Indexed Annuities…
5 reasons to avoid what could be the worst investment you’d ever make!

Indexed Annuities are defined as contracts with an insurance company where the owner will receive he greater of a fixed level of growth or portion of the growth of a selected stock market index based on predetermined formulas.

Commissions: Indexed annuities regularly pay commissions to the selling agent from 3% to as much as 12%!  That’s right, 12%.  So, if you invest $100,000, the agent can make as much as $12,000 as soon as your money hits the contract.  Not all companies pay large commissions, however, there is a huge financial incentive for an agent to “recommend” the product.

Misleading advertising and sales practices: Much of the advertising pertaining to the indexed annuity starts with a catch phrase like “you have stock-market gains with no risk to your principal”.  Not exactly true.  The interest credited to the account is based on some variation of the change in a stock market index like the S&P 500 or the Dow Jones Industrial Average; however, the gains are watered down significantly.  The gains are diluted by extremely complicated calculations that involve terms such as “participation rates”, “caps”, “monthly or daily index averaging” and many other code words for reducing potential stock market performance.  The fact is, none of the money invested in an indexed annuity ever actually goes into the stock market, if it did the product would have to be registered as a security and would have to have a printed prospectus clearly identifying all the risks and costs associated with the investment.  The money is actually invested primarily into bonds, with a small amount going towards the purchase of options on whatever index the interest corresponds to.

Lack of adequate supervision: One major drawback of the indexed annuity is the ease of entry into the market for selling the product.  It is strictly an insurance product, and as such, only requires an insurance license to sell it.  The state insurance exam, and subsequent licensure does not sufficiently address the complexity of the product.  There are hundreds of different variations of indexed annuities with a mind-boggling number of methods for crediting interest, liquidity provisions, annuitization methods, hidden costs and so many other moving parts that a basic insurance license doesn’t even begin to cover the necessary education required to be adequately trained to sell the product.  Instead, the insurance companies are placed in charge of training the agents to sell their product.  This invariably leads to a biased presentation of all the “advantages” of their particular annuity or annuities leaving out any true objective discussion of the potential “disadvantages” as well.  To further complicate the situation, without a registration process with the Securities and Exchange Commission, the inner-workings of the annuity are never truly revealed.  Insurance companies can hide the true costs of the product by creatively describing fees and costs as “participation rates” or “caps”.   Insurance agents, taking clues from the insurance companies will say clever things like “this annuity is a no-load, no-fee annuity”.  While falling short of being a boldfaced lie, it is absolutely a very liberal interpretation of the true definition of fees or costs.  The no-load description actually is a dishonest way to describe the product, as anytime there is a surrender-charge there is absolutely a “sales load” it’s just a deferred load as opposed to a front-end load.  Any reference to an annuity with a back-end surrender-charge, as a “no-load” annuity is an intentional misrepresentation designed to deceive the potential buyer into thinking there is no commission involved in the sale.  It is very safe to assume that any time an annuity has a surrender charge, it pays the selling agent a commission.  A general guideline, the percentage surrender charge in the first year of the deferred surrender schedule is very close to the percentage commission the agent is paid.   None of this nonsense would be possible if the insurance industry would come clean and agree to register the indexed annuity as a security.  The registration process would require the insurance company to file a prospectus and fully disclose the underlying investment strategies the company employs to produce interest, the compensation to the selling agent and impose more reasonable compensation limits to the product just to name a few possible improvements.

No reinvested dividends: Studies have shown that reinvested dividends comprise a very significant portion of the total return generated by the S&P 500.  Dividends are, generally, not included in the returns calculated in an indexed annuity.

Potential industry changing legislation: Recently, the FINRA has begun looking into the possibility of working with insurance companies to require a full registration of the indexed annuity as a legitimate security.  If this becomes a reality, it could have a profound and possibly negative effect on certain insurance companies, specifically, the companies that have taken a predatory stance with respect to product commissions and aggressive sales practices of their selling agents.  For instance, insurance companies that derive the majority of their sales from products that have surrender charges exceeding 12 to 15 years, that pay commissions in excess of 10% could possibly experience severe financial hardship as the new rules could restrict the commissions and surrender charges to much more reasonable levels.  Without the lucrative commissions as the primary enticement for agents to sell their product, these particular companies could experience a significant drop in sales leading to potential insolvency.  As a rule, potential buyers should be very leery of any annuity that imposes surrender charges in excess of 10 years for this very reason. 

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In summary, these are just 5 of many more reasons we believe there is almost never a situation where these products are a suitable choice for an informed investor.  In almost every instance there is an alternative to an indexed annuity that provides an equal or better potential return with substantially more liquidity and a more straightforward approach.  Finally, please understand that there is usually a substantial financial incentive for an insurance agent to promote the sale of this product, and as a result, they can be very convincing.  It’s always best to avoid any kind of investment that you don’t fully understand.