Producers nationwide should be aware of a new rule that goes into effect in Iowa this month, strongly recommending that producers provide an illustration to consumers before selling an indexed annuity.
Because Iowa is an extremely influential state, producers can expect this regulation to be implemented quickly in other states. As of press time, the state was still working out the implications of the rule, which could require producers to provide illustrations if they recommend an indexed annuity.
The new Iowa rules specify the minimum information that must be disclosed, the method for disclosing it, and the use and content of illustrations in connection with the sale of annuities. The goal of these new rules is to ensure that purchasers of annuity contracts understand certain basic features of annuity contracts, and to provide standards for the disclosure of certain minimum information about annuity contracts to protect consumers. The use of illustrations is not required when producers discuss only the guaranteed elements of an indexed annuity, or discuss indexed annuities in a general way, without making a specific annuity recommendation.
One of the most useful parts of the new illustration format are the graphs that are now required. Each illustration must contain three separate graphs that use the current caps, spreads, participation rates and other interest rate formulas for each index strategy over a historical timeline. One graph depicts the best 10-year period during the last 20 years; another the worst 10-year period during the last 20 years, and the third graph depicts the last 10- year period.
As you can see from the accompanying examples on the next page, the highest 10- year rate of return that could have been achieved with this particular indexed annuity product would have been 4.5 percent; the worst, 1.75 percent. This graph disproves that statement that “a monthly sum strategy with a 2 percent monthly cap has the potential of earning 24 percent per year.” Statements such as these build false expectations on the part of consumers and are the source for much of the negative press for indexed annuity products. These graphs will help producers understand and explain that a monthly sum index strategy may have the highest potential interest rate in a single year, but it also has the highest potential to earn a zero percent interest rate each year. Notice that, in each of these graphs, the monthly sum strategy returned a zero percent interest rate in seven out of the 10 years shown, whereas the other interest rate strategies were more consistently positive.
It is important for producers to know that these illustrations are not projections of future values, but are hypothetical in nature and for educational purposes only. Each must contain these, or similar statements: “The values in this illustration are not guarantees or even estimates of the amounts you can expect from your annuity” and “It is likely that the index will not repeat historical performance, the non-guaranteed elements will change, and actual results may be more or less favorable, but will not be less than the minimum guarantees.”
One part of this regulation that will affect the way producers sell guaranteed lifetime income riders (GLIR) on indexed annuities is the portion of the law that reads, “Costs and fees of any type shall be individually noted and explained in the illustration.” There is a huge difference in the minds of consumers (and, therefore, in the minds of regulators and consumer advocacy groups) between a statement such as, “The cost of the GLIR is .95 percent of the Income Account Value each year,” and providing a written table of values that includes a column labeled, “Rider Charge,” that reads, $1,250 in year 1, $1,350 in year 2, $1,450 in year 3, and $2,500 in year 10 and each year thereafter. In some products, the cost of the GLIR reduces the guaranteed minimum surrender value. In others, it does not. Disclosing these costs not only helps the consumer make an informed decision, but it gives the producer the tools necessary to guide consumers accurately in their annuity purchases.
Another requirement of this regulation is that, “Any charges for riders or other contract features assessed against the account value or the crediting rate shall be recognized in the illustrated values.” If the hypothetical value for a $100,000 lump sum premium into a product without a GLIR is $35,000 higher than the product with the GLIR, wouldn’t it behoove producers to explain this difference to their prospects? If the prospect’s main goal is having a guaranteed lifetime income in a certain number of years, he would understand the importance of actually exercising the GLIR option when planned. If the prospect is ambivalent about this point, he probably should not add the GLIR. The producer should keep a copy of both of these illustrations, along with notes on the documents about how and why the sale was made.
Wouldn’t producers want to know, after the guaranteed lifetime income begins, which product is likely to maintain a positive account value for the longest period of time? The best and easiest way to answer this, and hundreds of other questions, is to give producers the ability to create indexed annuity illustrations.
Another benefit of illustrating indexed annuities is that it will kill old myths. One such myth is that bonus premium products are better than non-bonus premium products. On page 230 of Jack Marrion and John Olson’s fine book, Index Annuities a Suitable Approach, there is a section titled “Bonus Products Are Not Free.” It reads,
A bonus is a cost to the contract, just like commissions and policy expenses, and these costs are amortized. If you are comparing two annuity contracts that are identical, except that one has an upfront bonus and the other does not, the one with the bonus will earn less interest during future renewal periods until the cost of the bonus is recaptured.
I ran an illustration to see if this statement is true. The product with the premium bonus not only has a longer surrender period, but it has a $5,000 lower hypothetical account value after 15 years. On the other hand, a bonus product generally will have a higher guaranteed lifetime income if a GLIR is illustrated.
When used properly, an annuity illustration can be one of the most valuable sales tools in a producer’s sales arsenal. These illustrations will help further a producer’s product knowledge, give producers a standardized way to compare products, and provide a better method to tailor annuity products to meet each individual client’s needs. It will also ensure that producers provide consumers with accurate information about the annuity products they sell. The adage, “get it in writing,” is as true today for annuity shoppers as it ever was. Giving the sales force the ability to give prospects a written illustration that provides all the information that a consumer needs to make an intelligent decision about the purchase of an indexed annuity product makes perfect business sense.