Easy To Predict 4/08
Last month The New York Times used the “D” word in a story titled “Depression You Say? Check Those Safety Nets” showing that concerns over this turn of the economic cycle had reached panic levels among reporters looking for a catchy headline. Keeping in mind that my rough research of Wall Street economists finds their predictions are wrong 80% of the time, and that I cannot claim a better accuracy rate, I still wanted to opine on what I see as cycle realities. 

It was easy to see coming 
In August 2005 I wrote that a bear market and recession were coming. I said this would happen by the end of 2006 (not counting on the effects of blind greed and the greater fool theory delaying the start for another year). Part of my concern was interest rates had remained too low in the recovery. The Federal Reserve Board, still fighting the last inflation war, didn’t seem to realize that altho low interest costs might keep corporate borrowing costs low and therefore corporate prices low, it also kept monthly payments too low. American homebuyers do not understand actual value they understand monthly payments, and low interest rates made it possible to pay more and more for the same low value without needing to accept that fact that this was dumb. Financial experts helped by creating new mortgage types that further distorted the value relationship. And the mortgage companies expanded the number of buyers able to buy real estate by not requiring homebuyers to have any skin in the game. Essentially the real estate market turned into a huge poker game where some of the gamblers kept bidding up the size of the pots with the knowledge that if they were lucky they could keep the winnings, but if they lost they wouldn’t be responsible for the losses.

The financial firms blithely ignored the reality that many of the mortgages were worthless because they were paid based on the number of mortgages written and not the ultimate quality. They created instruments that passed along the risk to others, but then failed to evaluate whether the buyers of this risk had the wherewithal to cover the risk.

A reason for this oversight is they made themselves believe the financial quants 99% rule. The 99% rule essentially says if a possible outcome is more than four standard deviations from the average outcome it can be ignored because this means the odds of the outcome happening are less than 1% according to the model used. Since the likelihood of a liquidity crunch caused by bad mortgages was 25 standard deviations away from the expected outcome (Index Compendium Sep 07) it was treated as an impossibility. The shell game was Company A sold the default risk on a package of mortgage bonds to Company B and Company B would be responsible for paying off in case of a default. However, because the risk of default was so low – the 99% rule – no one required Company B to actually have the money to cover the risk. Since the default couldn’t happen, based on the computer models supporting the 99% rule, Company C gladly lent money to Company B to pay for this risk. Of course if a default did happen Company B would not be able to payback the loans to Company C or cover the original mortgage investors in Company A. Good bye Bear Sterns.

Inflation  
The other part of my concern was the effects of $60 a barrel oil (in 2005) on the economy and the deficit spending in Washington (an aspect that is still being more or less ignored). The Consumer Price Index calculates that offering a 25” TV next year for the same price as a “24” inch TV this year offsets the inflationary impact of the price of bread going from $1.50 to $2 a loaf and results in net inflation of zero. The screwy way that changes in the CPI are deduced meant the Fed was able to delude itself that what they were doing was working and inflation was low. In reality, costs on real consumer goods were soaring.

The Economist uses the Big Mac index to compare international prices; I use the Taco Bell indicator. In 2003 you could buy a bean burrito from the Taco Bell value menu for 99 cents. By 2004 the value menu had been revamped with the 99 cent bean burrito replaced by this really gnarly 99 cent bean & rice burrito. The nearest edible food was a new combo burrito for $1.19. Price of the new combo burrito increased to $1.39 in 2006 and $1.59 in 2007. The bottom line is five years ago I could get my Taco Bell lunch for $2.10 with tax and today it costs $3.37 – a 60% increase or an annualized inflation rate of 10% a year. 

It is not only Taco Bell prices that are up. The average family has seen their monthly gasoline bill increase 140% during this time impacting all aspects of their life, and food prices have soared due to poor global wheat harvests and a politician-driven policy on gasohol. Rising prices and recession fears have caused some reporters to dust off old articles on stagflation from the ‘70s

And annuity markets?  
One nice thing about being retired is you don’t have to worry about losing your job. However, recessionary fears cause stock markets to swoon meaning the retirement nest egg gets smaller, and efforts to lower interest rates mean that the interest earned from certificates of deposit and money market accounts drops. Inflation means the cost of staples are going up whilst income is going down. All of this creates a positive environment for fixed annuity sales.

Falling rates means that fixed annuity rates and index annuity caps will continue to fall. The good news is bank rates will fall farther and faster. The 5% fixed rate or 7% index cap that is meeting some sales resistance today will turn into fast selling 4% fixed and 6% cap rates six months from now because CD rates will be at 2%. The sales environment for fixed annuities will steadily improve.

Safety
Northern Rock was a British mortgage lender that got into trouble in 2007. By early 2008 the Bank of England had dumped $108 billion in loans and guarantees to Northern Rock. FDIC has $52 billion on hand. It is interesting to note that the failure of one bank caused British regulators to kick in more than double what FDIC has on hand to cover $4.35 trillion of deposits.

Commercial banks originated and purchased mortgage packages and I think we will see several bank failures as a result. I also believe that FDIC coverage will be provided for all covered deposits (tho uncovered deposits in failed banks will get back less than a hundred cents on the dollar).

I have only looked at the balance sheets of a few annuity carriers; some own suspect mortgage loans and some do not. I would not be surprised to see an annuity carrier fail as the mortgage crisis fallout continues. However, it is important to remember that insurance carriers look at the financial world in a different way. Most of the financial world seems to use that 99% rule where if the risk is less than 1% it is ignored. By contrast insurance carriers are trained to look for hidden risk and act accordingly. Insurers do not ignore 1% risks they target them and hedge to cover the risk. This is why I believe fixed annuity carriers will generally weather this financial storm better than banks.

FDIC can borrow all the money they need from the Treasury, so if a bank fails the insured deposits should be available the next day. State Guaranty Funds are funded in arrears meaning that after an annuity carrier fails other carriers are asked for any needed money. This means that even tho an annuity covered by a Guaranty Fund would eventually be paid in full the entire annuity balance may not be immediately available.

Crystal Ball
I think this will be a nastier recession than the last two and that the stock market still has some way to fall (but the fall won’t be as bad as the millennium bear market). I think interest rates will drop in 2007 and then go up because this time there really is price inflation. I also believe fixed annuity sales will increase as bank rates fall and consumers get out of stock market investments and look for a safer place to put their money (however, it probably makes sense to diversify annuities between carriers). All in all 2008 and 2009 will be tough years, but the cycle will turn once again.

2007 Index Annuity Complaints Steady  4/08
In 2004 the index annuity carriers averaged one customer complaint for every $614 million of premium sold, in 2005 the rate was one complaint for every $310 million and in 2006 the index annuity carriers averaged one customer complaint for every $119 million of premium sold. In 2007 there was one complaint for every $109 million of premium. What this means is there were roughly six times as many specific complaints against index annuities in 2007 as there were in 2004.

There is a “but” in all of this. Even tho the rate of complaints increased slightly from 2006 to 2007 for all index annuity carriers if you exclude Allianz the complaints decreased. Without Allianz the rest of the industry had a complaint rate of one for every $145 million in 2007, down from $118 million the previous year. While all index carriers averaged one complaint per $109 million of premium sold the top 25 carriers averaged one complaint per $111 million. The worst ratio for any individual top 25 index annuity carrier was one complaint for each $50 million of sales.

The National Association of Insurance Commissioners (NAIC) gathers data on customer complaints from all of the state insurance departments. This information is available on the Consumer Information Source (CIS) part of their web site http://www.naic.org/cis/index.do on a company by company basis. I reviewed and totaled the number of closed customer complaints for 2007 relating to index annuities. I found no complaints for seven carriers.

Caveats
These closed customer complaints cover the gamut from fraud to delays in policyholder services, and although the complaints are closed I am unable to determine how many were resolved in the carrier or agents’ favor. The data base relies on voluntary reporting from the state insurance departments and may not be thorough. The NAIC database does not include complaints filed with state security offices, NASD or SEC; however, it has been difficult for me to find hard data from these other sources that would radically change the implications of the data collected.

Comment
I saw a slowing in the increase of overall complaints over the previous year, which is good news, but it is not as good as a decline in complaints. Based on anecdotal evidence I believe part of the reason for the increase is that annuity customers are being encouraged to complain by securities salespeople, but the fact remains that there appears to be more unhappy index annuity owners than there were a few years ago.  

But The Complaint Percentage Is Very Small
It is difficult to determine the percentage of complaints because this year's complaint list may include a purchase from a previous year. However, whether the complaint ratio is based on current year sales, in-force annuities, total index annuity owners, or any other parameter the percentage of index annuity owners that did not file a complaint has never been less than 99.7% and maybe as high as 99.999%.

Data Sources:LIMRA, NAVA, Annuityspecs.com

Rainbow Method 5/08
Altho new to the index annuity arena the Rainbow concept itself is not new. It has been used for many years in the investment world, and I wrote about this securities option strategy, as well as several others, three years ago. It is an option basket whose best-performing indices are weighted more heavily than those that perform less well. It is always a "look-back" because the money is allocated based on the ranking of the performance after the period is over. Currently six carriers offer rainbow allocation crediting methods, but not all allocation methods are rainbows. For example, Allianz Endurance and ING Envoy products also credit interest based on the blended performance of multiple indices, but the specific index allocation is fixed at the beginning of each year so they are not rainbow methods. 

Do rainbow methods run a better horserace? 

The Rainbow marketing appeal has been expressed by saying that the annuitybuyer gets to bet on the race after it has been run and that most of the bet will be put down on the horses that “win or place.” To determine whether the different rainbow allocations may be a better horserace I have run calculations going back to 1991 using April 2008 rates to produce hypothetical returns for both rainbow and S&P 500 only crediting methods. I attempted to compare rainbow methods with S&P 500 only methods within the same or similar carrier products. Because index annuities are used, any years with negative returns were replaced with zeros.

A problem with most rainbow indices is short history. With the exception of DJIA and S&P 500 the other indices generally have been around less than 25 years, and I am unsure whether this provides enough track record to be meaningful. Three of the four carriers include the EuroStoxx 50 in their mix and this index has only been around for 6 years, with almost all of its history occurring in a bull market. However, I discovered that a composite index made up of half German DAX and half French CAC 40 values had a 0.99 correlation with the EuroStroxx 50 since its inception. In others words, a 50/50 mix of the DAX and CAC has essentially mimicked the EuroStoxx 50, therefore I have used my composite index as a proxy for the EuroStoxx 50 prior to July 2003. 

I examined rainbow products from AIG, Aviva, National Western and North American Company. Rainbow products are also offered by American Investors and Midland National, but these were basically the same as the respective Aviva and North American ones. I picked products without bonuses and with surrender periods of 10 years or less. These examples apply current rates to 195 past rolling 12 month periods. The past does not predict the future and all of these rates could change wildly in years to come, so the returns should not be viewed as real numbers or investment advice. Finally, no index sponsors or endorses any index product.

Comments
If the S&P 500 is having a rotten year a rainbow method probably will not produce a great return; all stock markets tend to respond to news and changing economic conditions similarly. However, the rainbow method could offer higher returns than the S&P 500 alone in good times if pricing of the options was similar.  

The advantage of the rainbow method in having greatest participation in the top performing index is handicapped by a cap. Capping the rainbow method somewhat defeats the main attraction of using the method. However, if the option cost of the rainbow method permits higher caps than the S&P 500 alone might receive, then using the rainbow method would be justified.

In all hypothetical cases the Rainbow method produced higher average returns

The goal was to see which would have hypothetically performed better – the Rainbow method or the S&P 500 only methods. I discovered that in all cases the Rainbow method produced higher average returns, but there is insufficient data to deduce whether this is due to any inherent superiority of the rainbow method or simply an aberration in current option pricing. The rainbow method is a legitimate addition to index annuity methodology. I believe it provides the greatest potential interest when offered without a cap, even when offered at lower participation rates or higher spreads. However, if the rainbow method uses a cap, and the rainbow cap is higher than the cap for the S&P 500 alone, I would pick the rainbow method at a higher cap every time.      

Savings Bonds Are A Terrible Investment Now 5/08
Altho one might have purchased Savings Bonds in the past because they offered safety, tax deferral, minimum guarantees and usually rates that were at least competitive with banks, I would not buy one now. The new long-term rate on Series EE bonds is 1.4%. That's it, and the 1.4% is locked in and will not change. Series EE bonds still promise to return double your money in 20 years - an effective return of 3.5% - but if you take out your money early you would only earn 1.4%. In actual dollars this means if you put $5000 into a Series EE Bond today you would get back $10,000 in 20 years, BUT if you cashed in the annuity in 19 years and 364 days you would get back $6,602; this is equivalent to a 68% surrender charge!

Existing bonds have also taken a hit. Any Series EE bond purchased in the last 11 years is currently earning 2.74%.

I Bonds were attractive because they gave you a fixed rate of at least 1%, plus extra interest that was index-linked to the rate of inflation. But any I bonds purchased today do not have an interest rate floor. If inflation stays low I Bond returns could be much worse than other safe money places because the fixed rate is zero. Today, it does not make sense to buy U.S. Savings Bonds.

First Quarter Index Annuity Sales Drop   6/08
The Advantage Index Product Sales Report produced by AnnuitySpecs.com shows first quarter 2008 index annuity sales were $5776 million compared with sales of $6436 million for the previous quarter. First quarter sales were flat when compared with the same period one year ago.

The top ten carriers for the first quarter:

Average Commission
The index annuity commission received by the agent averaged 8.00% of premium. .  

  H.R. 5840 6/08
In April Congressman Paul Kanjorski (D-PA), Chairman of the Capital Markets, Insurance and Government Sponsored Enterprises Subcommittee, introduced the Insurance Information Act of 2008 (H.R. 5840). The Act would establish an Office of Insurance Oversight (OIO) that was outlined in the U.S. Treasury Blueprint for a Modernized Financial Regulatory Structure. 

The main purposes of the bill are to give the Federal Government an insurance resource that could talk about international insurance regulatory issues, and advise Congress, the President and the Treasury about important insurance concerns. The big teeth in the law is it would give the Treasury Secretary the power to preempt state insurance laws if they were at odds with U.S. policy. 

The NAIC reaction to previous attempts at federalizing insurance regulation has been to vigorously defend their turf, but not this time. NAIC proposed working with the Feds to fix problem areas and said they would be open to creating an insurance self-regulatory body – regulated by NAIC – that would work with the Treasury.  

The National Association of Professional Insurance Agents (are there amateur insurance agents?) does not like the bill, the National Conference of Insurance Legislators (NCOIL) expressed concern, and the American Council of Life Insurers seems to like it. I like it because it could stop the securities regulators from grabbing more insurance turf and requiring all annuities and cash value life insurance policies to be only sold by securities regulated agents. 

Nothing will happen with all of this in 2008, but a federal insurance department is closer than it has been before.

GLWBs Comparison 7/08
GLWBs were first offered on fixed rate and fixed index annuities two years ago and I compared the entire world of fixed annuity and top VA carrier GLWBs in a report initially issued 13 months ago. The report has been revised five times as carrier after carrier either entered the GLWB arena or redrew their offerings, and a complete overhaul of the report is underway as carrier GLWBs got both more creative and convoluted as competition grew in the annuity benefits race. This issue attempts to show some of the changes I am finding in the index annuity GLWB field. It also tries to compare the different products to see what guaranteed life payouts are produced given certain assumptions.

I placed $100,000 in each annuity using an issue date of age 50. I then calculated the income benefit account value based on the product guarantees and multiplied the values by the respective payout factors at ages 65, 70, 75 and 80 to produce the annual lifetime payout. The result is a list of the initial lifetime payouts that would be received if each annuity only earned the guaranteed minimum.

There is a little fudging. The guaranteed growth in some cases was the annuity contract minimum guarantee and many of these used floating rates; I used a 1.75% rate. Premium bonuses were ignored unless the bonus was built into the GLWB. And in cases where the rider cost could increase if the growth period was extended, I used the maximum permitted rider cost after the first 10 years. All numbers are believed to be accurate, but due to the fluid nature of the marketplace I will reserve space in the August issue to publish corrections.

Two Points: The Living Benefit Balance Is Not A Cash Value
Neither the 15% “bonus” on the Allianz Endurance, nor the 4%, 7.2% or 8% “guaranteed income account growth” on other assorted annuities with GLWB benefits are what the consumer first thinks they are which is cash in hand. These bonuses and growth guarantees really only come into play if and when the consumer’s money is exhausted.

To illustrate, if no interest is earned and you withdraw 5% a year on $100,000, or $5,000, the money is gone in 20 years. If by means of a bonus or growth guarantee the carrier says you may withdraw 5% on $120,000 or $6,000 a year you are still spending your own money until some time in the 16th year. If you die before 16 and two-third years you receive zero financial benefit from the bonus or guarantee. Indeed, due to the explicit or implicit costs of that GLWB you are worse off financially if you die while spending your own money. However, if you live a long life the actual benefit could be much greater than the bonus or guaranteed rate you were told.

And The Payout Is Not A Return
You receive a 5% income for life, what is your return? To figure out the return you need to know what you will receive and what your heirs receive. If you start with $100,000, receive $5,000 a year for 10 years, and your heirs receive $100,000, your real return is 5%.

But what if you receive $5,000 for 10 years and your heirs get $80,000? Then the real return is 3.3%. 

And what if you receive $5,000 for 10 years and your heirs get $50,000? Then the real return is 0%.

My Comments On SEC Release Nos. 33-8933, 34-58022; File No. S7-14-08  7/08 SEC Release Nos. 33-8933, 34-58022; File No. S7-14-08  7/08
“We are proposing that an annuity issued by an insurance company would not be an “annuity contract” or an “optional annuity contract” under Section 3(a)(8) of the Securities Act if the annuity has the following two characteristics.
First, amounts payable by the insurance company under the contract are calculated, in whole or in part, by reference to the performance of a security, including a group or index of securities.
Second, amounts payable by the insurance company under the contract are more likely than not to exceed the amounts guaranteed under the contract.”

The SEC proposed rule would make all currently marketed index annuities securities. Why should index annuities be made securities?

“We have determined that providing greater clarity with regard to the status of indexed annuities under the federal securities laws would enhance investor protection”

What about Safe Harbor Guideline 151 saying when an annuity is not a security?

“Indexed annuities are not entitled to rely on the safe harbor of rule 151 because they fail to satisfy the requirement that the insurer guarantee that the rate of any interest to be credited in excess of the guaranteed minimum rate will not be modified more frequently than once per year” 

According to annuity producers the overriding reason given for the purchase of index annuities is safety and avoidance of market risk – what is your exact opposite logic?

“these purchasers obtain indexed annuity contracts for many of the same reasons that individuals purchase mutual funds...and open brokerage accounts.”

 Section 3.A
“When the amounts payable...are more likely than not to exceed the amounts guaranteed under the contract, the purchaser assumes...the risk of an uncertain and fluctuating financial instrument, in exchange for exposure to future, securities-linked returns. The value of such an indexed annuity reflects the benefits and risks inherent in the securities market, and the contract’s value depends upon the trajectory of that same market. Thus, the purchaser obtains an instrument that, by its very terms, depends on market volatility and risk.”

Essentially the proposal says the future return of an index annuity is unknown therefore it is a security. The reality is the future is always unknown. A bank money market account rate floats from day to day, universal life insurance rates float from year to year, an I Savings Bond return varies based on the inflation rate, and even SEC registration prices are not locked in forever. And yet none of these are viewed as securities. 

The proposal attempts to minimize the index annuity benefit that protects principal and credited interest from market loss by saying the benefit does not eliminate all risk. I submit that because of an unknown future it is impossible to eliminate all risk in any aspect of life and is therefore an invalid criterion to use. The criteria should be “can the consumer lose principal without taking any action of their own”. 

“Should the proposed definition apply to forms of insurance other than annuities, such as life insurance or health?”

Altho the proposal only applies to index annuities there is nothing to stop the final rule to cover any other type of insurance that bases pricing or returns on an external index. If index life carriers are remaining quiet about the proposal in the hope they will be ignored, I believe this ostrich strategy will fail.

 How would “small entities” be adversely affected? 

Adding together the most conservative estimate of additional expenses to insurance agents combined with lost revenues to marketing organizations, the proposal could result in a loss of $852 million to insurance industry distribution channels. Most of this loss would be incurred by small entities, it would have a significant effect on the economy, and it would result in a major increase in costs for insurance agents.  

2008 – 8 9 Failed Banks So Far 8/08
After going 2½ years without a bank failure – an uncommonly long period – 3 banks failed in 2007, the most prominent being NetBank of internet fame. In the first half of 2008 4 banks had failed; a couple in Missouri, and one each in Arkansas and Minnesota. Three of these were small and even including the $2 billion ANB Financial in Arkansas the estimated cost to the FDIC fund was less than $300 million. And then came IndyMac.  

IndyMac Bank of Pasadena was an aggressive asset gatherer and lender. On 11 July FDIC took control of the $19 billion dollars of deposits – including the $1 billion of uninsured deposits. When the IndyMac dust settles the cost to the FDIC insurance fund is estimated to be between $4 and $8 billion, which means there should still be at least $45 billion sitting in the FDIC piggybank to handle future bank failures.  

When A Bank Fails  
Depositors of a failed bank receive an FDIC message saying “greetings, your money moved” telling them which bank now holds their accounts. Normally, insured accounts are seamlessly taken over by a solvent bank and even the dead bank’s ATM cards will still work the next day at the new bank. Uninsured deposits are usually another matter.  

Uninsured depositors become creditors of the bank. FDIC quickly paid out 50% of IndyMac uninsured balances to their depositors. They should receive additional payments as assets are sold. They may or may not get back 100 cents on the uninsured dollar and it can take years to get the money (for my list of 21t century bank failures and what uninsured depositors received go to http://safemoneyplaces.com/deadbank.htm) FDIC does not publish any ratings regarding the financial safety of banks, but six independent firms do (list is at http://safemoneyplaces.com/fdic.htm). The ratings are typically available to paid subscribers, but Bauer Financial (http://www.bauerfinancial.com/btc_ratings.asp) will tell you their rating for a bank simply by filling in the state and bank name.  

How Safe Is FDIC?  
The FDIC fund represents a little over 1% of deposits, but it is important to note that FDIC may borrow additional funds from the Treasury if needed. By the first of August a California bank, a Florida Bank and a Nevada Bank failed meaning so far in 2008 eight banks have failed, but 8531 have not. I believe there will be more bank failures due to the mortgage debacle – over 2300 financial institutions went belly up during the Savings & Loan problems twenty years ago – but I also see that the FDIC system that has meant no depositor has ever lost a penny of insured deposits since 1934 will continue to protect insured accounts.  

Should You Become A Registered Investment Advisor? 8/08
Since NASD 05-50 hit several agents have asked me if they should become a registered investment advisor.. My answer is yes if your goal is to work as a registered investment advisor. There is nothing wrong with working as a RIA. RIAs help their clients by offering a kaleidoscope of investments. If your goal is advise people on their investments, by all means pursue your goal. But if your goal is to sell more fixed annuities, then perhaps you need to think a little more.

 Becoming a registered investment advisor with SEC or a state may enable one to avoid FINRA, but you become a fiduciary. Let’s review what being a fiduciary means.

For Newly-Registered Investment Advisers
As an investment adviser, you are a “fiduciary” to your advisory clients. This means that you have a fundamental obligation to act in the best interests of your clients...You must employ reasonable care to avoid misleading clients and you must provide full and fair disclosure of all material facts to your clients and prospective clients...You must eliminate, or at least disclose, all conflicts of interest that might incline you — consciously or unconsciously — to render advice that is not disinterested. If you do not avoid a conflict of interest that could impact the impartiality of your advice, you must make full and frank disclosure of the conflict. [http://sec.gov/divisions/investment/advoverview.htm]

Does your seminar present “full and fair disclosure of all material facts” or is it perhaps slanted to showcase annuities?

It’s a given that the fixed annuity recommended by the agent is in the customer’s best interest – or else why would the agent recommend it. But will securities regulators agree that the 9% commission earned by selling the annuity did not cause a conflict of interest? And of course the agent told the customer that they were earning a 9% commission and that this sale meant the agent qualified for the free insurer trip to Prague?

Penalties 
U.S. Code TITLE 15 > CHAPTER 2D Investment Advisors § 80b–17. Penalties
Any person who willfully violates any provision of this subchapter, or any rule, regulation, or order...by the Commission under authority thereof, shall, upon conviction, be fined not more than $10,000, imprisoned for not more than five years, or both. 

About the only way an insurance agent can go to prison is by stealing premiums. RIAs have more ways to go directly to jail.

If your goal is to provide fee-based financial advice on your client’s economic well being, then becoming an RIA with your state or the SEC will enable you to do this, and if you stick with fees rather than earning securities commissions then you should avoid, at present, becoming registered with FINRA. However, if the reason behind becoming an RIA is simply to sell index annuities or avoid FINRA compliance, the liability may well exceed the gain.  

88% Of Public Comments Against Proposed Rule151A 9/08
After attempting to delete duplicate and triplicate responses from some commentators, and reading each comment to determine the intent of the author, I believe that 2046 of the total 2328 unique comments were against implementation of the SEC Proposed Rule Indexed Annuities and Certain Other Insurance Contracts (S7-14-08). Of the remaining comments 256 (11%) were in favor of turning index annuities into securities and 26 (1%) did not express an opinion.

 “I do not sell annuities. Never have and never will...I am uniquely qualified to comment in favor of this proposed rule” (an actual comment)

The comments in favor of making index annuities securities seemed to divide into three different camps. The first camp didn’t appear to have a clue how index annuities work and just assumes they must be securities. The second camp says anything that involves a securities index must automatically be a security. And the third camp says they realize index annuities are not securities but that they are being mis-sold by agents acting as unregistered investment advisors and one way to clean up this problem is to make index annuities securities.

The comments against Proposed Rule 151A has three major groupings too. One group’s argument seems to be that you shouldn’t make index annuities into securities because you will cost them money. Another group says that this is all a conspiracy by FINRA and the broker/dealers to protect their securities commissions and fees, and that there really isn’t a problem. Another group simply argues that FIAs are fixed annuities because they provide guarantees that make them so.

People in favor of 151A were some registered reps, life insurance agents, some variable annuity carriers such as AXA and The Hartford, the Financial Planning Association, a couple of lawyer groups, and, of course, NASAA and FINRA. Folks opposed to 151A were index carriers and agents selling index annuities, several state insurance departments and NAIC, but joining them were a number of financial planners, advisors, registered representatives and 18 Congressman that argued why the SEC proposal should not be enacted.

Number of Times SEC Compared to the Russians Or Stalin: 2

There were several groups that said they were neither for nor against the proposed rule as long as the final rule did not affect them. Comments were received from Assn. for Advanced Life Underwriting, America’s Health Insurance Plans, National Assn. of Health Underwriters, and NAVA National Assn. that I read as saying “Do whatever you want to those index annuity people as long as you don’t hurt me” – a Chamberlainesque response to the situation. Several other groups including American Bankers Insurance Assn., National Governors Assn., NCOIL, and ACLI simply asked for the comment period to be extended.  

At this stage the SEC could reopen the comment period, enact the original or a revised proposal, or do nothing. The last index annuity comment period ended in 1997 and 2008 was the first time an index annuity rule was proposed.

Second Quarter Index Annuity Sales Jump9/08
The AnnuitySpecs.com 2nd Quarter Advantage Index Sales & Market Report shows second quarter 2008 index annuity sales were $6931 million compared with sales of $5776 million for the previous quarter. Second quarter sales were up 6% when compared with the same period one year ago.

The top ten carriers for the second quarter:

Average Commission
The index annuity commission received by the agent averaged 7.81% of premium. .  

3 Card Monte Hypothetical 9/08

More Like 1 in 50

The problem may be that the reality of the entire hypothetical stew produces a 10% return only 2% of the time, 40% of the time the return was 1%, and 50% of the time the return was between 4% and 6%. Based on the real numbers there is a 90% chance the annuity will produce less than 6% if the past repeats. If you going to look at hypothetical results be sure you look at a broad range of outcomes to get a better feeling of the hypothetical probabilities.

Mass Women's Bar Needs To Take A Math Class9/08
It appears a class in actuarial statistics should be required before being elected to the legislature or becoming a lawyer in Massachusetts. The women's bar pushed through the Equitable Coverage for Annuity Policies (S2729) act, signed by the Governor, requiring the insurance industry to have the same payout for life income annuities for both men and women. This sounds fair, both men and women will receive the same immediate annuity life income payments for the same premium but it ignores the economic reality that women live longer.

Altho women receive a smaller yearly payout they receive the payout for more years than men. The current method provides equality because the men and women receive identical actuarially based benefits over their respective life expectancies. The new Massachusetts law sexually discriminates against men because men will now receive significantly lower lifetime income than women.

It’s A Time For Calming Consumers   10/08
My safemoneyplaces.com site lets consumers ask Safe Money Sue & Sam financial questions and usually gets one question a week; now it’s getting thirty. The current topic is how safe are their savings.  

The main question is “are my accounts FDIC insured.” Consumers seem to be confused about what is covered by FDIC. People ask whether credit notes, money market mutual funds, and 401(k) plans are FDIC insured. The answer is no, it must be a deposit of a bank to be eligible. Scarier to me are questions from consumers telling me they have X dollars in checking and Y dollars in savings and saying their bank told them they were fully FDIC insured. In the last situation I looked at $140,000 of the consumer’s money appeared not to be FDIC insured because of sloppy account titling. I am not getting many questions about fixed annuity safety, even after the recent AIG news, but I believe this is because consumers have not yet reached the annuity line on their worry checklist.

Wall Street woes and failing banks are not a good thing for annuities. Altho it might seem attractive to pitch annuities as an island of safety standing apart from the mainland crisis, most consumers will figure out that annuities are really a peninsula rather than an island, because they are still a part – albeit a more protected one – of the same financial mainland and thus could also fail. In times like these consumers need to be reassured that the entire system will be restored. This means not bashing investments or banks, but reminding people about the safety of fixed annuities.  

I'm reminding people that we survived 2900 banks closing during to the Savings & Loan Crisis of 20 years ago –  as well as the loss of Executive Life & Mutual  Benefit (and none of their annuity customers lost a dime of principal if they didn't bail) and to take a deep breath and keep selling strong annuity carriers.  

Direct consumers to the NAIC web site where NAIC President Sandy Praeger said "The federal bailout of the non-insurance portions of AIG does not negatively change the solvency strength of its insurance subsidiaries. The key distinction here is that AIG’s insurance subsidiaries did not cause this crisis, rather, they will play a critical role in the solution."

The reality is both life insurance and annuities are attractive assets because the surrender charges allow the carrier to maintain policy liquidity by regulating outflow, and if the parent gets in trouble the carrier life/annuity companies are purchased for their assets, or the policy blocs themselves are purchased. As an example, when Metropolitan Mortgage got into trouble annuity policies of two of the annuity subsidiary carriers were purchased by GALIC, while Western United was eventually purchased in whole by another company and is still functioning.

The exposure in an index annuity for the typical insurance company is the cost for the option link, a set and predetermined cost. If you had a dollar, made 6 cents interest and spent the 6 cents to buy an option on the index, and the index went down 20% what is your maximum loss? 6 cents. How much do you still have? $1  

These are tough times but annuities have survived many tough periods before because annuity carriers buy very few stocks, junk bonds, and real estate; because annuities are required to set aside additional reserves in addition to the premium paid in; and even tho some annuity carriers have failed in the past, it is worth remembering that every annuityowner was protected up to state guaranty fund limits. 

Tell your clients to take a deep breath. We will survive this crisis too.

5 Year Returns 11/08
There were 28 carriers active in the index annuity market in September 2003. Four carriers marketed term end point designs that have not yet reached the end of their index period and they cannot be included in the study. I asked the remaining 24 carriers for copies of customer statements with customer information whited-out for contracts issued closest to 30 September 2003 for a five year period ending 30 September 2008; seventeen of these carriers provided data on 25 annuities.

This is the seventh year I have collected 5-year return data and I deeply appreciate the cooperation and support of the carriers that were open in sharing what some of their annuityowners earned in their index annuities. 

What Is Important  
The average index annuity credited 5.57% for the five year period. Compare that to the 2.78% they would have earned in 1-year CDs or the 3.34% earned in a 5 year CD [www.bankrate.com]. Once again, index annuities did what they were supposed to do – be a safe money place with the potential for more interest.

The average reported FIA return was 5.57%, double the interest earned in by rolling over 1-year CDs over the last 5 years

The Lost Decade 12/08

End of November Close

Incredible bias is shown in that only the dividend effect is to be disclosed and not the total return of the index. An example of the effect of this bias is for the last five years an index fund or VA index subaccount would have shown a loss over the last five years while the average index annuity was up 30%. This new law will help hide the truth from consumers. 

I suggest an alternative idea, mutual funds and variable annuities be required to show how they would have performed as annual reset index annuities. After all, fair is fair.

Standard Life Insurance of Indiana Enters Rehab  12/08
The Indiana Department of Insurance took control of the carrier on 18 December that was reported to have been brought down by a high concentration of subprime debt. The state says "Surrender requests will be postponed until they can be dealt with in an orderly manner in the rehabilitation." This is the first annuity carrier to enter state control since 2004.