(Author’s note: A general understanding of indexed annuities is assumed)
High commissions, luxury trips, long surrender periods and high surrender charges are just some of the problems that make indexed annuities a non-starter for fiduciaries like myself. However, even if the insurance companies could overcome these barriers, it’s unlikely that a fiduciary would risk recommending these products. Contrary to popular opinion, fiduciary advisors are open to all products, it’s part of our responsibility to our clients. That said, I don’t recommend these products because I lack trust in the insurance companies and can’t get the data to overcome that lack of trust. I can’t get the data because the insurance companies don’t want to provide it. This trust deficiency is widespread among fee-only, fiduciary advisors.
Indexed annuities are typically long term contracts, and in those contracts, the party purchasing must have a level of trust in the insurance company that they will be treated with respect over the entirety of the contract and even beyond. Crediting a rate of interest that is reasonable is one primary expectation I have as a fiduciary. I have no way of knowing whether an insurance company selling indexed annuities will act responsibly because they will not make available historical renewal rates on their products.
With the hundreds of indexed annuity products in existence and the number of indices used inside of them multiplying by the year, shouldn’t we expect there to be a Morningstar type database for indexed annuities by now? The fact that there isn’t one is baffling until you realize that you can’t build a database without reliable data and a reliable source is not available.
It’s common for an indexed annuity to offer better terms during the first contract year than in later years and getting data to determine how policyholders are credited interest in those later years is, as far as I can tell, nearly impossible.
Let me provide an example.
A common crediting method used by insurance companies in their indexed annuity products is called point-to-point (P2P). The P2P method divides the difference between the ending index value and the beginning index value for the term (generally one year, excluding dividends), by the beginning index value. The formula produced is the percentage point gain in the index. See example below:
Beginning index value: 1,000
Ending index value: 1,100
Percent gain: 10% (1,100 - 1,000) / 1,000
In determining the interest to credit, the insurer will then apply some combination of a cap, a spread and/or a participation rate (I call these levers) at the beginning of the term. You might see a 100% participation rate combined with a 2% spread and a 4% cap, in this scenario if the index went from 1,000 to 1,100 during the term the participant would earn 4%.
Index percent gain: 10%
Participation rate: 100%
Interest credited: 4% (10% - 2% = 8%, the cap is 4%)
In the above example, the participant would earn 4% interest in a year where the point gain in the index was 10%. In many policies, you will see the cap and spread much higher in the first year. The cap might be 7% while the spread is 0%. The same product would then credit 7% instead of 4% in the example above.
You’ll notice how important the levers are to the annuitant’s return. The insurance company sets the maximum spread as well as the minimum cap and participation rate in the contract, but these are set in favor of flexibility to the insurer which allows the insurance company an incredible amount of leeway to manipulate the levers. Given that the insurance company has so much discretion in determining what it wants to credit each year, we need to know what these levers were renewed at in the past. If you don’t understand how the levers were manipulated in the past, you have no idea whether the insurance company is likely to treat you fairly. I’ve seen policies where the spreads were increased, and the caps were decreased to a point where the participant would never expect to make more than 2% in interest no matter how well the markets did.
Why isn’t this data already readily available to consumers, producers, and interested fiduciaries?
The only answer that comes to mind is that the insurance companies are playing games and don’t want the type of scrutiny that would come with disclosure. The industry might say they don’t release this information for competitive reasons, but this belies the fact that the data is available for other lines of business and is vital for performing due diligence. Not releasing the data breeds distrust and distrust precludes any desire to enter into a contract. Indexed annuities are hitting new sales high, so it’s not like the insurance companies are concerned that lack of data is affecting sales, but this thinking is like an ostrich with its head in the sand. The lack of disclosure is not a bug; it’s a feature. Pretending that the potential returns can be significant in these products allow the continued sale of them, but if the data is released and doesn’t confirm what is being sold, there is likely hell to pay.
Imagine someone trying to sell you a mutual fund, and when you ask for the return history, they tell you it's proprietary and can’t release it. Would you be less likely to purchase that mutual fund? Of course, you would. It’s the transparency and track record that allows a fiduciary to perform due diligence on a particular investment option.
Why are insurance companies allowed to hide such vital information or make it difficult to get? No one is pushing them on it. State insurance regulators don’t push for the data to be readily available and indexed annuities are outside the purview of the Securities Exchange Commission as well as FINRA. Insurance agents could boycott products that don’t provide the data, but they have an interest in not doing so and perhaps an interest in keeping the data private. I’d argue that insurance agents have the most to gain from compelling this data release, of course, if the data shows that these products are as bad as they appear, it would be an ugly indictment.
In California, many of the top products sold in public school teacher 403(b) programs are equity-indexed annuities. In one of the largest school districts in the United States I estimate that over 50% of new contributions are directed to indexed annuities, yet at no point in time that I’m aware have these companies disclosed publicly or made publicly available historical renewal rates for their products. Mind you that since these products are savings options within a public defined contribution plan, they are likely subject to greater scrutiny as there is a public interest.
There is no way to measure how a particular product would have performed in the past or whether the insurance company has a history of keeping its promises. I can find first-year data (by scouring the internet), but renewal data is only available if you can get statements from people who have already purchased the product (and even then it can be difficult). I’m always told by indexed annuity salespeople how great the product is, if true, prove it.
Agents have access to historical statements and could show us how great their product is for consumers, yet there is only silence. Of course, even if agents started sending me statements, that data would be subject to bias and incomplete (there is an incentive to send the statements where the performance was positive). Thus the information needs to originate with the source, the insurance companies themselves.
My distrust of insurance companies selling indexed annuities is well founded, but if they began to disclose first year and renewal rates and provided the same information on a historical basis, I would at least have something to work with. I could find people who own the product and request statements to verify if the data being provided is accurate. If the data turns out to be accurate, I could then easily determine the historical returns for different products and place those returns in the proper context. I could compare one point-to-point indexed annuity to another point-to-point indexed annuity and determine whether the insurance company is crediting reasonable rates. I could align the time periods with market data (interest rates and option prices) to see whether the insurance company is acting in my clients interest or their own.
I might even find that an indexed annuity issuer is creating a product that is fair and could deserve a spot in my client’s portfolios. If indexed annuities are as good as insurance agents tout them, then the data should prove it. After all the bad press these products have received (which hasn’t stopped their dramatic rise, that should tell you something), wouldn’t it be simple to show us that the press might have gotten something wrong?
Here’s what I’m saying to insurance agents and companies - please prove me wrong. Force me to change my mind. Provide the public with the data they need to make objective decisions about your products.
Prove me wrong, please, I beg you. Historically, providing the data without being required is much simpler than being compelled.
I always try to base my recommendations on the best data available, right now that data is almost non-existent. If indexed annuities are the superior product, it shouldn’t be tough to prove; there are now over two decades of data.
I want to be clear that I’m not looking for selective disclosure. I’m asking for everything. Every product, every time period. There is no other way to evaluate these options. Adequate disclosure should not be controversial; it’s the bare minimum in due diligence. I’m also asking that this data not be hidden behind an expensive firewall (i.e. made available only to an industry insider who can then sell it).
My plea to insurance regulators is to get on top of this issue. Learn about these products (and not just from the carriers) and work in the public interest to properly allow for more transparency. Don’t wait for an NAIC or ACLI working group to make a recommendation, be leaders and be true consumer advocates.