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If you are an adult with a modest bank account and some investments, there is a very good chance that someone is going to try and sell you a Fixed Index Annuity (FIA). Regardless of if you need one or not, the current "one size fits all" selling approach used by too many advisors will be pitched your way.  It might be a good idea to know the contractual steak behind that sizzle sales pitch.

Not a security

Fixed Index Annuities (FIAs) are not a security.  FIAs are a life insurance product that is regulated at the state level.  It only takes a state life insurance license to sell FIAs.

Unfortunately, the sales pitch too often used sounds like FIAs are a market growth type  product.  “Market upside with no downside” and “Market participation with principal protection” are just a few catch phrase cliché’s that garner a lot of attention and interest from the consumer.

In my opinion, if the words “market” or “stock market” are used to sell FIAs, then it should be regulated as a security.  FIA returns are based on index call options that are typically one year in length, with limitations (i.e. “caps & spreads”) on the upside that are locked in permanently on the contract anniversary date with most FIAs.  The index used (typically the S&P 500) does not include dividends, which historically represent over 50% of the return.

1995 was a good year

FIAs were introduced in 1995 to compete with CD returns.  After all, it’s a fixed annuity! When proposed to clients as a CD alternative that can provide enhanced CD type returns, FIAs are a legitimate recommendation.  There are years that the index option returns are very good, but the blended returns over time reflect CD levels.

It’s important that if you are considering a FIA, don’t buy the sales pitch dream because you will own the contractual reality.  Ask for a specimen policy to fully understand what’s being pitched.

Efficient income delivery system

FIAs are also an efficient delivery system for Income Riders.  These riders can be added to a policy at the time of application, and guarantee a lifetime income stream starting at a future date of your choice.

For “income later” type planning, both Income Riders and DIAs (Deferred Income Annuities) should be quoted to find the highest contractual guarantee available for your specific situation.  FIAs with attached Income Riders allow you to fully control the asset while knowing that you have a contractul income guarantee if you decided to use it in the future for that "personal pension."

Shiny things sell

All annuities are contracts.  FIAs are no different, but some of their contractual guarantees are presented as what I call “shiny things” to attract prospects.  Just understand that there are 100 pennies in the dollar, so everything pitched is just part of the overall contractual guarantee.  Below are a few “shiny things” you might hear:

· Upfront bonus for buying the FIA

· Income Rider with an unusually high annual percentage increase

· Long Term Care type coverage built in without underwriting requirements

Upfront bonuses can work in your contractual favor, but they are typically vested and not liquid.  There are no philanthropists at annuity companies giving money away.  Income riders with high interest numbers make you yearn for Jimmy Carter level interest rates.  Once again, these phantom percentage numbers can work in your favor for future income guarantees, but the growth amount is not real yield.  Most income riders can only be used to calculate the first lifetime income payment.  The LTC coverage typically pitched with FIAs is not really true Long Term Care.  LTC is a health insurance product, and the confinement care type coverage offered with some FIAs is literally getting your money back quicker when you get sicker.  Again, this is not a bad thing at all if you can’t qualify for traditional LTC.

The contractual steak behind the “shiny thing” sales pitch is sufficient for most rational people if the real benefits and limitations are fully explained.

What was the name of that index again?

A current practice with some FIA carriers is to run back-tested scenarios looking for a return.  Once that return is found, and index name is created to attach to the FIAs internal index option.  The problem is that these back-tested return numbers are too often shown in a sales presentation, even though the index was just put together.  That seems a little aggressive in my say the least.

Some states are now introducing legislation to stop this type of index creation out of thin air, and are asking for an index to be at least 10 years old before it can be used in a FIA option strategy. The lawyers are starting to sniff around this situation, so it might get ugly.

Once again, made up indexes out of thin air doesn’t mean it’s bad for the consumer, but the consumer needs to be fully aware of what is being pitched and have their levels of expectation in line with reality.

Bad chicken dinner seminar….now serving steak

I coined the phrase “bad chicken dinner seminar” a few years back to describe how too many FIAs are sold to the public.  You get this nice invitation in the mail to go to a nice restaurant and eat for free in exchange for listening to a scary sales pitch about markets going down and the end of the world...and a supposed perfect product to combat those fears.

Too often, FIAs are the only product being pitched…regardless of what you are trying to contractually solve for.  There are many types of annuities, and each have their own unique benefit proposition.  For example, if you need a lifetime income stream to start immediately, then a SPIA (Single Premium Immediate Annuity) typically offers the highest contractual payout of all annuity types.

Recently, I have noticed that the FIA “play for food” invitations I’m getting are to expensive steak house restaurants.  Always remember that the longer the surrender charge time period, the higher the commission.  In addition, the more complex the annuity product, the higher commission.  That’s some real food for thought.

Good product…bad pitch

FIAs are good products.  They produce CD type returns and can provide a future income guarantee if an Income Rider is attached at the time of application.  However, they aren’t for everyone and they are not one size fits all.  Just remember that if it sounds too good to be true…it is…every single time with annuities.  No exceptions. 

Just know the facts of the contract, because that is what you are buying and what you are going to own.