There was a Hollywood movie star who said: “I don’t care what you say about me, just spell my name right.”
Indexed annuities may not share that sentiment, but they certainly are getting a lot said about them at conferences and in print. In particular, a great deal has been written about National Association of Securities Dealers’ controversial Notice to Members 05-50 and the Securities and Exchange Commission staff’s August 2005 inquiry letter to index annuity insurers.
This article seeks to harvest something relevant about indexed annuities from all the swirling dialogue.
The question comes down to this: What is both the best thing about indexed annuities and the worst, or their biggest potential problem?
The best thing about them is the guarantee of a minimum rate of interest. As a retirement planning tool for the unsophisticated purchaser, the minimum guarantee provides a predictable minimum of future assets to fund the future liabilities of one’s retirement years.
Assuming the issuer is a financially stable entity, the number is a sure thing.
This floor is coupled with the potential for additional credited interest based on increases in an index that provide additional assets available to fund an improved lifestyle.
The biggest inherent problem in indexed annuities is their minimum rate of interest. The model minimum standard nonforfeiture rate (MSNFR) was changed by the National Association of Insurance Commissioners and adopted by the states. It no longer is 3%.
The 3% measure is the rate the SEC implicitly found to be sufficient as a safe harbor for permissible investment risk shifting for declared-rate fixed annuities when the SEC promulgated Rule 151 under Section 3(a)(8) of the Securities Act of 1933.
Although Rule 151 may not be relied on by indexed products, its analysis is relevant to any unregistered insurance product.
As the entire insurance product world knows, the relatively new MSNFR can be as low as 1%. When Rule 151 was adopted, few people dreamed that both short- and long-term interest rates would decline as they did. Not even Alan Greenspan anticipated that.
One thing that has not changed are the words and thoughts contained in the important Supreme Court cases, including SEC v. United Benefit Life Insurance Co. 359 U.S. 65 (1959), that address when insurance contracts are eligible for exclusion from status as securities.
In fashioning Rule 151, the SEC strove to distill the existing case law in its various provisions. The key concept this article focuses on is investment risk shifting–or put more colloquially, when, if ever, are purchasers made whole?