Confessions of an indexed-annuity insider

Indexed annuities are currently the hottest and most over promoted product in the annuity world, and the dream-return scenarios that are too often being pitched are translating into record sales.

I am one of the few people in the annuity world that hasn’t drunk the hybrid annuity Kool-Aid because indexed annuities were actually designed to compete with CDs, not market returns. High-income rider percentages veiled as yield along with upfront bonus teasers combine with the false narrative of no downside with market upside . This annuity nonsense has created a toxic formula of over hyped sales madness that is sweeping the country. The fact that Internet, TV, radio, and print promotions go largely unregulated and without repercussion has spawned a new breed of annuity elixir carnival barkers.

Buyer beware is an understatement.

Let me go on record that I think indexed annuities do have a specific place in some select situations, but should only be owned for their contractual guarantees. I do recommend them when they fit an appropriate need or goal, but I am continually disappointed with how they are typically sold and promoted.

Recently, I was contacted by an indexed annuity executive that is also fed up with how these products are being pushed. He wanted to reveal some well kept, closed-door industry secrets to consumers and arm them with some important truths about indexed annuities. Fearing industry backlash, he asked me to keep his name and company affiliation confidential.

Below are some of the topics that we covered and my take-aways or impressions from our discussion:

How index option strategies are created and can be manipulated

Annuity companies are in the business to make money, and that’s not a bad thing. However, the No. 1 concern when designing an indexed annuity product is the company’s return on investment. They start there, and then manipulate and craft the contractual functions to achieve the needed profit. Most index choices within a product typically return the same profit to the company.

Why most index annuity offerings have 10 years or more in surrender charges

Most people think that the agents are slaves to the carriers. It’s actually the other way around. The agents really run the show. The longer the surrender charge period, the higher the commission paid to the agent, and carriers know that agents are going to gravitate to high commissions … so that’s the products they give them. The carriers pretty much move the pieces around till they find the right “product recipe” to attract the agent and entice them to sell it to the client.

The new trend is for carriers to create a brand new index creation that never existed before, and then back-test the design in a favorable way to make it more attractive for the agent to sell. Really bizarre stuff in a traditionally boring fixed-annuity world.

The ugly secret is that carriers would really love to do away with agents altogether, but no one is sure how to pioneer a direct model. The money flow is too good to try to change.

Renewal rates on the index options

Most index option choices are priced for the initial sale of the annuity and not for the full term. That’s the ugly reality with too many indexed annuities. If the first-year cap is 7%, then typically the renewal rates continue to decline over the life of the policy. Very few companies are fair about the renewal rates. It’s too often a bait and switch. It all comes down to the cost of the option to the carrier. The volatility of the index will help determine if the caps are high or low, in addition to the bond rates. If the cap seems really high, then that carrier is just trying to buy business and attract premium. Once the money is there, then they will try to make it up later in the contract.

There’s only 100 pennies in the dollar, so if the indexed annuity is offering an upfront bonus or big income rider percentage, then they have to take it away from somewhere. That’s just common sense.

Hedge fund/private equity companies buying index annuity carriers

The hedge funds getting in the business has definitely shaken things up. First of all, these guys want a much higher ROI than a traditional old line annuity company. They are confident that they can manage the money better to create a higher rate of return through their proprietary investment formulas. That supposed higher rate of return leads to higher contractual promises in some cases.

I hope they are right because a lot of retirees that bought their annuities are depending on those guarantees. But my question is, what if their formulas are wrong?

Other indexed-annuity issues of concern

Indexed annuities are really a microcosm of human nature. The too good to be true pitch isn’t only embraced by too many agents, but too many annuity buyers as well. These products are sold, not bought, and that is tragic. Some indexed annuities really can work if placed properly.

Another problem that the industry doesn’t want to talk about is the testing and qualifications for the agent. In most states, you can take a cram course, pass the life insurance state exam, and be selling indexed annuities in a matter of weeks or less. Everyone behind closed doors knows this easy path to selling is an issue, but no one wants to interrupt the money flow. It takes a person a lifetime of work to put away money for retirement, and it takes a week for a person to qualify to sell an indexed annuity. Just think about how bizarre that correlation is, and the unbelievable fact that the fixed-annuity industry seems OK with it.

My comment

The sad part about the current state of affairs concerning fixed-index annuities (aka: indexed annuities, hybrids, equity-indexed annuities) is that the product can be a very effective alternative to a CD. It can also be used as an efficient delivery system for an attached benefit income rider to solve for future income. Unfortunately, that’s not the sales story that you hear at most bad chicken dinner annuity seminars or Internet promotional ads and videos.

Eventually the indexed-annuity world will get cleaned up, voluntarily or involuntarily. The more information provided to consumers the better, and I’m glad that some industry insiders are now coming forward to try to set the record straight.

Meanwhile, annuity caveat emptor, especially when it comes to indexed annuities.

Originally published 4.29.14 by –