From Oct. 15-17, many of the major players in the annuity world will gather in Scottsdale, Arizona at the Westin Kierland Resort & Spa for the 2014 IMO Summit for insurance marketing organizations. I will provide live highlights from the conference. In the meantime, here you can find out more information about the event.
Prior to the 2014 IMO Summit, the National Association for Fixed Annuities sent out a paper (“Answers every investor needs to know about annuities”) that can benefit advisors as well as consumers. On the following pages, NAFA answers five of the most important questions you’ll ever receive about annuities. These nuggets can be vital in helping producers educate clients and prospects on annuity products.
1. What kinds of returns can I expect with an annuity?
There are two types of annuities: fixed and variable. Variable annuities earn investment returns based on the performance of the investment portfolios, known as “subaccounts,” where you choose to put your money. The return earned in a variable annuity isn’t guaranteed. If the value of the subaccounts goes up, you could make money. However, if the value goes down, you could lose money. Also, income payments to you could be less than you expected.
Fixed annuities earn interest and not “returns.” This is an important distinction because investments earn returns and a rate of return calculates investment losses as well as investment gains. Life insurance and fixed annuities earn interest. Since there are NO investment losses in an insurance product like fixed annuities, the use of “return” is confusing and misleading.
Unfortunately, mixing up these two distinct concepts is a common mistake made by those who don’t sell or understand fixed annuities and who, perhaps, make their living selling risk-based investments. With fixed deferred annuities, the insurance company either calculates and determines the interest to be credited based on the insurance company’s earnings (for set or declared rate annuities) or based on the positive performance of a market index (for indexed annuities).
The National Association of Insurance Commissioners (NAIC), which regulates fixed annuities, considers both products FIXED annuities, regardless of how interest is calculated. All fixed annuities, including indexed rate and declared rate annuities, guarantee you will not suffer losses because the markets do.
2. Is it true that indexed annuities can limit how much interest I earn?
The main difference between fixed indexed annuities and other forms of fixed annuities is the way interest is calculated. And, just as you don’t receive all of the positive earnings from the insurance company investment portfolio in a declared rate annuity, you do not earn all of the positive index performance in an indexed annuity.
The insurance company must pay for the insurance guarantees of the annuity, as well as the usual and customary company expenses to develop, market and service the annuities sold. Insurance companies use participation rates and caps in indexed annuities to pay for these expenses and ensure profitability.
A participation rate or a cap can be raised up or down, reflecting current market and economic conditions. During strong economic times, these rates and caps will be higher; during weak or negative economic times, they will be lower. This flexibility is advantageous for the consumer: the annuity contract adapts to market conditions while also being protected with minimum guarantees and suffering no losses because the index change is negative.
Sometimes folks that “hate” annuities like to show “hypothetical” performances of an indexed annuity by cherry picking economic cycles or other market variables. But, since indexed annuities have been sold for almost 20 years, we have studies that review ACTUAL interest earnings paid into the annuity contract using a statistical sample of over 300 real-life indexed annuity contracts. NAFA encourages you to read the full academic paper called, “Real-World Index Annuity Returns.”
The authors of this study are often called upon to discuss real, historical scenarios, not hypothetical examples using select periods, explaining how fixed indexed annuities actually perform for their owners.
3. Okay, so please explain about the kinds of expenses associated with the annuity?
It is common for those who do not sell fixed annuities and engage in negative advertising about annuities to confuse concepts and features between fixed and variable annuities. Both types of annuities can play a role in financial and retirement planning, but it is important to understand the differences between the two products.