email saying:

Dear Sir:
My index annuity only returned 10.5% for 2003 although
the stock market was up 25%. Which index annuity will produce better returns?
A. Consumer

When I received this email I was able, by touching the computer screen, to magically transport myself back to the fall of 2002 and be in the room when this consumer met with his financial counselor. I heard the consumer lament that he had lost half of the value of his mutual fund portfolio, so he had sold all his funds, never wanted to risk a penny more of his principal, and therefore was going to place the mutual fund proceeds in a 1-year CD that was yielding 1.5% interest. I then heard his financial counselor plead with the consumer to try an index annuity and at least retain the opportunity to achieve a higher return, and after much resistance and rending of garments the consumer agreed to put the money in the index annuity.

And now this putz is complaining because he only made seven times more interest than he would have made in the CD. Or to look at it another way, if rates stay the same and the index annuity doesn’t credit another dime the consumer’s CD choice would finally credit more total interest by sometime in 2009 than had already been earned with the index annuity.

In 2000 and 2001 consumers were in hope mode whereby they did nothing when their investments fell a little on their way to falling a lot because they hoped they would go back up. In 2002 and 2003 consumers entered fear mode and many sold their investments convinced that the bad times would continue forever.

Today, with a year of stock market increases behind them, consumers have reentered the greed mode, determined not to miss out on the maximum possible gain and ignoring any risks. For the index annuity story to be successful in 2004 the producer needs to disconnect the consumers from this emotional investing cycle, and there are a couple ways to help achieve this.

Fixed Index Annuities
If you use the phrase equity index annuity you set up a scenario for unrealistic return expectations. In greed times the use of the equity word causes consumers to think of unobtainable high returns, and in bad times equity makes consumers think of losses. An index annuity is a fixed annuity with interest linked to the movement of an index. Over time, an index annuity is designed to compete with other safe money places. If a consumer wants maximum potential growth and can emotionally handle the risk the consumer should not buy an index annuity. BUT, they should be very aware of the risk associated with going for the big returns.

Risk Education
Investors are rejoicing that the major stock indexes increased 25% to 50% last year, but as of this writing the indices are all still below their highs of four years ago, and some investors that came into the fray at the end of the last bull market may not be made whole for years. Consumers have short memories. The consumers that today say they can handle the risk need to be asked what they did two years ago. Did they stay in the game or did they fold. If they walked away from the table once they need to be reminded that they will probably do it again. These emotional consumers would be better served by an index annuity.

The Wrong Response
to the greed mode is to feed it, although that will be the solution of some carriers and producers. I am already hearing index annuity claims of “possible 24% to 36% returns” and “you’ll average double digit yields”, neither of which will happen.

Talk to your clients about loss and ask how well they cope. If they do not have the temperament for market risk and understand that protection from loss limits maximum potential gains, then an index annuity is an answer. And if an index annuity product claim is too good, challenge it and ask for supporting documentation.

For the past three years the index annuity story has been “a vehicle that protects against loss”, now the story is index annuities provide the potential for competitive returns. The index annuity story is an excellent one; you simply need to keep consumers grounded in reality.

Heroes Needed    2/04
In the fall of 1981 I was desperately trying to get my parents to buy 10 Year U.S. Treasuries with a 15% interest rate and it was tough going. They kept asking me why should they lock up their money and only get 15% interest when they could earn 17% in a six-month CD and still have liquidity. Besides, everybody knew interest rates were going to keep rising. I managed to talk them into buying $25,000 of 10/91 Maturity 10 Year Treasury Bonds with a 15% coupon. And they complained every step of the way.

The last time I saw my father cry was October 1991 when he received the $25,000 back that He had wisely decided to place in Treasury Bonds back in 1981, a story showcasing his wisdom that he had retold many times during the previous ten years, and he placed the $25,000 back into a six-month CD yielding 5.28%.

By the spring of 1993 Dad had passed on. The interest Mom was earning from those six-month CDs had dropped to around 3.25%. However, 10-year treasury yields were around 6%. I convinced her to move about 60% of the $25,000 into 10-year treasuries and the balance into an index fund. My thought was the interest from the treasuries should equal the CD interest she was earning, and the index fund would hopefully at least run in place and might grow.

Mom died last year. But during the previous ten years while the treasury bonds produced their consistent income the index fund kept growing and growing. Mom felt she had so much money that she gave my son $10,000 out of the index fund when he graduated college and there is another bequest that will give my daughter $10,000 when she graduates from college this June.

The really cool thing – besides the fact that Dad and Mom had a decent retirement – is my kids say (and I think I believe them) that they are going to keep half the $10,000 they received invested and stuck away until their future not yet conceived children have graduated from college and tell their children this is a gift from the great-grandparents they never knew.

The hero of this story is I. If I hadn’t hammered home the message that when a safe money place has a historically high return – as in 1983 – you should lock in money for as long as you can, my parents wouldn’t have enjoyed a decade of returns that were double then current yields. And when rates hit historically low levels in 1993, my thought that it can make sense to risk some current yield for some future growth of capital enabled my mother to increase the nest egg and provided her with additional opportunities.

In 2004 we have another period of historically low rates. Although rates should head up at some point this year, the peaks of this interest rate cycle could make interest spenders envious for the bottoms of past cycles. And although the 2004 stock market could very well post another year of double digit gains, I remember that the market gains of 1993 were followed by a flat to falling 1994.

I had to risk a possible principal loss to try to gain a higher return during in 1993. My choices back then were acceptance of poor returns and protection of principal, or acceptance of risk to principal. There wasn’t an instrument that offered the potential for higher interest and yet provided protection from market loss. Today there is. Your clients are looking for heroes.

And So The Hype Resurfaces... 3/04 
Back in early 1999 a carrier asked me to review a marketing piece on index annuities for them. It was basically okay, except every time they showed the potential index annuity interest they talked about 15% returns. I sent back the piece with a note saying “See you at the trial”. The marketing veep from the carrier explained they needed to talk about 15% returns because that was the only way they could get their producers interested in selling the product. I suggested he find smarter producers.

I am hearing claims made for potential annuity returns that are in no way supported by history. I am getting emails from consumers with questions about certain index annuity components, where it is apparent the producer neglected to mention some of the less attractive parts – as in how the surrender charges really work. And I am seeing more instances of pure product misrepresentation, although I cannot be sure whether this is intentional or simply due to a lack of understanding about the product.

Why? We are in a world of 2% certificates of deposit and 4% fixed rate yields; index annuities offer a realistic opportunity of better returns coupled with protection of principal from market risk. I have found when you discuss the realties of risk and return with consumers – and the realities of index annuities – they like the index annuity story. No hype is necessary.

I have, at times, been asked by different attorneys to be an expert witness on certain annuity cases if they went to trial, but I’ve always declined. I normally do not have a lot of sympathy for trial lawyers. However, I may have to reconsider. Proving misrepresentation in the some of the instances I have seen would be like shooting fish in a barrel.

Fixed Index Annuities  3/04 
An index annuity is a fixed annuity. It has the same advantages as a fixed annuity, it has the same disadvantages as a fixed annuity, and it has the same legal status as a fixed annuity; meaning it is not a security.

The reason why is because index annuities do not meet the definition of a security under the Securities Act of 1933. In addition, in 1986 the SEC created Rule 151 saying that a product would be deemed an insurance product, and not a security, if the product met three “safe harbor” guidelines.

Index annuities meet the safe harbor definitions and are therefore insurance products and not securities.

The issue was raised again in in 1997 when SEC issued a “Concept Release” (Release No. 33-7438: File No. S7-22-97) requesting comments as to whether index annuities should be registered as securities. In the release the SEC says, “Equity index annuities typically are general account products whose value does not vary according to the investment experience of a separate account. These products therefore appear to satisfy the...Rule 151 investment risk test.” The comment period ended January 5, 1998. The SEC has not ruled index annuities are securities.

The courts have also affirmed that index annuities are not securities. Two years ago in Beverly S. Malone vs. Addison Marketing, Inc. et al. the plaintiff brought action under the Securities and Exchange Act of 1934 by claiming the index annuity purchased was a security. The Court dismissed the plaintiff’s complaint and ruled the index annuity was exempt from federal securities laws under Section 3(a)(8) and that index annuities are protected by Rule 151.

Federal law and the courts say index annuities are fixed annuities as long as the guidelines are followed. Traveling along this legal line it should follow that producers selling index annuities would not be required to have a securities license or registration to sell a fixed insurance product, and this is so. Since federal law does not define index annuities as securities, all fifty states – as of this writing – correctly regulate and license index annuities as fixed insurance products.

An index annuity is a fixed annuity. The insurance industry needs to be vigilant in getting this truth across, and ensuring both products and producers continue to meet the guidelines.

Historical Returns & Other Delusions  3/04 
The first Advantage Compendium publication for the index annuity world plugged current rates and caps into fifty years of index movement to develop hypothetical returns for individual index annuity products. These hypothetical returns did not attempt to predict future returns. The problem with creating any return assumptions is that eighty percent of the index products can change some aspect of their crediting prior to the end of the surrender period, meaning that even if the market past repeated exactly, changes in renewal rates could make original assumptions meaningless. The much bigger problem is even if the crediting rates never changed, past performance can never be used to determine returns over a future period because future market movements are based on random and unpredictable events.

I created hypotheticals mainly to use as a type of lie detector and comparative tool. For example, I might hear some carrier talk about their index annuity “producing 18% returns”. However, if I plugged in their product’s current rates into fifty years of index changes, and the best hypothetical return this half century of history produced was 8% a year, it caused me to doubt the veracity of the carrier’s marketing message. Or, I would input current rates of similar products and see the types of returns generated. If two products use similar methodology, have the same surrender period, and offer similar commissions, and yet one product’s initial hypothetical returns are 25% higher than the other, I would be very interested in seeing the crediting rate renewal history of the higher one. All carriers live in the same financial world and current rates that are too optimistic may well be brought back to earth.

The problem is not the hypothetical illustrations; the problem is using any past period – whether the performance numbers are actual or generated – as a predictor of future performance. Unfortunately, many people try to use historically based returns to determine what the return will be in the next period, instead of as merely a comparative tool. To prevent my hypotheticals from being used in this manner, I no longer offer any hypothetical publications to new subscribers

Although hypotheticals cannot be used as a predictor of future index annuity returns they are still useful as lie detectors, and the most common hypothetical lie is cherry picking past periods.

I am seeing some carriers base hypothetical returns only on index movements of the 1990s and I have a problem with this. The 1990s produced the second highest market return of any decade in the twentieth century, only the 1950s had a higher return. The return of the previous decade was 70% higher than the average for the century. Using the 1990’s as a basis for future return expectations is like using last July’s 75° days as a predictor of Duluth’s winter highs.

If a carrier wants to show hypothetical performance over the 1990’s perhaps they could provide balance by showing hypothetical performance during the 1970’s – the third worst decade of the last hundred years. Or at least mention that the ‘90s market returns were 70% higher than average and to bear that in mind.

Hypotheticals may be legitimately used to see how different methods broadly perform over different market environments. For example, hypothetical modeling leads me to believe that certain term end point methods, those that calculate index movement over a number of years, could outperform annual reset structures in bullish markets, and annual reset designs could outperform term end point designs in bearish markets. So, if you believe the next seven, nine, twelve years will be strongly bullish a term end point structure would be indicated – if competitive participation can be achieved, and if you think the market will be choppy to down for the next decade an annual reset structure is indicated. But I would be hard-pressed to be any more specific.

4th Qtr Index Annuity Sales Set Another Record  4/04
Sales for the fourth quarter of 2003 were $3728 million compared with sales of $3429 million for the fourth quarter of 2002. Fourth quarter index sales were up 12% when compared with third quarter index sales; up 9% when compared with the same period one year ago. The top selling index annuity carriers were:

Total fixed index annuity sales for 2003 were $14.015 billion. In fact, 2003 sales were roughly equal to total index annuity sales for the years 1995 through 1999. Fourth quarter index life premium was $30,079,448; 2003 index life premium was $99,427,661. The top selling index life carrier was AmerUs Group with a commanding 52% share of the market for 2003. 

There are 32 carriers offering equity index annuities. If you separate available products by features, there are:

135 Index Annuities - By Surrender Period & Methodology

143 Index Annuities - Previous Plus Bonuses, Cap/No Options

193 Index Annuities - Previous Plus Other Available Indices

Eleven of the carriers offer a single product, 21 of the carriers offer multiple surrender period products, different crediting options or additional indices. The new addition to the ranks was EquiTrust with the MarketPower Bonus. American Equity introduced the Gold series, LSW mined their own Gold, Fidelity & Guaranty introduced Spectrum Reward Reserve, and Sun Life brought forth SunDex 100.

The weighted agent commission based on index annuity premium paid fell again from 9.96% in the fourth quarter of 2002 to 7.68% in the fourth quarter of 2003. Average weighted commission paid by carriers ranged from 3.36% to 11.60% of premium. The market share of bonus annuities was 52%.

The average index annuity sales premium reported was $40,772; average premium ranged from $13,672 to $71,000. The average fixed annuity premium was $38,872; average premium ranged from $6,137 to $56,000. The average index sales premium was lower than that reported in the previous quarter.

This is the twenty-sixth quarterly index sales survey conducted by The Advantage Group. In all, 95% of the active index product companies accounting for over 99% of sales are represented. The Advantage Index Product Sales Report will continue to gather index sales data on a quarterly basis; the report for the first quarter of 2004 will be available in May.

Risk & Uncertainty 4/04 
Uncertainty cannot be determined. You cannot say that the stock market will not go down more than 5% next month because the future course of the market is unknown and cannot be predicted. The problem is people often try to do just that.

Folks tend to base future return expectations on their own view of the world. Unfortunately, the view is tainted. Our view of whether the market will be up or down in the next few years is, to an extent, dependent upon how optimistic or pessimistic we are in general, which has no bearing on the market. We attempt to predict and control future returns, and this cannot be done.

Risk, on the other hand, may often be quantified. You could put money in the stock market, but hedge the risk so that you wouldn’t lose more than 5% of your original stake. Or, you could even transfer the entire risk of loss to another party.

An index annuity protects against loss of principal and credited interest from index declines. The cost of this protection is part of the future potential index-linked interest. An index annuity does not eliminate uncertainty, but simply removes the risk of loss from the equation, improving the odds of receiving a competitive return by making it less likely that one will try to control the market by buying and selling at the wrong times.

Women & Retirement   4/04

Your parents never told you the biggest difference between boys and girls    (....Girls Live Longer...)

Upon retirement the average woman is likely to live 3 years longer than the average man – if a 65 year old man will live to age 79, a woman will see age 82^*. This means a woman needs a bigger nest egg for retirement. (*National Center for Health Statistics)

Women Need More As an example, if you need $20,000 a year from your savings to maintain your quality of life during retirement, and earn a 6% return, based on life expectancy a man age 65 would need savings of $197,381 to produce the $20,000 a year, while a woman needs capital of $217,932 to produce the same income for her life expectancy.

To put it in a savings perspective using the same 6% return, a man age 45 would need to save $5,366 a year to meet his goal; a woman age 45 would need to save $5,924 a year to meet her goal - 10% more than the man. These numbers ignore taxes and inflation. They also ignore the possibility that the woman may not die “according to schedule” and need even a bigger nest egg to cover the added years.

What Can Be Done?
Take the maximum advantage of tax advantaged retirement plans and tax advantaged saving annuities, and avoid investing too conservatively - even a 2% increase in the average annual return can mean hundreds of thousands of additional dollars at retirement. There are new instruments that can protect retirement savings from market risk and still provide the potential for higher returns. Learn the facts about planning for a secure retirement, talk with your financial counselor.

Changing Face of Marketing Organizations  4/04 
For years if you flipped through the marketing materials and web site pages of the scores of annuity marketing organizations (MOs) out there competing for the producer’s attention they ALL listed the same benefits: Personal Support, Top Commissions, Wide Array of Products, Carrier Sponsored Trips, and Sales Ideas. Which marketing organization got the business? Typically it was the one that got in front of the producer first with the new product of the week.

Organization success was directly correlated to marketing reach – the bigger your ad and agent-mailing budget, the more agents you recruited – providing you had a new product story to tell. Carriers often responded to the “new story” need by tweaking existing products just enough so a new annuity could be created and touted to the agent masses. The approach enabled marketing organizations to talk about their sales force of tens of thousands of recruited agents.

However, often the loyalty of the agent force to the marketing organization was similar in nature to the old course of the Platte River – about a mile wide and an inch deep. Most of the contracted agents only sold the organization’s annuity until the new annuity de la semaine appeared, and if the new product was offered through a different organization, the producer signed anew. There was no reason for the producer to stay with one MO because they all looked the same.

But many producers had unmet needs. Annuity products were getting more complicated, as were the financial solutions needed by customers; prospecting for new customers was becoming more difficult and the compliance and regulatory environment was changing.

Some forward thinking MOs began going beyond the ledger sheet approach to marketing and attempted to meet these needs. Some carriers began offering serious ongoing annuity training to their agents (as opposed to product dog and pony shows), others worked to develop and improve customer prospecting methods, still others worked to identify new areas that could help producers be more successful or help the producer avoid problems down the road, and some offered a combination of these new services.

Compared with five years ago the average MO is providing better producer education, giving agents more tools to get them in front of consumers, and supplying more overall support to the agent in the field. It appears to be paying off. Over the last couple of years the MOs providing these new services tell me their business now is exploding, by contrast the old style ledger-sheet MOs generally say business is flat or down.

The service bar has been raised and will only go higher. The marketing organizations that will own tomorrow’s distribution will continue to offer more and improving agent education, take a more active role in helping their producers succeed, and assist agents in providing appropriate recommendations to customers. The end result of this will be greater industry revenues, educated producers with higher incomes, and better served consumers.

Talking With Consumers  5/04 
I get emails from consumers. Although most of these emails are requests for general information, a few are from index annuity buyers that have expressed a concern – no, let’s call it what it is – a few annuity buyers feel they were lied to about the index annuity they purchased. The three biggest complaints about index annuities that I hear are:

The consumer did not understand they would not receive at least the minimum guaranteed interest rate credited annually to their policy, or
The consumer did not understand how the crediting method really works, or
The consumer did not realize the length and severity of the surrender charge.

My typical response is to suggest they contact their agent or the carrier with their concern.

Based on my experience, consumer complaints are often the result of selective listening – the producer did cover both the good and bad points but the consumer only remembered the good; however, they also result from some agents doing a circuitous presentation dance, twisting the facts with such verve it would spin a dreidel to the earth’s core. From talking with consumers I have found there usually are ways to provide full and complete disclosure that still results in an annuity purchase.

Minimum Guarantee – With the exception of a few products, an index annuity minimum guaranteed return will not be credited until the end of the surrender period, and will only be credited if the index-linked interest is less than the guarantee. In addition, three-quarters of the products out there base the minimum guarantee on less than 100% of the premium.

You can try to explain that a minimum interest rate of 3% is in reality an effective rate of 2.21% or 1.46%, or even zero, and you can go on to explain this rate isn’t even credited each year, and it’s not paid in addition to the index-linked interest earned. Or, you can say “At the end of 7 years (or however long the period is) the insurer guarantees you will have an account value of at least $1.10 (or $1.07 or $1) for each $1 of premium, and if you don’t the insurer will go back and RETROACTIVELY credit you this minimum guaranteed return.”

The key word here is “retroactive”. When I tell consumers they will probably see years with no interest credited, I then add on the prior sentence and the consumers understand that they will still get at least the minimum return because retroactive means a benefit isn’t lost, it’s just delayed.

I don’t get into 3% on 90% or 2% on 100% or 1.75% on 87% because those are just numbers. I calculate the total return produced by the guarantee because this is the worst case the consumer is going to get. If I ever have a consumer ask what the effective annual return is – and so far no one has – I will tell him that the $1.1069 returned after 7 years (without going into how $1.1069 is 3% compounded on 90% of the premium) is an effective rate of 1.46% a year (and as you know, the effective annual rate or I.R.R. or A.P.R. is not calculated by dividing the total return by the number of years).

Crediting Method – Any crediting method works as long as the producer fully understands it and can explain the good and bad. Most of the consumer queries I get are about methods using averaging. The consumer remembers the producer saying averaging smoothes out the low points, but they don’t remember being told that if you have a year like 2003 when the index went up 26%, that averaging would produce a 10% gain.

The key to explaining averaging is balance. If you say averaging means you will never end the year on a low point you also need to explain you’ll miss the high point too. And you need to explain averaging means their annuity statement calculation will never agree with the returns printed in the newspaper.

I have also received questions on how caps work. A couple of consumers seemed to think the cap was the guaranteed interest. The simple solution is emphasize the wiggle words when cap talking – you know, the annuity interest paid “might, could, may, good lord willing” hit the cap, but there are no guarantees.

Surrender Charges – The consumer must know what it will cost to get out of the contract on any given day and understand exactly what the surrender charge is and when it is applied. However, I have a problem with the phrase “surrender charge” because it is not truly accurate. It sounds like a charge against all annuity owners, but who actually pays the charge?

Do you pay this charge if you keep the annuity? No.

Do you pay this charge if you withdraw the annual interest credited? Typically not, most annuities permit an annual 10% withdrawal beginning on the 366^th day of annuity ownership without incurring a surrender charge?

Do you pay this charge if you die? Typically not, and even annuities that do not waive surrender charges at death usually offer a way to get around them by delaying the payout.

Do you pay this charge for as long as you own the annuity? Typically not, unlike a certificate of deposit that restarts it’s penalties with each new interest period, the annuity charge usually ends at some specified point in the future.

I prefer to look at these charges as temporary and voluntary liquidity costs, with the realization that all financial instruments have liquidity costs.

Whether the first year surrender penalty is 5% or 15%, the consumer only pays the penalty if they cash in the policy. The real question is what was the alternative to buying the annuity?

If an index annuity credits 12% the first year, and has a 10% surrender charge, and the money market account the annuity funds came from pays 1%, which instrument has cost the consumer the most if cashed in at the end of one year?

The consumer always needs to know exactly what liquidity costs. Perhaps a better way for the producer to explain liquidity cost is to compare the real net results of the annuity with the alternative.

The Realities Of Risk – CDs & Annuities  5/04
Pity the poor CD buyer. Four years ago they were earning close to 7% on their certificates of deposit, three years ago nearly 5% interest rates were paid, but for the last two years yields have hovered on the short side of 2%. Think about the magnitude of the drop. From May 2000 to May 2002 certificate of deposit rates fell 72%; they then dropped another 40% from the 2002 point over the next two years. If you were retired and attempting to live off your CD interest you’ve seen your income drop over 83% since the turn of the millennium. And yet, $800 billion of consumer money remains in CDs. *

Included in this mix is $166 billion sitting in bank IRAs. Let’s see, if we use the Rule of 72 to determine how fast money doubles, and our bank IRA is paying 1.25%, the $20,000 sitting in the bank IRA will double to $40,000 in ... 2060.

What possesses people to hold CDs in this environment? One reason is that CDs have guarantees.

But you know the real reason people own CDs. It is because they are FDIC insured. Although you may not have received all your money back if your CD in a failed bank exceeded FDIC limits, bank balances of $100,000 or less were paid out promptly.

The credit risk of an FDIC insured account is for all practical purposes the same as that of a direct U.S. government obligation. Some producers try to sell annuities by bashing FDIC coverage. It doesn’t work. In some of my consumer testing I’ve asked consumers if their agent ever brought up the risk of possible failure of FDIC. The response I get is the consumer believes their congressman will not let FDIC fail and they think the agent is just ranting to make a sale. I don’t care if the agent knows they’re right about FDIC, the consumer thinks they’re wrong. An agent is not going to win on a safety issue involving a non-government insured instrument by saying the safety of the government insured instrument is suspect. A better way to handle the safety issue is to explain the realities of credit risk.

The financial books of insurance companies are examined by states on a regular basis. Independent companies assess the financial strength of carriers and assign ratings based on their assessment.

What if a company does go belly up? An annuity contract is an asset of the insurer, and another insurer usually buys the annuity contracts of the troubled company and life goes on. At worst, every state has a guarantee fund to dip into designed to protect annuity contract owners if a company tanks. The big picture is the consumer’s car is insured, their house is insured, their pension is often insured, and their life is insured. If they’re not losing any sleep over these insurance companies, why should they treat the annuity carrier any different?

Let’s look at some hard numbers. From 1993 through 2003 there were 104 bank failures. Although CD deposits within federal deposit insurance limits were protected, the same did not hold true for account balances over the insurance limits. Bank account balances above FDIC limits were treated as creditors of the bank, and these customers stood in line to get paid just like other creditors. Savings customers were at the front of the line, but not every customer was made whole (someday I may publish a bank-by-bank list of the percentage of principal uninsured account balances actually received).

During the same period customers of 42 life & health carriers received cash from state guarantee funds. Every state guaranty fund covers up to $100,000 of cash value in the event of carrier insolvency, but here’s the real deal. I have been digging though the records of insurance company failures for over eighteen months. Based on my research every annuityholder in a failed company during this period received up to $100,000 of the annuity value. In fact, during this period there was only one failed carrier that did not provide all of the annuity value – even for account balances in excess of $100,000 – for all of their annuity customers; owners of annuities issued by National American Life Insurance Company of PA did receive up to $100,000 but account amounts above $100,000 may never be fully paid.

Even when I go back twenty years I have only been able to find one other carrier that did not, at the very least, return 100% of the principal in the event of a failure. Annuityholders of Inter-American Companies, an Illinois insurer that went under in 1991, took a hit. Out of $648,747 that was still due from the annuities, the owners received a final payout of $97,653. There may be other carriers out there that have not returned a hundred cents on the annuity dollar, but I sure can’t find them.

All of this is not meant to slam FDIC. FDIC insured accounts are very, very, safe, and consumers know this. Producers need to present fixed annuities as another safe money place. Will a consumer lose money due to bank failure with their CD? Almost certainty not. Will a consumer lose money in their fixed annuity due to an insurer failure? Almost certainly not, at least based on actual history.

Fixed rate and fixed index annuities offer a safe alternative to CDs with higher current rates and the potential to outperform CDs down the road. When consumers understand the realities of risk they often choose the annuity.

* all CD data is from Federal Reserve Board. Other sources include Federal Deposit Insurance Corp., National Organization of Life and Health Guaranty Associations, National Association of Insurance Commissioners, Illinois Department of Insurance, California Department of Insurance, Florida Department of Insurance.

Compendiumisms  5/04 
I met with a bank inhouse brokerage group a while back and in the course of our talks found that they never went back to the same customer twice. The rule was one meeting, one sale, and move on to the next one. They said they were too busy to keep in touch with old customers.

When I was president of my broker/dealer one of the broker activities I stressed was holding an annual review with their customers. The purpose was to keep communication lines open, which helped avoid future compliance problems, but the review also helped to identify new needs. I discovered the reviews were generating 20% of our total sales, because the customer had new money, or more often, told our brokers about money they had last time, but now they felt more trusting.

Not going back to existing customers is like throwing away ten weeks production out of a year. If you did $2.5 million of sales last year these same customers will produce $500,000 of repeat sales this year.

There are similarities between a sales person trying to make a sale and a new political candidate trying to unseat the incumbent, both involve moving people out of their comfort zone. Neither a buyer nor a voter will try something new if they are content with the status quo. Both groups need to be unsettled to make them question whether they need a change, and then offered a compelling reason to do so.

When you ask a prospect what their objective is and they respond “growth” offering an index annuity may not seem to be the right response. However, if you talk about the risks of growth vehicles, and the prospect seems goosey about the possibility of incurring reasonable losses, then you may well have an index annuity candidate.

An Aesop Fable tells us a great rivalry existed among the creatures of the forest over which could produce the strongest litter. Some sadly said they only had two or three, while others boasted of having a dozen.

At last the committee called upon the lioness. “And to how many cubs do you give birth?” they asked the lioness. “One,” she replied proudly, “but that one is a lion!”

Moral: Quality is more important than quantity.

1st Quarter FIA Sales Explode  6/04
Sales for the first quarter of 2004 were $4186 million compared with sales of $3249 million for the first quarter of 2004. First quarter index sales were up 12% when compared with fourth quarter index sales; up 29% when compared with the same period one year ago. The top selling index annuity carriers were:

First quarter index life premium was a record-breaking $31,233,932 with AmerUs Group in first place accounting for over half EIUL sales. This is the twenty-seventh quarterly index sales survey conducted by Advantage Compendium. In all, 97% of the active index product companies accounting for over 99% of sales are represented.

There are 33 carriers offering equity index annuities. If you separate available products by features, there are:

141 Index Annuities - By Surrender Period & Methodology

151 Index Annuities - Previous Plus Bonuses, Cap Options

201 Index Annuities - Previous Plus Other Available Indices

Nine of the carriers offer a single product, 24 of the carriers offer multiple surrender period products, different crediting options or additional indices.

New products are Allianz PowerDex Elite 5 and PowerDex Elite 10, ING Income Outcome, Investors Summit Mark Series and Transamerica Select Index 500. American General reentered the index annuity market with the Constellation. Allianz added a new EIUL; Americo discontinued equity index life sales at the end of March.

VA and FIA Realities  6/04 
I was going to title this article “Lies My VA Wholesaler Told Me” after hearing some of the amazing assertions some VA marketing folks were making about their principal or income guarantee variable annuity add-ons, but then I thought I would probably have to do another article on “Fibs From My Annuity Marketer” due to hearing claims from a special few essentially stating an index annuity gives you stock market gains without losses.

I once said that variable annuities are airplanes and index annuities are boats. Even though “your seat cushion may be used as a flotation device”, this does not mean that airplanes are the right choice to sail across the ocean, and even though you could glue wings on a catamaran and get airborne in a strong wind, this doesn’t mean you should head for the harbor instead of the airport if you’re trying to set a new maximum altitude record.

Variable annuities are mutual funds with a tax-deferred wrapper and a death benefit, and they perform similar to mutual funds. Index annuities are fixed annuities with the potential for a higher index-linked interest rate than yesterday’s fixed annuity.

Mandated Portfolio Mix
One variable annuity principal protection version guarantees that at the end of a specified period – the shortest I have seen is three years – the accumulated value will at least be equal to the original premium. This is accomplished by the carrier controlling the percentage of premium allocated to the fixed account in the variable annuity, and letting the consumer invest the remainder as they wish.

The mandated portfolio mix either locks the fixed account allocation for the entire period or adjusts the account percentage in the fixed account on an ongoing basis. The main variable affecting locking the allocation for the entire period is the initial fixed account interest rate. The locked method is akin to a split annuity, with less weight given to the fixed account as the period lengthens, and the balance is then invested in the consumer’s choice of sub-accounts. An ongoing allocation system is affected by sub-account performance and fixed account interest rates. 

Affecting both the ongoing and locked methods are fixed account rates. If the fixed account were paying 6% instead of 3% less money would need to be allocated to the fixed account because the 6% account would build faster. Higher interest rates mean more money available for the other sub-accounts; lower rates mean less money in the other sub-accounts.

So in general, if the consumer’s equity account choices are doing very well and/or fixed rates are high, then more market participation is available; if the consumer selections are doing poorly and/or fixed rates are low, then less market participation is available.

If someone promises to pay you a 10% return, but only on half of your money, the real return is not 10%. Any money on the fixed side effectively dilutes the market return

This is all well and good. The problem is some VA marketing folks explain this mandated portfolio option as being better than an index annuity because “you get all of the upside and there are no fees or return caps”. This is not necessarily true. In fact, every VA prospectus I have read that includes this feature always says something like, “this means that you may not always be able to fully participate in any upside potential returns”. To get a better idea of the return realities, it is helpful to plug in some numbers.

Let’s say we have a period where the fixed account rate was 5%. During the same period the base market index averaged a 10% increase, and reinvested dividends bumped up the return another 2% for a total market return of 12%. The extent to which the consumer participates in this market return depends on how the premium is divided between the index and fixed accounts.

Let’s say we have $100,000 and the carrier puts 50% in the fixed account and leaves 50% for an index account. $50,000 earning 5% returns $2,500; $50,000 earning 12% returns $6,000. The total return is $8,500, or 8.5% of the total beginning account value. Although 8.5% is respectable, it isn’t equal to the 12% market return or even the 10% base index earned, so we didn’t “fully participate” this year. And there are other fees.

Variable annuity M & E could easily take 1.5% from the return, and even though index sub-accounts have lower management fees than managed sub-accounts, they still have fees. All told, at a 50/50 allocation, the VA has a net return of about 6.75%, or an effective participation rate of 67.5% in the base index return (6.75%/10%). I use the base return for comparison because index annuity returns do not include reinvested dividends.

How does this compare to an index annuity? For the ten year period from April 1992 to April 2002 the S&P 500 averaged exactly an annual return of 10.0% without reinvested dividends. An annual reset approach didn’t require a 67.5% participation rate to achieve a 6.75% annual return for this period, nor did it require a 57.5% rate, the annual reset structure hit the 6.75% annualized return with a participation rate of 49.5% for this period.

The point of this is not that index annuities will produce better returns. Index annuities do usually offer much stronger minimum guarantees than any variable annuity protection, but annual reset index annuities can usually change either their cap or their rate or their spread during the period, and VAs with mandated portfolio mixes could conceivably at times have 10% of the premium on the stock market side or 90%.

The reality is with both annual reset index annuities and variable annuities with mandated portfolio mix it is unlikely you will achieve true market returns over time – either could provide returns that reflect 25% to 85% of actual market returns depending on the timeframe.

Guaranteed Withdrawal Features
A recent VA rider offers a guaranteed withdrawal allowing one to withdraw 7% a year until the original principal is gone (in 14.28 years). This is not a 7% return, this is a 0% return (but if you think it is a 7% return I am prepared to offer you 20% of your principal back each year for five years – just because I like you). There are different withdrawal levels available depending on the product, and the carrier then usually charges a fee for the rider.

The thinking behind the feature is a customer can play the market with the knowledge that they will still get all of their own money back. I looked back over the last fifty years and ran some historic hypotheticals whereby I withdrew 7% a year from the major stock indices. I never came close to running out of money in any 14.28 year period! At a 10% withdrawal rate I had a couple of hairy periods when I ended the principal-back scenario in September 1974, but even at a 10% withdrawal rate I still had money left after ten years in every other period I ran. Of course, I did not deduct any extra protection fees charged by the variable annuity for this feature, which might have made a difference.

Is the benefit worth an extra fee? I cannot put a price on peace of mind. For consumers bound and determined to market time themselves into the poor house by leaping from sub-account to sub-account as headlines change, this is a valuable benefit.

I don’t know how you try to compare this VA feature to an index annuity. Every index annuity will offer a longer withdrawal period than any VA with this benefit, at whichever withdrawal rate is selected, simply because index annuities pay a minimum interest rate. Which has more upside potential? The variable annuity should have the advantage, but annual reset index annuities never lose value due to market declines, they simply show a year of no growth. I have never run numbers attempting to evaluate the effect of 7% or 10% annual withdrawals from an annual reset index annuity; perhaps I should.

Summary
All of this discussion misses the key point. The key point is an index annuity is a savings instrument designed to provide the potential for higher returns than other savings instruments, while protecting principal and credited interest. Variable annuity principal protection features are designed to lower the market risk of owning a variable annuity. They are products designed for two different worlds.

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