Another Warning about Indexed Annuities (this time from an industry insider!)

Annuity specialist Stan Haithcock (aka “Stan the Annuity Man”) recently posted a sobering article reporting that an indexed annuity executive is “fed up” with how indexed annuity products are being pushed by insurance companies. The article is posted here.

According to this post, the indexed annuity industry insider acknowledged that insurance companies issuing indexed annuities manipulate and craft contractual functions to achieve needed profit – not for the protection of the annuity purchaser (who is typically a retiree). Of course, this profit first scheme is contrary to the insurance company’s up-front promises of “principal protection” and income benefits tied to equities that will beat bank certificates of deposit and savings accounts. According to the article, such conduct by the insurance companies amounts to a “bait and switch.”

Mr. Haithcock’s post also notes that agents selling indexed annuities are not adequately trained concerning the indexed annuity complexities. This point only confirms my previous post concerning the existed of “embedded derivatives” in indexed annuities that the agent is unable (and not told how) to value. 

As I mentioned in an earlier article, even some banks appear to recognize that the products are too complex for the market. InvestmentNews noted that Wells Fargo Advisors does not carry these annuities “largely because of the complexity that comes with combining an annuity with structured products.”

Are Structured Product Annuities’ promises of “Principal Protection” too good to be true?

InvestmentNews reports that insurers are concocting annuity contracts “that use structured products to buffer clients’ account values against downside losses.” Protection of investment principal against downside losses is certainly attractive to investors – especially retirees and seniors – but at what cost and do these products really protect principal? 

First, it is worth noting that the average investor cannot possibly discern the prices or values of these products without expert valuation models. The insurers themselves have to use these valuation models to calculate their obligation to the annuity holder. The price or value of the product is not quoted in the paper or through exchanges, and there are no available price references. You would have to consult an expert in finance to discern the true prices of the structured products and determine whether or not you are paying too much for principal protection, or not protecting all of your principal. Second, the products are extremely complex. Your agent may not be adequately trained in complex derivatives and structured products, or their valuations. 

Even some banks appear to recognize that the products are too complex for the market. The InvestmentNews article noted that Wells Fargo Advisors does not carry these annuities “largely because of the complexity that comes with combining an annuity with structured products.” 

Click here for the entire InvestmentNews article

Derivative Contracts: Where is your Counterparty and why should you Care?

A recent Wall Street Journal article, entitled “Big Banks Make Swaps a Foreign Affair,” serves as a reminder for investors who are parties to derivative contracts that the devil is in the details.  The article suggests that U.S. banks, including Bank of America, Citi, Goldman Sachs, JPMorgan Chase and Morgan Stanley are changing the terms of swap agreements so that the U.S. parent bank is no longer the guarantor under the derivatives contract.

The article also suggests that, without a tie to a U.S. parent, the derivatives contract will not fall under U.S. jurisdiction, and could avoid Dodd-Frank rules altogether.  Although there may be other bases for U.S. jurisdiction, investors in bad derivatives contracts with offshore entities without any tie to a U.S. bank may be face very serious problems enforcing those agreements, or availing themselves of investor protections under U.S. laws.  This added risk should be carefully weighed by investors entering into these derivative contracts, and considered by the investors as a negative impact on the valuation of the derivative contracts.

U.S. Regulator Warns About Indexed Annuities

The U. S. Financial Industry Regulatory Authority, Inc. (FINRA), the successor to the National Association of Securities Dealers, Inc. (NASD), has issued warnings about the dangers of “guaranteed” and “principal-protected” indexed-annuities that offer fixed “income benefits” to “beat the bank."; These investments may be unsuitable, can lose money, and are subject to misleading sales practices.

The FINRA/NASD warns in Notice to Members 5-50 (http://www.finra.org/Industry/Regulation/Notices/2005/P014820):

• Indexed-annuities are “complex investments.”  Most issuers tell their shareholders (but not the retired annuity investor) that the indexed-annuities contain extremely complex structures called “embedded derivatives.”  These embedded derivatives are complex financial instruments that are extremely difficult to value.  Investor Warren Buffet calls derivatives “time bombs."
• Many indexed-annuities are “not registered under the U.S. Securities Act of 1933” and therefore the investor does not have protections afforded by the U.S. Securities Laws.  State insurance regulators do not check the fair values of the so-called “embedded derivatives” for reasonableness.
• Sales materials for indexed-annuities can “confuse or mislead investors” because they do not “provide a balanced description of the features and risks.”  Beware of these claims:

“What if the market goes down and you would lose nothing? The market goes up-you gain!”

“A Win/Win Investment Vehicle!”

“How Your Retirement Funds Can Have: Security of Principal, Higher Than CD Rates of Interest, Opportunity for Growth (No Losses)”

“If you’re looking for upside potential and no market downside look no further than [name of Indexed-Annuity].  This fixed annuity... enables you to make the most of S&P 500 Index gains. . . .”

“Growth Potential without Market Risk.”

• Sales agents do not fully understand the complexities and risks of the indexed-annuity.  Most sales agents cannot value the “embedded derivatives” that can cause you to overpay for “guaranteed” “protection” of your retirement savings.

A FINRA/NASD “Investor Alert” http://www.finra.org/investors/protectyourself/investoralerts/annuitiesandinsurance/p010614):

• You can “lose money.”  “Many insurance companies only guarantee that you'll receive 87.5 percent of the premiums you paid, plus 1 to 3 percent interest.  Therefore, if you don't receive any index-linked interest, you could lose money on your investment.”