Imagine a neighbor knocks on your door, complaining he is “tired of your kids misbehaving and acting out of control.” Claiming he’d be a better parent than you, he picks up your kids and takes them home.
Wild imagination? Not if we’re talking index annuities. Last month, the Securities and Exchange Commission Chairman Christopher Cox behaved like that angry neighbor. He charged that too many index annuity agents are engaging in abusive sales practices and then proposed regulating IAs as securities, not insurance. In effect, he wants to take IA regulation away from the states and give it to the SEC.
A careful reading of the SEC’s 96-page proposed Rule 151A (File No. S7-14-08) makes clear that the SEC has some major misconceptions about IAs. It’s time to debunk them. Here’s my Top 10 List. (Note: all supporting data below come from research by Annuityspecs.com.)
Misconception 10: All IAs have high surrender charges. Actually, over 45% of IAs sold had 10-year surrender charges as of 1Q 2008. Note: NBC-TV’s Dateline expos? on IA sales earlier this year highlighted an IA with a 16-year surrender charge, but it was one of only 2 index annuities having the longest surrender charge duration in the industry. Ignored was the fact that some IA surrender charges are as short as 1 year.
Misconception 9: All IAs pay big bonuses. Not so. Many IA advertisements do involve big bonuses of, say, 10%. However, top selling IAs tend to have more modest bonuses. As of 1Q 2008, for instance, over 23% of all IAs sold had a 5% premium bonus. Keep in mind that carriers usually need a longer surrender charge to offset a premium bonus, so some of these IAs have longer surrender charges.
Misconception 8: All IAs pay high commissions. In reality, the average street level commission for all IAs as of 1Q 2008 was 6.89%. Judged by IAs sold, the average IA agent commission was 8% of premium in that quarter. One IA did pay as high as 13%, but keep in mind that some IAs pay as low as 1%; also, IA commissions are paid one time in exchange for the agent servicing the policy for the entire term.
Misconception 7: IAs are just used to target seniors. Let’s get real. Do cereal companies “target” children with breakfast cereal? No, but children are the primary demographic for cereal, just as seniors are for index annuities. IAs are retirement income products, folks, and usually people retire when they become seniors. Gasp! How predatory of the financial services industry. (Note: The average IA issue age in 1Q 2008 was 63.)
Misconception 6: IAs are investments. Wrong! IAs are a safe money place, comparable to other safe money places such as CDs and traditional fixed annuities. To compare IAs to “risk money” places, such as variable annuities and mutual funds, is apples-to-oranges. Consumers buying IAs want the safety of guarantees with the potential of some extra upside potential; they are too risk-averse for securities.
Misconception 5: IAs have countless consumer complaints. In my review of closed consumer complaints of the National Association of Insurance Commissioners database, I found that all 58 current IA carriers had a total of 235 complaints in 2007, averaging just over 4 complaints each. With any single carrier, the complaints ranged from 0 to 95. Interestingly, VA carriers drew a greater number of complaints than IA carriers in the same period on an absolute basis.
Misconception 4: IAs are illiquid. That’s false. Only 6 of the 344 IAs available today do not offer the option for 10% penalty-free withdrawals annually (many offer it as early as the first year). In addition, 89% of today’s index annuities have some sort of surrender charge waiver, allowing clients to access funds without penalty, say in event of nursing home confinement, disability, terminal illness, unemployment.
Misconception 3: IAs put the consumer’s money at risk. The only risk to the IA client’s money is if the owner surrenders early, or takes out more than the penalty-free amount. One of the IA’s primary attractions is that it provides principal protection. The funds backing the IA are held in the insurer’s general account, not a separate account (as with securities). Consumers always have the peace of mind of knowing they are protected by the IA’s minimum guarantee. If heaven forbid “something happens” to the insurer, the consumer would be protected by the state guaranty fund–like “sleep insurance!”
Misconception 2: IAs aren’t regulated. This is absolutely inaccurate. IAs are fixed products, and thus regulated by the individual state insurance departments. To date, 31 states have adopted the Suitability of Annuity Sales model regulation. The American Council of Life Insurers and the National Association of Variable Annuities have worked on a joint annuity disclosure pilot project modeled on the NAIC Annuity Disclosure Model Regulation. Several states require advisors to take additional continuing education to sell annuities, and the state of Iowa specifically requires 4 hours of CE to sell index products. Products must meet strict non-forfeiture testing, marketing material guidelines and other tests that each state sets forth.
Misconception 1: IAs are complex. That’s anti-IA hype. IAs are just fixed annuities with a different way of crediting interest.