Annuity IQ

Do to the reaction from our comments on the Dateline NBC story, “Tricks of The Trade”, where they performed an expose of equity index annuity sales we feel that our position needs to be clarified. While Annuity IQ likes annuities, immediate, traditional fixed and specifically variable annuities we do feel that equity index annuities have little place for most investors. Below we will further explain our position.

Surrender Schedule:

While the annuity surrender schedule needs to be taken into consideration it must not be the only litmus test for any investment. if the surrender schedule fits the needs of the investor then it is a non-issue. However, some contracts should not be available to older, say above the age of 70, for some clients, specifically surrender schedules that surpass 10 years.

While there is liquidity for most annuity products while they are in the surrender period we feel that contracts that have surrender schedules longer than 10 years is a bit excessive.This is especially true for investors who are older than 70 as the contract will not mature until they are at least 80. Also, with contracts with surrender schedules longer than 10 years we often see the first few years penalty, above the free out amount, in excess of 10% which would invade principal.

Caps:

A cap is set by the insurance company and it dictates the maximum amount the contract owner may recieve in any particular year. If the annual cap is 10%, for example, then the investor will never see more than a 10% gain for that year, even if the index the annuity is pegged to sees returns of much higher. This is a way for the insurance company to hedge its risk and to make a profit from the product, that is not a bad thing by the way.

Most of the popular equity index annuity products have caps, either annual, monthly or for the term of the contract. These caps can move on an annual basis and many caps that start out high often move lower on contract anniversaries the longer the contract is held. That is not to say the caps will always go down, but like fixed annuities that seems to be the trend.

Bonus:

Many of the popular equity index annuities have bonuses attached to them to entice investors. The bonus will be credited to the purchase payment amount and can be as high as 16%. While these bonuses seem attractive one has to ask himself why the insurance company would give someone a 16% bump for money invested.

The answer is because it is highly profitable for the insurance company. While they pay you that huge bonus they often times have a vesting schedule and very long surrender schedules. There may also be lower caps, a spread (where the insurance company will take a certain percentage of the earnings) or some other fee attached to it.

Some of the more disturbing things about these miracle 16% products is the fact that the insurance company may force you to annuitize the contract after the surrender schedule in order to realize the benefits of the bonus and the earnings in the contract. While annuitization can be a good thing, forced annuitization is not. Also if the contract has a 10 year surrender schedule and you have to annuitize the contract you could own this product for a very long time or forever.

Monthly Averaging:

Monthly averaging is where the insurance company will average the previous 12 months returns for the index the annuity is pegged against in order to determine your rate of return. Monthly averaging will reduce your rate of return, it says this right in the sales material. Some people pitch the monthly averaging as a way to reduce volatility, but that is not true, it only reduces what you will earn.

If you combine monthly averaging with a cap or a spread then your return will be severely reduced, that is a mathematical fact. if the contract offers a point-to-point annual ratchet chances are it will be better for the investor.

Dividends of The Index:

Many of the popular equity index annuities sold have their rate of return pegged to the S&P 500. The problem is that about 35 - 40% of the S&P 500’s rate of return is derived from dividends and, to our knowledge, no equity index product in the market includes dividends in their returns. The reason that dividends are not included is because the insurance carrier buys options on the S&P 500 and does not actually own the index and options do not include dividends.

This means that the investor is already starting out behind the eight ball. If dividends are not included, there is a cap and monthly averaging then the rate of return may only be slightly better than a fixed annuity product.

All of these moving parts individually put the investor at a loss, but combined it proves the product to be ineffective. While there are some great equity index products available they are not always sought after. Generally the better products pay less commission versus the bad products that usually pay higher commissions.

Odds are that the products being attacked by Dateline are the bad higher commission paying products, but they never actually showed what exact product was being singled out. That is the real problem, the media never truly identifies the product that is the worst and they simply group all products in the same class.

While we do not like equity index annuities and think the Dateline story had some merits, we also feel that they did not show any of the positive things that the product can do. The good products are hard to find, but they do exist and one must do their own research to find the best product for their needs.

The hottest trend for investment firms is planning for income distribution for the Baby Boomers. As the Boomers age they are seeking investments that will provide income for their retirement needs. The insurance industry has had a lock on the guaranteed income angle for the better part of 200 years through annuities.

Now, mutual fund firms are trying to get in on the action. The hottest trend, besides ETF’s, are income replacement funds which will allocate the investors money and then start to pay a stream of income after a set number of years. The income is derived from income paying securities, dividends and good old fashion withdrawals. The big question is will these products work?

Well the jury is out because all of these products are brand new and have zero track record. With the existing strategies it seems feasible that they will work if the market only goes up and interest rates increase, but then again all investments look good in that scenario. The truth is only time will tell.

They can as part of a diversified portfolio, but not as a stand alone solution. Like investing at any point in a persons life diversification is key and having guaranteed income mixed in with mutual funds can make perfect sense. In a recent article a person from Morningstar was even quoted as saying that for guaranteed income the variable annuity, with living benefits, makes much more sense than just income replacement funds.

While some annuities are less than appealing, EIA’s for example…huh, hum, Steve, a variable annuity with a living benefit can provide guaranteed income along with inflation protection by keeping money invested in equities. As with any type of investment a variable annuity should be considered an asset class and not as a stand alone solution. By using mutual funds and an Annuity the investor will reduce their risk and improve long term returns, Ibbotson has proven this.

The only thing is how do you know what variable annuity is good and which ones are below par? Sign-up for Annuity IQ to find out.

The existing variable annuity contract data has been updated. However, there are still a few minor updates that need to be addressed, like purging companies we are dropping. There are also going to be new contracts added to the database. Genworth, Amperiprise and Lincoln are on deck to be added in the very near future.

Annuity IQ is working with FRC, Financial Research Corporation, to complete an adviser survey to help the variable annuity industry create products and services to improve the industry.

If you are a financial adviser take a few minutes, literally 10 minutes, to complete the survey. You may reach the survey via this link: Survey Link

Please only complete it if you are a financial adviser. Thank you.

It is with deepest concern and sympathy that Annuity IQ reports that it’s founder, Scott DeMonte, was diagnosed with a rare cancerous tumor which was successfully removed almost 3 weeks ago.

While the cancer was rare the doctor’s do expect a full recover, but the type of cancer is recurring and his fight will more than likely continue for many years to come. Scott was diagnosed with a Myxoid Liposarcoma, which is a deep tissue tumor that usually strikes the victim’s extremities such as legs and arms.

Scott has requested that a portion of all sales be donated to the American Cancer Society to help others fight and survive all types of cancer. Going forward for the rest of the year Annuity IQ will donate 10% of all profits to the American Cancer Society.

Our best wishes for a speedy recovery goes out to Scott and his family.