The annuity business has grown in popularity as investors, especially those nearing retirement, look for options to protect themselves from stock market volatility and give them a decent income stream in retirement. With over $200 billion in annual sales, the annuity industry is big business with lots of salesmen trying to persuade you to make a purchase.
Today I will dig deep into an indexed annuity which has been booming in popularity in recent years. Sales of indexed annuities, a fixed annuity that provides a minimum guaranteed rate of interest combined with an interest rate tied to the movement of an index, increased to $39.3 billion in 2013, a 17% gain year over year. This is the biggest percentage increase of any form of annuity.
You will often hear that annuities are sold, not bought. This is exactly why I will go in depth into some of the most popular annuities because there is shockingly little information available about them. Most of the information comes from the companies that sell the annuities and they gloss over the fees, risks and downsides. More importantly, annuities have grown into extremely complex instruments which even the most seasoned professional may have trouble deciphering. Indexed annuities, often the black sheep of retirement products, have a history of being so complex that they were a focal point of litigation and regulatory action in the 2000s. While the negative attention led to a change for the better among the carriers, indexed annuities are still complex and difficult to truly understand.
It is of the utmost importance to make an informed decision. I have dealt with too many clients that have come to me asking for help getting out of an annuity and I can’t help after the fact. Stiff surrender penalties can’t be avoided for many years after you sign on the dotted line.
A Perspective That You Can Trust
I am writing this blog from the perspective of a curious analyst. I am totally impartial as I am a fee-only registered investment advisor. I hope to bring a unique perspective to this topic drawing on my years of experience analyzing companies as a research analyst. I’ve met with hundreds of company CEOs and CFOs, including Steve Jobs and Richard Branson, and I will use my analytical skills to break down these complex instruments into something easier to understand.
While many investment professionals hate annuities, I do not believe that they are all bad and some of them can make sense as a small part of your investment portfolio. Annuities should never, I repeat never, be the large majority of your portfolio because of their lack of liquidity which is one of their biggest drawbacks.
Issuer Review: Security Benefit
It is important to look at the issuer of the annuity first because annuities are NOT a guaranteed investment by the FDIC, SIPC or any other federal agency. They are only backed by the ability of the issuing insurance company’s ability to pay.
Security Benefit is a turnaround story. The company was on death's door during the Financial Crisis of 2008-9, but today is coming off its best year ever. Sales at Security Benefit have grown from about $1 billion in 2010 to a record $7 billion in 2013. It created several fixed index annuities that provide steady income for life and possible upside if the stock market is positive. Today, Security Benefit has two of the top selling annuity products in this space nationwide and has a 12.3% market share, behind just Allianz, in indexed annuity sales.
Security Benefit's credit rating fell to non-investment grade status in 2009. This rating has recovered in recent years. In May 2012, Standard & Poor's upgraded Security Benefit to A- from BBB+. S&P stated that the outlook on SBLIC is stable, but it is unlikely to raise the rating during the next two years.
S&P warned, “We could lower the rating if margins on the new business being written compress due to assumptions on the product deviating from pricing estimates. In particular, we will be focusing on the lapsation utilization and the market dynamics that affect the GMWB rider. We would view adverse performance quite negatively as the company already possesses a narrow earnings profile. We could also lower the rating if the company doesn't maintain redundancy at the “AA level of capital.”
In August 2013, A.M. Best affirmed its rating of B++ (Good) and issuer credit ratings of “bbb+.” A.M. Best warned that “factors that could lead to negative rating actions are Security Benefit Life having an increase in its exposure to higher risk assets to support spread margin, a decrease in its risk-adjusted capitalization due to operating results and unfavorable investment performance, as well as continued accelerated growth in its fixed-indexed annuity liabilities.”
Annuity Review: Security Benefit Total Value Annuity (TVA)
Maximum age for initial purchase: 80
Minimum initial premium: $25,000; Subsequent: $1,000
Maximum Purchase Amount: $1,000,000
Rider fees: Income Rider (GLWB): 0.95% per year, may increase to no more than 1.80%; Death Benefit Rider (GMDB): 0.95% per year, may increase to no more than 1.80%. The fees are guaranteed for the length of the Stacking Roll Up Term.
Website: www.securitybenefit.com
Beware of Surrender Fees
The surrender charges and periods for this annuity are the worst that I've seen of any annuity reviewed thus far. Surrender fees go for 10 years! For most states, surrender fees are over 10% for the first 5 years. This is essentially illiquid for those years unless you just want to give your money away to Security Benefit. Here is the brutal surrender charge schedule.
I believe surrender fees are one of the worst features of annuities. These are huge lockup fees and if you need the money, they sock it to you. This is why annuities should NEVER be a significant part of your investment portfolio because they are essentially illiquid for many years. Unless you are positive you will not need access to these funds, then annuities are NOT for you.
The good news is that the TVA contract owners may access funds under several circumstances. After the 1st contract year, you may withdraw 10% each year without surrender fees. However, if you are under age 59.5, you are subject to a 10% IRS tax penalty as well as income taxes. The TVA contract does include a Nursing Home waiver and a Terminal Illness waiver which allows penalty free withdrawals (Not approved in all states and other state variations may apply).
The Standard Benefit TVA pitch as per their brochure
Security Benefit highlights these points:
- Accumulation with minimal risk
- Your purchase payments are safe from market risk
- Innovative interest crediting options: The Transparent Value Blended Index Account (TVBI) and the Annuity Linked TVI Index Account (ALTVI)
- Bonus of up to 00%
- Guarantee income for life with an optional Income Rider (additional cost)
- Provide for others with an optional Death Benefit Rider (additional cost)
- Tax deferred growth
How will you likely be pitched this annuity?
This indexed annuity (also called an equity-indexed annuity, fixed-index annuity or hybrid annuity) will likely be packaged around two main components:
1. Principle protection with uncapped potential of the Transparent Value Blended Index
2. Guaranteed income for life with the GLWB rider
Even though you have 4 interest crediting options, Security Benefit is pushing their newly created Transparent Value Blended Index (TVBI) hard. I have heard from potential buyers that this annuity with return at least 4% but has the potential to returns of 10%+ annually. Let me say that this is an incredible sales pitch. Who doesn't want 10% returns with no downside risk? Please do not trust anyone that promises even 8% returns with no downside risk. It is too good to be true. Trust your instincts and run if any agent is selling you that dream.
Let's dig into this annuity so you have a better understanding of the nuts and bolts…
Interest Crediting Options (aka your investment options)
It is important to understand that you are not investing in the underlying securities of any index. With index annuities, you are not making investment choices like a variable annuity. Your interest crediting options are mathematical formulas that the insurance company is using to attract you into buying xyz annuity. The insurance company invests your money in whatever they choose (likely diversified, conservative investments). They just have to earn a return higher than their mathematical formula (or interest crediting option) so they can pay you, their salesforce, marketing, operations, etc. This is why index annuities will likely only generate low single-digit returns.
For the Security Benefit TVA you may select among four different interest crediting options: the Fixed Account and three Index Accounts: the S&P 500 Annual Point to Point Index Account (no dividends), the 5 Year Annuity Linked TVI Index Account and the Transparent Value Blended Index Account. The first 3 options make no sense for any potential buyer of this annuity.
As of March 17, 2013, the Fixed Account current interest rate is 1.50%. I'm not sure why anyone would want this option. You can buy a 5-year Treasury Note and earn 1.73%.
The S&P 500 option has an initial cap of 3.25% and a guaranteed minimum cap of 1%. As an example, the S&P had a stellar year in 2013 and was up 29.6% point to point. Because of the cap, you would be credited with a 3.25% gain for 2013. A far cry from true equity returns. Don't let any salesman lead you to believe that you can generate equity returns with this investment option. It is impossible. If you choose this option, your maximum possible return is 3.25% and your true return will likely be around 2%.
When you are sold this annuity, the salesmen will likely pitch you either the Transparent Value Blended Index Account or the 5 Year Annuity Linked TVI Index Account. Why? Because both of these options do not have a cap on the upside. Therefore you theoretically have more upside potential with these options. Doesn't that sound wonderful? You have downside protection and more upside potential. Well you can't have your cake and eat it too. There is obviously a catch.
Let's first look at the 5 Year Annuity Linked TVI Index Account. The TVI index measures the movements in prices of 24 futures contracts on physical commodities, global currencies and US interest rates. I will cut to the chase with this index: it has been a terrible investment option. First of all, major currencies don't move very much and US interest rates are still near all-time lows. Over the past 3 years, this index has gone in one direction, down! Your upside potential turned into a 0% return. Here is the chart:
Since the previous three options are difficult to sell, Standard Life decided to come up with a new option last year: the Transparent Value Blended Index (TVBI). Don't you love the name? Transparent and Value. How can you go wrong? But seriously, this index has a lot of potential as the returns are uncapped and it is a far better option than the previous three. However, don't expect S&P like returns as this is a blended index of stocks and bonds. There are also some real complexities that can hurt returns. I will discuss these in detail.
Let's start with the structure. The index consists of two parts, the Transparent Value Large-Cap Defensive Index and the S&P 2-Year US Treasury Note Futures Total Return Index. The Large-Cap Defensive Index consists of 100 stocks from the 750 stocks in the Dow Jones US Large Cap Total Stock Market Index. The company uses a quantitative model to choose the 100 stocks that it deems most likely to outperform. After that it uses a daily algorithm, yes daily, to time the market. Therefore, the shift from equities can be between 0-100% on any given day. If this strategy is poorly executed, it may be underinvested on up days and overinvested on down days.
More importantly for Strategic Benefit, salesmen are armed with theoretical returns as the index just went live in March 2013. Be sure to know that when you are shown 3, 5 and 10 year returns that none of these are actual returns. They are purely hypothetical, not real world results. When looking at sales material for the TVBI, I'm shocked at how little disclosure there is that the figures are backtested and not real returns.
There is added complexity in the fact that the TVBI (and the ALTVI) are 5 year index accounts. This is important to understand if you are seriously considering these options. After you select these options, no transfers are permitted before the end of the index term of 5 years. Furthermore, an annual spread is subtracted from the annual returns. The current annual spread is 0.75%.
(Note this has increased to 1% as of mid-April 2014 for new buyers.)
However, this can rise to a maximum spread of 5%!!! (note this can only change at the end of the index term) Yikes! This is a serious red flag in my book. 10 year historical, more like theoretical, returns are 6.79%. If the spread rises to 5%, then you are left with just 1.79%. The final point to understand is the participation rate. If you make any withdrawal during the 5 year time period, your vesting percentage decreases your returns. For example, if you take out even $500 after year one but before year two, your vesting percentage is 20%. If the TVBI was up 30% in the 5 year period, you are credited with just a 6% return (20% vesting x 30% TVBI return). I'd suggest reading pages 5-7 of this document so you understand the nuisances of this process.
If you have additional questions about these options (I know they are tricky and complex), please submit a question using our secure form. We will answer your questions within 24 hours via email. No strings attached, just a little free help to point you in the right direction.
Who should buy this product?
In summary, the Security Benefit Total Value Annuity (TVA) is something to consider for someone that doesn't want to worry about market volatility, won't need access to their money for at least 10 years and is happy with low single-digit returns. The annuity can make sense for an extremely conservative investor who is looking for guaranteed income with no market risk. If you are happy with low investment returns (less than 4%) and a guaranteed income stream, then this product with a GLWB may be acceptable for you. Be sure to evaluate how it fits into your entire investment strategy and how it will help you reach your financial goals.
In the end, three of the interest crediting options aren't very attractive. You'd probably be better off buying a laddered bond portfolio on your own than investing in their Fixed Account, S&P 500 point to point index or the 5 Year Annuity Linked TVI Index Account. These 3 options aren't likely to give you returns better than 2%. On the other hand, the Transparent Value Blended Index Account (TVBI) has potential but still has a lot to prove in terms of real world results. In its first year of real world existence, it has lagged the S&P 500/S&P 2-Year US Treasury Note Futures Total Return Index 50/50 Blend. As of May 31st, it lags over 3 months, 6 months, 1 year and YTD. If the TVBI can generate returns of 5% after spread, then you should be elated. I am highly skeptical that it will return much more than 3-4%. Don't buy into any sales pitch that is promising rates of return of 8-12% or more. It just isn't possible to generate 10% returns with no downside risk. If anyone promises you even 8%+ returns for this annuity, don't just walk away, run for the door and find a new advisor.
Thanks for sticking with me on this incredibly long blog post. I learned a lot in my research process and I hope you are able to make a more informed investment decision because of it. Please don’t let your agent pressure you into a sale before you have made an informed decision. Since annuities lock you into a long-term contract with stiff surrender fees, please be sure to take your time to make the best possible decision for you and your family.
Have questions about this Annuity?
If you're considering this annuity and have additional questions, feel free to reach out. You can contact us via our secure contact form. We will answer your questions within 24 hours via email. No strings attached, just a little free help to point you in the right direction.
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