Beware of index deferred annuities, says Lisa Gibbs in her CNNMoney article, “Index annuities are a safety trap.” If your goal is to protect principal, you give up too much for that protection in an index annuity; there are better ways to do it, according to the article.
Index annuities account for a disproportionately large share of investor complaints, according to the article: “According to data that 16 states provided to MONEY, index annuities accounted for 30% of annuity-related complaints to regulators in 2009, even though they represent just 13% of annuity sales. In senior-heavy Florida, it was 55% of complaints.”
One of the big problems in this area is what regulators call “switching.” It happens when a sales person convinces an index annuity holder to sell an existing index annuity and buy a “better” one. If the sale occurs within the “surrender period” ? up to 16 years from the purchase date ? the investor is socked with a monetary penalty of up to 12.5% of the amount invested. A related problem is that sellers are incentivized not to explain the surrender charge and to falsely assure investors that, should they need to, they can get their money out any time they want.
Agents make nearly twice the amount of commission on a sale of an index annuity as they do on sales of other deferred annuities ? 6.8% versus 3.5%, according to the article. In addition, insurance companies like Allianz pay an extra percentage point if agents meet sales targets, and also give “credits” that agents can exchange for merchandise, trips and other prizes.
The corruption lies in the fact that agents are incentivized to give unsuitable advice. “There’s no question the incentives insurance companies pay are designed to influence the advice agents give,” Matthew Gaul, deputy superintendent of New York’s insurance department, was quoted as saying.
It is also troubling that insurance companies derive a significant percentage of their revenues from surrender charges, according to the article: “For example, in 2009 American Equity Investment Life, which does 62% of its business in index annuities, collected $63 million in surrender penalties ? equal to more than half its $101 million operating income.”
Some reputable insurers have decided not sell index annuities because of their complexity and the fact that both agents and consumers do not understand how they work. The article identified MetLife and New York Life as insurance companies that decline to offer index annuities.
Salesmen often pitch the product to seniors at “free dinner seminars,” by saying: If the market goes up you win, and if it goes down you win because you don’t lose. The first prong is false; if the market goes up, you lose because of the costs and surrender charges and lost upside potential.
“The costs and onerous terms of an index annuity aren’t enough to compensate for the minimal extra return you get over a CD,” Charles Fitzgerald, director of the Financial Planning Association of Florida, was quoted as saying.
In an index annuity, the upside is typically limited by “performance caps” of 8% of the price appreciation of the reference index and 0% of dividends, which historically have generated about 40% of equity returns. In addition, that “up to 8%” is often further reduced by a “participation rate.” Thus, investors often must take multiple haircuts and wind up with, at best, 60% of up to 8% of price appreciation – or a max of 4.8%. When the S&P 500 goes up 23% like it did last year, that’s a heavy price to pay.?
On top of that, the issuer makes a “market value adjustment,” a complex calculation that usually reduces the cash value of the account. If all of this does not sufficiently benefit the insurance company issuer, the fine print contains a provision allowing it to change its initial promises, according to the article.
State regulators have sued or issued warnings about deceptive sales of indexed annuities. ??Last year, a federal jury found that Allianz Life Insurance Co. of North America, the nation’s top indexed annuity seller and a unit of Allianz Se, misrepresented one product by promising a 10% “bonus” to hundreds of thousands of buyers. The bonus was illusory and could not be cashed, according to the article.
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