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The Correct Context For Viewing Index Annuity Returns

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A financial magazine published an article about index annuities that cited my findings from the actual return data I collect, quoting that the average annual index annuity return was around 5.6% for the 5 years ending September 30, 2008.

The article then said, “In other words, an investment that’s often marketed as a safer way to own stocks delivered bond-like returns.”

This summation neglects a key point, also made in my study–that the annual return for the top-selling index mutual fund for the same period was 5.05%. Therefore, the average index annuity earned 0.5% more than the top index fund for the 5-year period.

Put another way, a product design that is not intended to produce “stock market returns” has in fact beaten the stock index for half of the 5-year periods recorded.

Consider: if averaging returns for all the 5-year periods, the average annualized index annuity gain was 6.25%. By comparison, the average annualized period gains for the S&P 500 was 4.2%. (Note: the ending date for the 2002 5-year period was January 2 but all other 5-year periods ended at September 30.)

Before jumping to the conclusion that might seem justified by the actual data–namely, that one should never own stocks or mutual funds when an index annuity is available–readers should factor in some qualifiers.

First, index annuities have had annual returns to report for only a dozen years, and even in those dozen years, data was only available from a few carriers in the early years. So today’s data may not be an indicator of future performance, since many more insurers are now in the market.

In addition, the index annuity carriers who participated in the studies may not have supplied the returns for all of their products in the specified periods. This means that the figures given are representative but may not be exact.

Also, the average 4.2% S&P index return mentioned above does not include the roughly 2% the policy owner would have earned from reinvested dividends in an index fund over the very same years. (But, then, neither does that 4.2% figure factor in a deduction for fund fees).

The reality is, when assessing the entire universe of index annuities, the earlier mentioned index annuity returns are probably overstated a bit because the figures do not include returns for every product.

But this does not take away from the facts–namely, that index annuities have not only been truly competitive, but that they have served their main function as a fixed annuity, which is to safeguard principal and credited interest from market risk.

That is the context in which they should be viewed.

When agents learn that index annuity returns have regularly topped returns for bond funds, certificates of deposit, and fixed rate annuities, they invariably want to show prospects a copy of the research. That is, they want to do this until they find out that the index annuity returns are in the range of 5% to 6%. Their objection, as voiced to me, is that they “can’t sell 5%.”

My response? If an agent has trouble selling a tool that has steadily produced, on average, 5% yields during the worst investment decade of the last 30 years, the agent is using the wrong benchmark.

An index annuity should never be viewed as a place for “safe high returns,” which is a financial oxymoron. Rather, it should be presented as an alternative to the risk of stock investments.

Based on the index annuity’s performance against other safe money benchmarks, agents, the media, and the politicians should recognize and respect index annuities for doing what they were designed to do.

Jack Marrion is president of Advantage Compendium, a St. Louis, Mo. research and consulting firm on annuities. His e-mail address is [email protected]


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