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Back in 1999, many financial counselors were urging clients to “take some money off the table.”

I also spread this refrain in my turn-of-the-century presentations on index annuities, reminding financial counselors that $100,000 invested in an S&P 500 index fund five years earlier had almost tripled in value.

My advice then: Tell clients to take half their investment money and place it in a vehicle that protects principal. The ideal choice for providing this principal protection would be fixed index annuities, I said, but fixed rate annuities or even certificates of deposit would be fine, too, as long as they protected at least some gains.

If a client objected–because theyd have to pay taxes on these gains–I cheekily suggested the agent respond, “Fine, Ill be back after youve lost $100,000. Then, youll have less to pay taxes on.” (As it turns out, my estimate of loss was, in some cases, conservative.)

My response wasnt meant to be flippant. It came only from the recognition that sometimes you need to treat a client like a Missouri mule and give a verbal 2×4 between the eyes to get his attention.

My point? The index annuity story told three years ago was that it would be prudent to invest in such a product to protect gains and principal from market risk while providing the potential for higher returns. Today, the story is the same.

Yet, some clients may hesitate anyhow, because they feel the stock market may keep on struggling for several more years. These individuals completely dismiss the rationale for index annuities–the potential in the product to pay excess interest linked to an equity index.

What is an advisor to say to such clients? Instead of arguing over which version of the future is correct, I suggest showing how the index annuity concept would have fared in another troubled time in the market. (See chart)

In 1972, the S&P 500 Index closed at the highest year-end value up to that time, and it didnt reach that level again until 1980. If you could have bought the index at the end of 1972, you were under water for the rest of the 1970s. Even at the end of 1979, the S&P 500 was still 9% below its 1972 high. That means, for over seven years, the S&P 500 closed at a loss from its 1972 value.

Now, I want to point out something about index annuities that has bearing on my message. There are index annuities that use an “annual reset” method for crediting index-linked interest. In such products, any gains are locked in and cant be lost if the index subsequently declines. In addition, in a choppy market, such annuities do what their name says–they reset. So, if the index drops, the policy records no interest for the year, but it does “reset” so that future crediting calculations will start at the now lower index level.

If you look at the S&P 500 from 1972 to 1979, and if you apply this annual reset methodology, you will quickly realize such a product would have earned cumulative gain for those seven years of over 77%–even though the index had not yet returned to its former high.

Getting back to responding to clients who hesitate: Do they believe the market will be the pits until the end of the decade? Great! Show them how an annual reset index annuity would have worked in another prolonged bear market.

The cumulative gain shown in the chart reflects 100% of the positive annual changes in the index. No index annuity using an annual reset design today comes close to this level of index participation, after taking into account current rates, the effects of averaging and interest caps. However, what returns are your clients earning in other vehicles that offer the same protection from market loss?

The point is, index annuities with annual reset crediting methods take advantage of bad markets and offer the potential for more interest.

What if your client is a little more optimistic about the future of the stock market, but still wants guarantees? Index annuities with term end point or high water market crediting methods offer higher effective index participation than annual reset designs for increased interest potential. They also offer a minimum guaranteed return if the market doesnt perform as desired.

My message in 1999 was “protect your gains with index annuities.” Today, the message is, “preserve your potential with index annuities.”

is president of The Advantage Group, an index product research and consulting firm in Maryland Heights, Mo. His e-mail is jack.marrion@gte.net.


Reproduced from National Underwriter Life & Health/Financial Services Edition, August 12, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.