If an insurance agent pitches you an “indexed annuity,” here is something to ask: What fabulous prize are you helping him, or her, to win?
The question springs from a probe under way by Sen.
Elizabeth Warren
(D., Mass.) targeting sales incentives for annuities, which are tax-deferred savings, investment and lifetime-income products issued by insurance companies. Much of the senator’s focus is on the indexed annuity, widely known within the industry for the perks available to agents, according to industry executives and financial advisers.
In simplest terms, this type of annuity promises a return tied to a stock-market index, while guaranteeing against losses if the market falls. But it is much more complicated than that—with serious limitations on the upside potential—and long has been controversial because of the many ways consumers can misunderstand it, experts say.
In the first quarter of 2015, sales of indexed annuities rose 3% from the year-earlier quarter, to $11.6 billion, even as total U.S. annuity sales fell 7% to $54.4 billion, according to Limra, a research firm funded by the insurance industry.
Royal treatment
In letters dispatched in April to 15 of the nation’s largest annuity issuers, Sen. Warren quoted from marketing materials aimed at insurance agents with a record of high-volume annuity sales, describing sales incentives including “four days in the heart of California’s wine country at the prestigious Calistoga Ranch and Spa”; a trip to South Africa to visit Cape Town and Kruger National Park; and the opportunity to “tour the Mediterranean on a private yacht, like royalty, celebrities, and the wealthy elite.”
The letters say perks also have included cash awards, car leases and, in at least one instance, “a diamond-encrusted NFL Super Bowl Style ring with high-quality gold and a ruby in the middle.”
Sen. Warren’s letters seek from the insurers “a list of all incentives,” saying that annuity sellers who are “more interested in earning perks than in acting in their clients’ best interest can place Americans’ savings and retirement security at risk.”
So, does that mean you should steer clear of indexed and other types of annuities?
Industry’s defense
The American Council of Life Insurers says consumers should feel comfortable in their purchases. “From product development to advertising to sales, life insurers offering annuities must comply with state and federal laws and rules that help protect consumers’ interests,” the trade group said in a statement after Sen. Warren’s letters went out. “State regulations include extensive product disclosure, strong suitability standards, as well as truth-in-advertising and credentialing requirements.”
Still, many financial advisers and even some insurance-industry executives advise caution. “While I believe that an indexed annuity can find a place in many conservative investors’ portfolios, I also believe it is a product that is frequently incorrectly sold,” says
Scott Stolz,
president of the insurance and annuity division of securities firm
Raymond James Financial
Inc.
RJF -0.54%.
Here is more of what you need to know if you are considering a purchase:
THE INNER WORKINGS: While the stock-market link is part of the pitch, financial advisers and agents who understand indexed annuities say they tell their clients to think of them more as juiced-up bank certificates of deposit. Insurers back the contracts mostly with bonds. Often, the return is pegged to the S&P 500, but increasingly insurers are using proprietary indexes.
Insurers typically restrict the upside potential, setting a cap on annual gains at a given percentage figure or limiting them to a percentage of the index’s gain, for instance. So even if the stock market is roaring, the consumer would likely get a single-digit return, Mr. Stolz says. What’s more, insurers typically exclude dividends from the calculation of payouts, though these can notably boost results in a lackluster market year.
And many indexed products’ contracts allow insurers to adjust the participation in gains for the coming year, subject to specified minimums and maximums, says
Lawrence Rybka,
president of ValMark Securities Inc., a securities and insurance brokerage firm based in Akron, Ohio. He calls it “changing the deal for clients.”
Some—and possibly many—buyers don’t understand the role of the upside restrictions when they lock themselves into the long-term contracts, critics say. Early-withdrawal penalties range from three to 16 years and the average is 10 years, according to Wink Inc., an index-products consulting firm.
“An indexed annuity is not an equity investment in any way,” Mr. Stolz says. “Anyone who buys it as an equity alternative is going to be disappointed at the results.”
Agents’ commissions are paid by the insurer; the expense is built into the product. In general, the higher the commission, the longer the period during which early-withdrawal penalties, also known as surrender charges, apply. “Look for indexed annuities with surrender-charge periods of seven years or less, and you will likely have one that offers good consumer value,” Mr. Stolz says.
THE BEST USES: Indexed annuities can work well for conservative savers who want to earn, on average, 1.5 to three percentage points a year more than they would get on bank CDs over a seven- to 10-year period, Mr. Stolz says. They also are preferable to bank CDs in that the interest is tax-deferred until it is withdrawn from the contract.
Some indexed annuities include riders, for an extra cost, to guarantee monthly income for life, an attractive feature to those who don’t have an old-fashioned pension plan and worry about outliving their savings. And some also offer long-term-care benefits should the buyer become incapable of independent living.
Stan Haithcock,
an annuity specialist who is a critic of aggressive sales tactics and is quoted in Ms. Warren’s letters, cautions that consumers buying an indexed annuity for the lifetime-income feature should purchase only those issued by highly rated carriers. Some indexed annuities make sense “if fully explained by the agent and understood by the client,” he says. Mr. Haithcock contributes regularly on annuities to MarketWatch.com, which is published by News Corp’s Dow Jones & Co., publisher of The Wall Street Journal.
ValMark’s Mr. Rybka says potential buyers should consider whether other types of annuities would work better for creating a lifetime income stream. He says his firm’s brokers sell few indexed annuities, because they find drawbacks often outweigh advantages.
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