Many articles in the past months have lamented about the growing popularity of indexed annuities as evidenced by 2001-2004 sales statistics. However, NAFA would like to add a little perspective. The $13.8 billion of indexed annuities sold in the first half of 2005 represent 8% of the total $109 billion of annuities sold during the same period ($67 billion in variable annuities and $42 billion in traditional fixed annuities). Does this increase from nothing 10 years ago make the product worthy of pejorative treatment? What is it that stimulates the wrath of journalists and securities industry sources? It is more than coincidence that the increase in indexed annuity sales follows the tech sector collapse, the flood of baby boomers nearing retirement, and the tepid performance of the market since 2003. People value safety and they tend to value it more as they near retirement and develop a greater need to insure their savings against loss. Indexed annuities have principal guarantees these people need. NAFA believes indexed annuities, like all fixed annuities are a safe place for money when a safe place makes sense.

Much has been made of the "regulatory controversy", quoting the NASD's concern that multiple regulatory regimes create a real risk for brokers. At this time, the NASD is the only organization creating the controversy with their Notice to Members 05-50. The National Association of Insurance Commissioners has not acted nor has the Securities and Exchange Commission. The NASD has issued a NOTICE not a Rule as it would be beyond their purview to declare indexed annuities to be securities. What the SEC determines is the status of indexed annuities as a class or any particular design will be based on precedent and will be well reasoned and, thus likely determine they are not securities. The NASD's Notice is only a suggestion to broker dealers asking them to consider supervising the indexed annuity sales of their registered reps for fear those reps when talking to clients are making them sound like securities. This would seem a desirable, but unnecessary, goal. At this time the state insurance departments are increasing regulation of annuity products through the Producer Licensing Disclosure Model Law and the Senior Protection in Annuity Transactions Model Law.State departments already regulate disclosure and advertising of all fixed annuities through advertising and fair trade regulation.Indexed annuities should and will remain fixed annuities regulated by the state insurance departments.

Many articles in the press refer to the annuity owner as "the investor" effectively making a proof that indexed annuities must be securities because we define everyone who buys them as an "investor." The securities industry has co-opted the terms "security" and "investor" among others. To them, they no longer hold their broader Webster definition. According to the NASD, they represent just the set of financial products that the SEC regulates, ironically enough, products which provide very little "security" and which transfer risk to their purchaser. Some have opined that since these new indexed products have interest credits based on an index, they should be securities since the index if purchased separately would be a security. Presenting such a product and talking about the equity index on which it is based should make it a security with all of the appropriate SEC protections. By this logic though, every insurance products is a security. After all, every declared rate annuity has funds invested in bonds, mortgages, etc., which if sold separately would be securities. Indexed annuities are insurance contracts that provide guaranteed protection of principal and guaranteed payout options as even the U.S. Supreme Court has held.

One of the most important "insurance" features of indexed annuities is the minimum guarantee and often times the math used to determine the guarantee is faulty. If a product has a typical 90% of premium at 3% guarantee, in 10 years the client is guaranteed a 21% increase in value. There is, however, a high probability that indexed interest credits will exceed the guarantee. Annuity contracts do carry surrender charges for a fixed period as do most financial products; but they can never reduce value below minimum guarantees. Surrender charges are a way for any financial company to assure that it recoups its up-front expenses even if the owner decides to terminate the contract early. In fact these guarantees ARE intentionally designed lower than declared rate annuities (while still complying with state laws) in order to make more funds available for hedging a higher indexed interest credit. Products have a wide range of surrender charge terms today (5-16 years). Agents should help clients determine the appropriate length of time to place their premium under surrender charge.

We read frequently the index-linked interest described as participation or sharing in the index. Then an author concludes that means the insurance company receives the "extra" money (the excess of index performance over what the client is actually credited). For example, if the S&P500 index increases 30% in a year and the company's index calculation yields a 12% interest credit, some conclude that the company ravaged the client by taking an 18% haircut or "spread." This is patently false and makes one wonder why journalists don't consult experts who fully understand that indexed annuities credit interest in the same manner as all other "spread-type" financial products. In reality the company is simply exchanging the interest it otherwise would have credited in the policy for a specific option on the index. Roughly speaking, if the company would have credited 3.5% interest today to the annuity, it spends that same 3.5% on an option that has the gain formula and adjustments guaranteed in the policy. The insurance company does not own stocks or funds underlying the index and they certainly do not gamble on the outcome

These products are not designed to provide any participation in the markets and related investment risks and most agents are not presenting them that way. This is why it is so misleading when journalists comment on how clients lose purchasing power and opportunity cost when inflation picks up and the market drops. The indexed annuity is not for money whose profile is all the risk and all the upside. We've seen "financial experts" promote, the idea that it would be better to own the equities market so that the retiree's entire nest egg (which must last them a lifetime) grows with a market increase, but also plummets with the market decline. To believe this is to indulge in the fantasy that the investment rep is smart enough to time the market and that their clients can sleep nights if the representative presides over perhaps a 20% decline in their life's savings.. Following is the real value proposition to a client of a typical indexed annuity.

NAFA has seen some articles that suggest that a zero coupon bond plus indexed mutual fund is a better alternative to indexed annuities. This argument is a straw man. It is designed to inoculate a client's conservative money against an indexed annuity purchase through its ostensibly superior performance, though it is rarely every actually proposed or executed for a client. The proof is in the pudding: NO ONE DOES IT. It may theoretically perform better if a client holds the assets to bond maturity, however it lacks true principal protection. Where is protection from asset loss at death? Where is the emergency partial liquidation feature without loss of value? Taxes must be paid by the client every year and the zero coupon bond gives you no cash flow to do so. This is like trying to set a screw with a hammer because it is the only tool in a securities representative's toolbox. More importantly, most people are ill equipped to watch the values of this approach decline 20% during an interest rate rise or market decline and not feel forced to make the bad economic decision of selling and realizing the loss . This is why there have been a growing number of registered representatives who have started selling the insured, principal-protected indexed annuity.

Declared rate and indexed fixed annuities are responsible for protecting billions of dollars worth of retirement assets and have saved many a contract owner from losses in riskier vehicles. They provide tax deferred growth, solid return potential, minimum guarantees and eventually something no other financial product can provide, an income you can't outlive. These benefits fulfill the conservative promises of safety and minimum guarantees for which many people are looking. In fact, fixed annuities can be the ideal foundation for a sound retirement portfolio.

For more information on this article or to find out more about what NAFA is doing to promote and preserve fixed annuities visit our website at www.nafa.us or join today and let your voice be heard!