The Great Annuity Bundle Bungle: AB 360

banker 2 The Financialists are at play in the current session of the Nevada Assembled Wisdom, with the support of Assemblyman David Gardner (R-NV9) and his AB 360 which will be heard in the Assembly Government Affairs committee today.  Here’s the summary:

“This bill: (1) requires a program for deferred compensation that is made available by the State or the Board of Regents to offer an employee at least five investment options to choose from; (2) provides that any plan authorized by 26 U.S.C. § 403(b) or 457 must offer at least two investment options consisting of fixed or fixed index annuities and at least two securities investment options offered by different investment management companies; and (3) provides that a third-party administrator of a program for deferred compensation must use an open and competitive request for proposals process when selecting investment options for the program.”

Sounds techy?  This link will take you to the UNS page explaining the supplementary (and voluntary) retirement programs currently offered by the institutions of higher education in Nevada.  There are two “record keepers” for voluntary retirement programs: ING and Hartford; and, there are also plans separated from these two offered by TIAA CREF, Valic, and Fidelity.  So, why would the University System have to offer five, including “fixed or fixed index annuities?

First, what’s a fixed index annuity?  The SEC explains the forms currently available:

“There are generally three types of annuities — fixed, indexed, and variable. In a fixed annuity, the insurance company agrees to pay you no less than a specified rate of interest during the time that your account is growing. The insurance company also agrees that the periodic payments will be a specified amount per dollar in your account. These periodic payments may last for a definite period, such as 20 years, or an indefinite period, such as your lifetime or the lifetime of you and your spouse.

In an indexed annuity, the insurance company credits you with a return that is based on changes in an index, such as the S&P 500 Composite Stock Price Index. Indexed annuity contracts also provide that the contract value will be no less than a specified minimum, regardless of index performance.

In a variable annuity, you can choose to invest your purchase payments from among a range of different investment options, typically mutual funds. The rate of return on your purchase payments, and the amount of the periodic payments you eventually receive, will vary depending on the performance of the investment options you have selected.”

So, what could possibly go wrong?  There are several reasons why annuities aren’t all they are cracked up to be.   First, we ought to remember that annuities are forms of insurance, and are regulated as insurance policies and NOT like securities.  For example, with fixed or fixed index annuities there aren’t the disclosure requirements which are in place for investments in securities.  The individual purchasing the annuity is on his or her own to figure out the fees, the comparative performance, and even how the money is being invested. [Kiplinger]   Thinking about fixed index securities? Think again.

FINRA issued an “alert” regarding those “Fixed Index,” or sometimes called “Equity Indexed” annuities (pdf)

“Sales of equity-indexed annuities (EIAs) have grown considerably in recent years. Although one insurance company at one time included the word “simple” in the name of their product, EIAs are anything but easy to understand. One of the most confusing features of an EIA is the method used to calculate the gain in the index to which the annuity is linked. To make matters worse, there is not one, but several different indexing methods. Because of the variety and complexity of the methods used to credit interest, investors will find it difficult to compare one EIA to another.” (emphasis added)

If a person isn’t knowledgeable and comfortable with terms like “ratchet” indexing, or “high water mark,” or “point to point” indexing methods, then the session with the salesperson will be (a) quite long or (b) really confusing.  The salesmanship is an important element, and leads us to the second thing that could go wrong.  Did we explain that because annuities are lightly regulated, unlike equities, that the commissions for selling and managing annuities are in the really high range – like around 6%? [Orman

So, with an almost unregulated product, the opacity of which is nearly legendary, and the fees are some of the highest in the business, why require the University System to offer them?

Because the whole business in annuities goes back to the Romans, but the recent interest has more to do with insurance companies trying to shave off a bit of the money that was going toward money market accounts  in the late 1980s and early 1990s.  And, what the salesman is telling the potential buyer doesn’t usually include: (1) The high costs and fees; (2) The illiquidity (for ‘premature’ distribution; (3) The complexity of the product – remember it’s really hard to compare products; and (4) The taxes, “All withdrawals received from an annuity contract that are not considered to be a return of principal are taxed as ordinary income, regardless of the holding period of the contract (see below). There is no chance to qualify for capital gains treatment.” [Investopedia]

Why AB 360? Perhaps because somewhere out there in Nevada there are insurance companies still seeking to pick off investors who might otherwise sign up for retirement plans associated with the equities or money market sectors – who are ripe for the picking.

If a reader still isn’t sure why DB is opposed to this bit of legislation designed to enhance the bottoms (and bottom lines) of the insurance business, then I’d recommend “Beware the pitch for indexed annuities,” Reuters 2010; and,  “Annuities are not bought, they are sold,” from Forbes 2012; and, “The low down on equity indexed annuities, “ Bankrate.

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