February 2010

Selling Fixed Index Annuities to Loss-Averse Clients: How-To's and Reasons Why

By John Williams, Regional Sales Director

Let’s face it, with the average annualized return of the S&P 500 for the 10 years ended December 31, 2009 at 0.84% and the current average yield for five-year CDs at 2.07%, prudent savers don’t have many options to earn inflation-beating rates of return while safely compounding – especially in an account which allows them to sleep at night without fear of losing money. The ultimate money allocator, Warren Buffett, Chairman of the Board at Berkshire Hathaway, wrote in a 2008 letter to shareholders that "clinging to cash equivalents or long-term government bonds at present yields is almost certainly a terrible policy if continued for long."1

Compounding these problems for clients between the ages of 55-85, chances are they don’t have the savings time horizon required to recoup recent stock market losses. As Mr. Buffett alludes to, investing in bank CDs or cash at current interest rates will surely make it difficult to stay ahead of the impending increase in inflation which many analysts foresee as the economy picks up.

Attitudes about money have changed greatly in the last 20 months. No one has been immune from the effects of the Great Recession, which has affected how many of us feel about savings, losing money, and taking risk. Many people are now loss averse. Loss aversion refers to people's tendency to strongly prefer avoiding losses to acquiring gains2, and it’s greatly affecting how people make financial decisions.

How can someone in this predicament compound their money in a tax efficient way while not losing prior years’ gains? How can a prudent saver earn a fair rate of return on their money over the next 5-10 years? What type of account offers the chance to earn inflation fighting returns and guarantees? The answer lies with a common tax-deferred savings product offered through insurance companies and sold by independent insurance brokers like you – a fixed index annuity.

Before the Great Recession, clients used to ask financial professionals, “How fast will my account value rise?” Now, when potential clients work with us they declare, "Whatever you do, don't lose my money." As a result, many pre- and post-retirees have chosen to allocate some savings into an index annuity underwritten by a reputable insurance carrier like The Standard.

Fixed Index Annuity Advantages

Fixed index annuities just might be the ultimate "whatever you do, don't lose this money" account option. As you know, many insurance carriers sell tax-deferred annuity products which link the upside gain of the account to a stock market index like the S&P 500. These “safe money” product offerings have been available for more than 10 years. In today’s marketplace, the real value of these deferred annuity products lies in their downside protection, upside potential, liquidity options and guarantees. With a fixed index annuity, once interest is credited it can never be taken away if the market index it tracks experiences a negative return.

Your potential clients should clearly understand that these financial products are not intended to provide interest returns commensurate with the full upside of the stock market as a whole. Analysis by an independent fixed annuity research firm found that the average annual index annuity return was in the 5-6% range for the 5 years ending September 30, 2008.3 Is it possible to average more than 6% per year from an index annuity? Yes. Could your clients earn less than 5% per year? This is absolutely true, too.

For example, if the market index returns 0% or less (like the -37% return of the S&P 500 in 2008) in any policy year, the index annuity will not grow in that particular year. Your client’s account will not increase by even one dollar. But they won't lose any money either, even prior years' gains. If in subsequent years the market index linked to that index annuity shows a gain, the account will be credited a gain up to a maximum.

The idea is simple and appealing. Your client gets some of the upside of the market index and none of the downside. Once interest is credited, it will never be eroded by the negative return years of the market index that the index annuity is linked to. Your clients can count on their fixed index annuity because it’s an insurance contract, issued by an insurance company which affords guarantees, promises and safety as part of their contract.

This pleasant experience of watching your account value grow while not participating in the down years of a market index is ideal for loss-averse individuals. Before selling any fixed index annuity to your clients, however, be diligent in asking specific questions. Ask the carrier how long their surrender charges are and how your client may access their money when needed. The liquidity options promised by the insurance company who builds the index annuities you sell should be paramount to your choosing a product which performs as your clients intend, while providing ready access to their money in an especially difficult economic environment.

Danette Kennedy, President of Gorilla Insurance Marketing, Inc. goes so far as to say, "At the heart of criticism against the FIA is the product’s liquidity features. Whether a FIA’s liquidity provisions are matched to a client’s needs is determined by needs-based selling and a suitability analysis. Consumers have to understand what liquidity features they need. Producers need to understand how the liquidity features in an FIA work." ³

Choosing an Index Annuity and Index Annuity Company – What Do You Need to Know?

Always check the financial viability of the insurance carrier. Is the insurance company foreign or U.S. based? How long has the company been in business? Has the index annuity carrier ever experienced any litigation relating to the marketing of their index annuities? How long has the company maintained their current insurance rating?

Here’s a checklist of features to research:

 

Customer Satisfaction =

Your Performance ----------------------- Customer Expectations

 

1. Withdrawals – Find an index annuity product which allows at least 10% free withdrawals immediately and doesn't require your client to wait before accessing funds. If a company sales representative explains how your client can access her money from a particular index annuity product marketed by that company, and you still can't understand it, I’d suggest you look for another fixed index annuity to sell to your clients.
2. Surrender Schedules – Find an index annuity with a surrender charge of 5-7 years. If you're comfortable locking up your client’s money for as long as 10 years, there are also viable alternatives available with 10-year surrender charge schedules. A friendly warning, however; don't complain if after 4 years, your client decides to surrender his 10-year surrender index annuity, and the insurance company deducts a hefty charge before handing over his funds. No doubt you’ll be the first person to receive a phone call from this disgruntled and confused client. In this situation remember the following equation:
You can control your own performance, but you have to manage your customer’s expectations. If there’s a breakdown in the equation then your customer won’t be satisfied. Let the buyer, and salesperson, beware.
3. Renewal Rates – Ask your index annuity carrier for a history of renewal rates for the index annuity you plan to sell. Review the renewal rates, including renewal cap rates, renewal participation rates, fixed account options, etc. If you find them strangely irregular and renewing at rates substantially less than the rates when the product was first issued, then keep looking for a carrier with impeccable renewal rates.
4. Guarantees and Waivers – If you find an index annuity with a renewal rate guarantee or bailout rate guarantee, more than likely you’ve found a consumer-driven product you can be proud to sell. A renewal rate guarantee guarantees that if the insurance company ever reduces your clients’ renewal rate cap below a certain threshold, they may surrender the annuity and receive the entire account value without surrender charges. Guarantees like this are worth their weight in gold and show integrity by the insurance company making the promise.

Also look for an index annuity which waives surrender charges upon death, annuitization, terminal condition or if your client needs money for a nursing home. In addition, many index annuities offer a principal guarantee feature. This unique product feature, which may be added when the product is issued, goes a long way towards providing peace of mind to your clients’ aversion to losing their principal amount. A principal guarantee rider allows the purchaser to receive their original principal amount, minus prior withdrawals, without surrender charges. It's a full money back guarantee. Who couldn’t use a guarantee like this when making an important financial decision?

You Can Count on The Standard

In conclusion, consider offering fixed index annuities to your loss-averse clients. Be clear in selling the concept and managing your client’s expectations. Sell only after thoroughly reviewing both the product and the company who markets the product. And don’t forget: our team is here to support you and provide clear answers to all your questions. You can be confident selling the Index Growth Annuity from The Standard.

1. Buffett, W. E. (2009, February 28). Retrieved January 18, 2010, from Berkshire Hathaway Inc. Website
2. Wikipedia. (2010, January 18). Wikipedia. Retrieved January 18, 2010 , from Wikipedia, the free encyclopedia.
3. Marrion, J. (2009, March 2). The Correct Context For Viewing Annuity Returns. National Underwriter.
4. Kennedy, D. L. (2009, March 2). Liquidity Is The Answer To What Ails FIAs. National Underwriter.