Congress sells out seniors: No SEC regulation of indexed annuities

You can’t turn your back on Congress for a minute. Just when you think an issue will be settled in favor of investors, a Senator oozes under the door and slides a quick pro-business, anti-investor change into a bill.

That’s how the equity-indexed annuity — a costly product with a woeful past — slipped out of the hands of a potentially strong regulator and into the cushioned lap of a weak one.

The Securities and Exchange Commission had planned to regulate these annuities, widely sold to older people, pending a review of the industry. A court decision last year affirmed that the products lie within the SEC’s jurisdiction.

The insurance industry fought back — using, as a weapon, Iowa Democrat Sen. Tom Harkin.  A last-minute change in the financial reform bill last week, inserted at Harkin’s behest, left oversight (such as it is) in the hands of the states. For savers and investors, that’s not good news.

An equity-indexed annuity sounds like a conservative investor’s dream. You hold the annuity for a certain term — typically, five to 10 years, although some run longer. Your gain depends on how well the stock market does. If it rises, you get a share of the gain. If it falls, you get a minimum return, guaranteed by the insurance company that issued the product. All gain, no pain. (Some annuities are tied to other indexes but stocks are the most popular.)

What’s wrong with this picture? The disclosures (or lack or them), the sales tactics (high risk of abuse), and the cost (a secret). Taking them in reverse order:

You don’t know what you’re paying for an equity-indexed annuity. You’re promised a return that’s calculated in a particular way. The price is built into the calculation so you never see it. Salespeople might tell you that there’s no commission or that you don’t pay it because the insurance company does. That’s effectively a lie. They earn 5 to 10 percent on the sale, one of the highest commissions in the business, and their payment comes right out of your returns. The longer the salespeople lock you into the product, the more they earn.

The sales materials themselves might say, “no annual fees, no investment charges,” but that’s misleading too. One way or another, you pay. Had the SEC been in charge, the companies would have had to tell the truth.

You might not understand your risks because the salesperson didn’t explain them.  For one thing, a 10-year contract is inappropriate for a buyer who’s, say, 80. If you run low on cash and need to retrieve your money from the contract, there’s a large surrender charge. These annuities are only for people who are sure they can afford to hold them to the end of the term. A few state attorneys general have prosecuted salespeople who sold them older people as a one-stop savings account.

Aggressive insurers offer “signing bonuses” that might bring your first-year’s apparent return to 10 percent. But believe me, that’s not a gift. You pay for the “bonus” yourself, in reduced returns during the annuity’s term. Signing bonuses are a sure sign that the product is high in cost and low in final yield. The SEC would have forced disclosure on the effect of bonuses, too.

If the stock market does poorly over the term of your investment, you do get the minimum guarantee–typically 2 percent.

You might be confused by the way the insurance company calculates returns. You typically get only a percentage of the market’s gains, excluding dividends. There might be a cap on the amount the annuity credits you with. Your yield might depend on the level of the market at the end of the term compared with your starting point, regardless of any gains that were made in between. Annuities that credit you with gains in between will lower the portion of that gain you’re allowed to receive.

If the insurance company wantsto earn more on these annuities, it can reduce your share of the stock market’s gains (the contract lets it change the terms of the deal any time it wants). Because of these differences, it’s impossible to compare the various equity-indexed annuities on the market, to find one with a lower cost.

The states mostly ignored these problems until lawsuits were brought and the SEC got involved. To fend off federal regulation, the National Association of Insurance Commissioners recently approved a model “suitability” law for stronger state oversight. It requires more training for salespeople, and holds the insurance companies responsible for seeing that the product suits the needs of the people buying it.

So far, Wisconsin has adopted the law, Iowa is close, and 29 others are considering (or planning to consider) it, says Jim Mumford, Iowa’s first deputy insurance commissioner. Typically, a state will require its own insurers to apply the suitability law to sales in states that haven’t yet passed it themselves.

Reports of abusive sales have diminished in recent years, Mumford says. Given the states’ past history, however, I’ll believe in tougher oversight only when I see it.

Texas Securities Commissioner Denise Voigt Crawford worries about the aftermath of the Harkin coup. Congress might decide to block SEC regulation of other hybrid investment/insurance products, too, she says.

FINRA, the Financial Industry Regulatory Authority, has posted an Investor Alert about the complexities and risks of equity-indexed annuities, which any potential buyer ought to read. Use this product only for a small part of your savings. No one should invest heavily in any vehicle that socks you with huge charges for taking your money out before the end of the term.

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Robocop // 07/07/2010 at 10:02 am

Ms. Quinn —

There should be no surprise when advocates of various types of financial products are involved in a turf war over who is going to control and regulate industry distribution of various sorts. The securities side of the business wants to limit and inhibit sales on the insurance side and vice versa. You argue that the securities industry would provide more effective regulation of certain insurance products, ignoring the financial incentive that industry has for limiting access to competing products. Others think the more local and the specialized insurance regulation of the various states is more effective. While reasonable people can surely disagree about the better conclusion, given the disastrous regulatory conduct by the SEC and FINRA during the recent financial crisis (see, for example, Madoff, Bernie), the better course is, at a minimum, surely more in doubt than you suggest. Moreover, your hyperbolic headline is clearly overblown.

In the interest of full disclosure and transparency, you might also have included (or at least mentioned) an independent study of fixed index annuities and their returns and benefits. The Wharton Financial Institutions Center from the Wharton School at the University of Pennsylvania released a study last October entitled “Real World Index Annuity Returns.” The study was updated and expanded in March of this year. It provides the first empirical exploration of fixed indexed annuity returns based upon actual contracts that were sold and actual interest that was credited on those contracts. It is linked below.

The study concluded that from 1997 through 2007, for the contracts examined, five-year annualized returns for FIAs averaged 5.79%. These returns compare to 5.39% for taxable bond funds and 4.73% for traditional fixed annuities over the same period. The study also found that for the period from April 1996 through December 2008, a specific and typical FIA’s returns bested the S&P 500 alone 66% of the time and a 50/50 mix of one-year Treasury Bills and the S&P 500 80% of the time.

The study’s conclusions won’t be a surprise to those familiar with FIAs. How will FIAs perform in the future? We do not know but the concept has proven to work in the past and any comprehensive article on FIAs, including this one, should reflect that reality. FIAs were not designed to be direct competitors of index investing nor should FIAs be promoted to provide returns to compete with equity mutual funds or ETFs. FIAs are designed for safety of principal with returns linked to upside market performance.

FIAs, like any and every financial product, are susceptible to unscrupulous sales practices. Such practices should be attacked vigorously. But one can surely and reasonably differ on the best ways to do that. On the other hand, one cannot reasonably differ from the Wharton conclusion:

“Using the criteria of multiperiod utility analysis, …for moderate and strongly risk-averse individuals, the fixed indexed annuity is judged superior in performance to various combinations of stocks and bonds. This is not surprising because a risk-averse consumer will penalize an investment alternative that does not avoid downside risk in a quest to achieve superior returns. Because FIA?s are designed in a way to avoid downside risk, they tend to produce preferred return patterns for such consumers when compared to alternative investment strategies that expose consumers to significant levels of that risk.”

Real World Index Annuity Returns (revised edition):

Jane // 07/07/2010 at 1:35 pm

Thanks, robocop, for the link to the Wharton study. It is interesting but has limitations. The biggest ones are that participation was voluntary, insurers got to choose which EIAs it submitted for analysis, and in some categories the selection was small. I look forward to more work in this area. Still, the returns aren’t my issue. My issue is whether EIAs are properly sold.

Geoffrey // 07/07/2010 at 12:46 pm

Oh you mean they would have to tell the truth like they do for mutual funds that have commissions of anywhere from 5 to 8% as well as management fees, 12b1 fees that you need a degree in finance to figure out what they are really charging? You mean like those?

By the way just how much money did people lose in Equity Index annuities this past year, two years, three years or ever due to the market??? Oh, opps that would be NONE as in Zero. In fact how many people have EVERY lost money in an annuity due to failure or market problems… oh, opps that would be zero as in NONE too.

The only reason FINRA wanted these under there regulation has nothing to do with public safety.. It all comes down to money. There are billions of dollars coming out of the stock market and moving nto these products. It’s a joke to say that it was public safety and its a joke to have FINRA post an investor alert about the complexities and risks. Let’s do a side by side from a Mutual fund perspective and see which one you get through.

Your article is grossly misleading, and a significant injustice to the public. If you want to look at lawsuits against brokers vs those selling Indexed Annuities bring it on. There are bad people in any field.

The bottom-line FINRA has no business regulating an INSURANCE product and their only true interest is their pocket book.

Jane // 07/07/2010 at 1:33 pm

I wasn’t arguing against the EIA as a product. I well understand that many investors are happy with a no-loss/maybe-gain investment, especially in recent years. The issue is abusive sales of EIAs.

As is well known, abusive sales have been an issue for years, with insufficient action by the states. That’s why the SEC (not FINRA) planned to take over regulation. To avoid this, the National Association of Insurance Commissioners opened a dialog with the SEC and has just updated its suitability standard for sales. The new standard makes insurers responsible for seeing that sales are properly made. I had still hoped for SEC regulation (as I wrote), because–once the heat is off the states–I’m afraid that they’ll fall back into their old ways. So… we wait and see whether the states and insurers will actually do their duty.

Mutual funds are required to disclose their costs (and by the way, 5% up front is rarely found these days and 8%, not at all). You don’t need a degree in finance to figure it out, it’s all up front in the prospectus in a single short table, for anyone who wants to look. No-load funds have the table online. The point, however, isn’t the size of the fee, it’s whether you know what you’re paying–or can find out. With EIAs, you can’t find out.

Doughboy // 07/07/2010 at 2:35 pm

Jane–As a former RIA I decided to move ALL my clients out of the rigged stock market in March of 2000 and into Equity Indexed annuities for the sole purpose of protecting their investments. Not one of them is unhappy with that decision to date.If you really want to understand the markets I suggest you write about the Plunge Protection Act and how they ( Goldman Sachs etc.) currently manipulate the markets. How about doing some research into the Fat Finger Flash Crash, where’s the transparency there?

Indexed annuities are insurance products and always will be. With all due respect, please stop demonizing a product that you REALLY don’t understand that all my clients like and are very happy with.

Jane // 07/20/2010 at 1:11 am

I haven’t demonized the product. I have strongly objected to abusive sales and lack of disclosure about costs.

Geoffrey // 07/07/2010 at 3:23 pm

And you have faith in the SEC? Are you kidding? lets take a look at lawsuits in the securities industry vs insurance industry. Let’s talk about abusive sales from investment brokers. Those sales that have resulted in millions of dollars in losses to their clients? Sometimes ALL of their money. The SEC doesn’t exactly inspire confidence.

Have their been inappropriate sales within the annuity sector? yes! Have clients lost their life savings? NO! I stand by the fact the SEC wanted control over FIA’s because their are billions of dollars coming out of the stock and bond markets. They control the market they can shut down FIA’s.

As far as your response about “maybe” gains in an FIA..Two points, one is I will take maybe gains with NO CHANCE of loss any day. Second, Are you saying the stock market isn’t “MAYBE” gains? I would like to see that market.

Can you find out what the “fee” is for my CD, money market, Savings account at the bank? I’d like to know that too…Because I do know they make lot’s of money from those deposits and pay pitiful returns. That is much of a fee to any client as your example.

Jane // 07/20/2010 at 1:10 am

Insurance regulators have allowed abusive sales of indexed annuities for years and years and years. At least the SEC would require the sellers to disclose the cost. Salespeople keep telling customers that these annuities don’t cost them anything. (That’s something else the SEC would stop.)

jim // 07/08/2010 at 7:11 am

I have read about annuities, from a very limited skim view, but do not trust any of them, with one exception. The immediate pay fixed annuity, if you simply need lifetime income and need to convert a savings or certain amount of money into a stream of income, rather than a holding of savings, and for life.

Jane // 11/24/2010 at 12:59 pm

I have written positively about some annuities. See
I have written negatively about equity-indexed annuities (which the industry likes to call “fixed annuities,” even though they aren’t fixed), due to lack of disclosure, hidden fees and, yes, abusive sales, as several lawsuits by attorneys general can attest. the National Association of Insurance Commissioners promulgated special rules for the sale of EIAs because of the abuses.

Richard // 03/01/2011 at 1:16 am

The supporters of EIA’s are so benevolent. They are making more commissions than they ever would in mutual funds selling these products. It’s interesting when they refer to the S&P 500 in there sales process, however, EIA’s are not listed as variable products. So, where does the S&P fit in this equation except to mislead consumers. They also don’t enjoy the same scrutiny in there sales practices as Variable Annuities and the person who said VA’s are bad is absurd. Last but not least is the surrender period for many of these products. If EIA’s are so great why is it that the largest mutual insurer in America won’t sell them and will terminate any contracted agent who does.

Jane // 03/08/2011 at 5:49 pm

Here, here. The industry renamed these variable products “fixed annuities,” to help evade regulation by the SEC. And their dropped the work “equity” from the name. (It used to the Equity Indexed Annuities; now I get hate mail if I use that term.) Anyway, they’re kinda fixed (to avoid more regulation) but kinda linked to stocks (but don’t call them variable) and rise with the S&P (but don’t call that equity). Where there has to be so much subterfuge in selling, you know you have a product that the industry doesn’t want to bring out to the light of day.

jonk // 05/19/2011 at 10:25 am

Or, to boil it all down to a simple sentence: ours is a government Of, By, and For the corporations. Great article Jane.

Kevinne // 02/28/2013 at 11:47 am

Jane, I have been a variable annuity wholesaler for 15 years. the abuses with equity index annuities are rampant. Yesterday i came across a client who had been sold 6 indexed annuities in two months. this unfortunately is all too common. It is almost always Insurance agents who do this. No more than 30% of any ones total investable assets should be in an annuity. The surrenders should never be longer than traditional B- Shares.

I am very disappointed in our industry. If an Insurance agent recommends the liquidation of an equity (Stocks or mutual funds) to buy an indexed annuity then they are giving financial advice and should be required to have a securities license. Let’s see how that goes over with Insurance agents!

Jane // 03/04/2013 at 5:44 pm

Thanks for the input, Kevinne, this should help a lot of readers.

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