Iowa Indexed Products

Training Course

  Of all the people in history that have reached 65 years of age, half of them are living right now.  We are experiencing the largest “graying of America” than we ever imagined when Social Security benefits were enacted.

Types of Annuities

  There is no “perfect” investment vehicle.  Each vehicle carries some type of risk, with some types of annuities being more risky than others.  Annuities are often chosen for their security and stated guarantees but with equity indexed annuities there are many complicating factors.

  There are different types of annuities.  Each annuity type brings unique characteristics.  The investor and selling agent selects the type of annuity that best suits the investor’s needs, or at least that is the goal.  There is no specific type of investment that is always right or always wrong.  Each investment vehicle has qualities that work well under some conditions and qualities that make it unsuitable in others.  The goal is to identify the type of investment vehicle that best suits the investor.

  Nearly 80 percent of annuity investors say they chose their product not only for safety but also to earn a good return.  Compared to other forms of savings, annuities offer guaranteed returns.  This is because annuities define an investment in the present giving a return of the same value in the future.  Insurance companies sell them with a guaranteed rate of return on the money deposited.  This means, even if the investor has not paid the full amount of the annuity, he or she still earns the contracted rate of interest on the money deposited with the insurance provider.  Also, if the investor has started withdrawing money from their annuity, he or she keeps earning the rate of interest on the money that remains with the insurance company.

How are Benefits Paid?

Immediate Annuities

  Individuals who receive a lump sum settlement or who have other sources of accumulated savings often chose to purchase an immediate annuity.  It is called an “immediate” annuity because the buyer immediately begins to receive income from the investment vehicle.  For example, Ruby has a certificate of deposit at her local bank that she wants to convert into continual lifetime income or income for a specified number of years (this depends upon the payout option Ruby selects).  She withdraws the funds from her bank’s CD and buys an immediate annuity from her local insurance agent.  The amount of income Ruby receives would, of course, depend upon the amount she puts into the annuity.  The insurance company uses specific tables to determine the amount they will pay Ruby each month (she could have selected other payout time periods, such as quarterly).  The insurer determines that, based on Ruby’s expected longevity, she can receive $450 each month for her lifetime.  Ruby could have received a higher monthly income if she selected a different payment option, but it would not have lasted for her lifetime – it would only pay based on the number of years she selected.  Ruby chose lifetime income because that was her goal when she chose to buy an annuity.  She will receive $450 each month no matter how long she lives, even beyond what her annuity purchase price, plus interest, actually paid for.  If Ruby lives a very long time she could come out thousands of dollars ahead.  On the other hand, if Ruby dies prematurely the insurer will keep any unpaid funds since lifetime income options do not pay beneficiaries any left over funds.

Deferred Annuities

  Deferred annuities may receive funds in any annuitization manner offered by the issuing insurer, including lifetime income or income for a specified period of time.  Although deferred annuities may be used by anyone, they are commonly used by individuals who need to accumulate funds for use at a later date.  Individuals deposit premium payments over a period of time, often many years.  At some point they will have accumulated enough funds in their annuity to fund a specified event, usually retirement.  Deferred annuities are likely one of the most common annuities since so many investors need to accumulate a pool of money to fund their retirement.  This is especially true today with the decline in company-sponsored pension plans.

Split Annuities

  Split annuities are considered tax efficient since they combine two different types of annuities: a single premium deferred annuity and a single premium immediate annuity.  “Single premium” means one premium payment is made into each annuity versus multiple payments over a period of time.

  One annuity pays the investor a set sum of money each and every month over a specified period of time.  As in Ruby’s case, the length of payments will depend upon the payout method selected by the investor upon annuitization of the annuity.  The other annuity is left in place to grow on a fixed interest basis.  The goal is to maximize the length of time funds will be paid back to the investor.  By the time the funds in the investor’s immediate annuity are depleted, the single premium deferred annuity will be restored to the investor’s original starting principal.  This allows him or her to then restart the process with new prevailing interest rates.  Prevailing interest rates will hopefully be higher than they would have been when the first annuity was annuitized.  Of course, there is no guarantee of that; historically rates rise, but recently that has not been the case.

Annuity Premiums Methods

  Although there are many reasons an investor might select one type of annuity over another, one reason might be how premiums may be made.  A young family is unlikely to have a lump sum of money to invest in an annuity but time is on their side while someone just retiring may have a lump sum, but no time on their side.  Therefore, the young family would likely want an investment vehicle that allows them to deposit funds monthly (perhaps with a payroll deduction).  In some cases, the young family may not be able to make systematic premium payments (the annuity deposits) so they may need a vehicle that allows them to make payments as they are able to.  Systematic payments are always recommended since individuals are less likely to save anything if it depends on having extra dollars available to save in an annuity.  Most people never find those elusive “extra dollars.”  Only when saving for the future is considered in the same mind set as bills will money be saved in most cases.

Single Premium Annuities

  Single premium annuities are annuities purchased with a single premium payment, thus the name.  These are often used when funds are being transferred from another type of investment vehicle, such as Certificates of Deposit.

Flexible Premium Annuities

  Flexible premium annuities allow the investor to save over a period of time, often many years.  “Flexible” means premium deposits are flexible allowing a young family to make premium payments either systematically, such as through payroll deductions, or as they find those elusive extra dollars.  As previously stated, systematic saving into an annuity is likely better than depositing here and there, as able, but any amount of saving is better than none at all.

  The contracts sold by insurance companies will offer different options; not all allow any amount to be deposited for example.  In most cases, there is a minimum amount that can be deposited into a flexible premium annuity, such as no less than $50 per premium payment.  Some contracts may require systematic deposits if the premium amounts are low.  Most contracts allow premium payments to be monthly, quarterly, semi annually or annually throughout the life of the policy holder, or for 2 or more people.  Contracts can also be for a predetermined time period.  In all cases, it is important for the investor to select an annuity contract that suits their needs and saving abilities.

  Flexible premium deferred annuities often accept ongoing small deposits as low as $50 per month.  The interest rate guarantee period on each deposit is for one year; at the end of the guarantee period the depositor can benefit from competitive renewal rates, which are based on current market conditions.

  Each type of annuity is an advantage for some investors, based on their goals.  A primary advantage of flexible premium annuities (all annuities really) is the principal guarantee they offer; investors will not have to worry about losing their principal no matter what the general economy is experiencing.  Annuities are considered conservative investments; they may not experience the growth that stocks might for example, but the guarantees of principal have become very important in recent years.

Policyowner Risk

  There is absolutely no investment without some type of risk, even if that risk is due to inflation.  If the earning ability of the investment is too small, then inflation will not only erase the interest earnings but also the buying power of the principal itself.  Having said that, there are other more identifiable risks in many investments.

  Each investor has what is commonly referred to as “risk tolerance.”  This means the ability of the investor to accept the risks of the investment – and there are always risks.  Some investors enjoy risk; there is something exciting in the possibility of making big returns and the risk that accompanies this excitement is not a deterrent for these individuals.  As investors age, however, risk is seldom wise.  A young investor has time on their side; if they lose big, they have time to make up their losses.  An older person does not have time on their side.  Older investors should always seek safety rather than excessive risk.

  Some types of annuities have more risk than other types.  The riskiest annuity is the variable annuity; return is variable – not guaranteed.

Variable Annuities

  Variable annuities are issued through insurance companies, just as other annuities are, but they are not like other annuities.  There is no doubt that variable annuities involve investment risk and are not suitable for all investors.  Between fixed annuities, equity-indexed annuities and variable annuities, variable annuities pose the highest degree of investment risk.

  Variable annuities get their name from the fact that the rate of interest earned is variable, dependent upon the market index the contract is based on.  The money deposited in a variable annuity is tagged with a portfolio of investments that earn based on what the market is doing.  Generally speaking, the risk in these annuities is at the maximum, just as stocks might be.

  Variable annuities are complex (often described as mutual funds wrapped in an insurance policy).  Variable annuities may be purchased as an immediate product or as a deferred contract.  In other words, a single premium may be made or multiple premiums over a period of time.

  Variable annuities offer a range of investment options, all of which contain investment risk.  Like most annuity products, variable annuities are designed to be held for several years; they are long-term investments.  Variable annuities have surrender fees, as do most annuities that may last as long as ten years or more.  Many investment professionals feel the insurer surrender penalties are not as worrisome, however, as the many other fees that might be in these products.  That is because the surrender fees are clearly stated whereas some underlying fees may not be.  For example there may be underlying fund expenses that are imposed by the underlying mutual funds investment.  These are often indirectly paid by the investors making it difficult to understand their investment impact.

Fixed Annuities

  Both immediate annuities and deferred annuities are fixed annuities.  A fixed annuity earns its name from the “fixed” aspect of the contract.  It ensures a fixed rate of return on the investor’s money.  The rate may be less if compared to other types of annuities but this form of annuity is the safest from a risk standpoint.  Even during the saving period the annuity earns the fixed rate of interest.  Therefore, the amount of money that is with the insurance provider keeps growing at the fixed rate of interest stated in the annuity contract.  Fixed annuities have less investment risk than fixed equity-indexed annuities.

  Annuities are tax deferred vehicles, but taxes will eventually be paid.  Interest earnings in non-qualified contracts will be taxed in the year in which they are withdrawn.

Declared Rate Fixed Annuities

  As we know, the principal in a fixed rate annuity is guaranteed but in declared rate fixed annuities, the interest earnings may also have a guarantee.  It may not necessarily be labeled as a declared rate fixed annuity but the declared rate of interest will be posted in the contract or on an attachment to the contract.  The declared rate of interest earnings are typically connected to the length of annuity commitment in some way.  For example a ten year surrender term is likely to promise a higher rate of return than would a five year surrender term product.

  The contract will have a minimum guaranteed rate but many contracts will also have a currently paid rate of interest that is higher than the minimum guaranteed rate (depending on current markets of course).

Indexed Fixed Annuities

  An equity indexed annuity is first and foremost an annuity product.  Unfortunately, indexed annuities are often thought to be a form of variable annuity, which they are not.  Rather equity-indexed annuities are a type of fixed annuity product.  For this reason equity indexed annuities are sometimes referred to as fixed equity-indexed annuities.  They may be one of the best retirement tools developed in recent years, especially considering how the stock market has recently performed.  EIAs typically guarantee at least one year of initial premiums returned if the product is held past the surrender period.  Since the indexed annuities have a link to a major stock index, there is the potential of growing faster than a traditional fixed annuity product.  However, their complexity means they are not for all investors.  Any person who does not fully and completely understand how the product works should neither sell equity indexed annuities nor buy them.

  An equity indexed fixed annuity will experience variable returns because the annuity is linked to a market index but it is not a variable annuity even though the earnings are variable.  They are certainly more secure than variable annuities but they are also very complex.  Equity indexed annuities (called EIAs) are not regulated as securities even though they are linked to the stock market index.  This means they are not regulated by either the Securities and Exchange Commission (SEC) or the National Association of Securities Dealers (NASD).  As a result, salespeople are not required to have a securities license as is the case with variable annuities. 

Two-Tiered Annuities

  A two-tiered annuity is another method of creating interest.  Many professionals consider them a poor use of annuities since they can be misleading.  Some states have even outlawed them.

  In 2008 the National Association of Insurance Commissioners defined two-tiered annuities as an annuity with two separate and independent values, usually called the annuitization value and the cash value.  These values are calculated separately and frequently become further apart over time.  In contract over time account values and cash values of a single-tier annuity becomes closer together rather than further apart.

  The tier-one value is the value of the annuity bearing interest.  The earnings are growing on a tax-deferred basis and it works just like a fixed annuity.  The client will receive the full accumulated value of the annuity contract after the contract surrender term has been completed or when the contract is annuitized and placed on systematic payout.

  The tier-two value is the cash that can be withdrawn by the contract owner.  The cash value balance earns a minimal rate of interest that is set by the insurer.  This rate of interest is less than that credited in the tier-one portion of the contract.  Typically on a two-tiered annuity only the annuitization value will be credited with any bonuses and index gain that the investor receives.  Therefore, withdrawals greatly damage the total value of the product.

  The surrender value only comes into play if the client decides to surrender the policy earlier than the intended time period.  The surrender value is the contract value minus the surrender charge and may include the market value adjustment which will give the net surrender value.

  These products are not suitable for many investors, including those with short-term goals.  Investors may have to wait a long time to access the tier two values outside of annuitization so in a way, these products require annuitization.

  Clients should make sure that these types of annuities are suitable for their situation. These annuities are not suitable of everyone and agents should make sure their clients understand the different values of the contracts prior to purchasing a two-tier annuity.

  The two-tiered approach credits the contract with a lower rate of interest if a partial or total surrender is made.  Sometimes this is true for a specified time period; sometimes it is true for the life of the policy.  They often have substantial charges for withdrawals, a charge that may never disappear, depending upon contract terms.  Accounts may be credited with an artificially low rate if a minimal payout period is selected by the policy owner.  Investors may believe they are receiving a competitive rate of interest when, in fact, they are not due to charges in the contract.

Contract Provisions

  All contracts have general provisions.  In life and annuity insurance policies the general provisions establish what might be called the “ground rules.”  The following is a sampling of what might be seen in an equity indexed annuity policy.

Entire Contract

  The contract must be identified.  It might state something similar to: “This Contract is an individual deferred annuity contract.  It provides for both declared and indexed interest rates.  It is restricted as required to obtain favorable tax treatment under the Code.  This contract, any riders or endorsements to it, and the application for it, if any, form the entire contract between the owner and the issuing insurer.”

Changes and/or Waivers

  The contract is always the final word on the terms and conditions of the annuity.  Agents do not have any authority to make changes or waive any part of the contract.  The policy will state this in wording similar to the following:

  “No changes or waivers of the terms of this contract are valid unless made in writing and are signed by the insurer’s President, Vice President, or Secretary.  No other person or producer, including the writing agent, has any authority to change or waive any provision of this contract.  The insurer reserves the right both to administer and to change the terms of this contract to conform to pertinent laws and government regulations and rulings.”

Misstatements

  We usually think of misstatements in terms of age but it can relate to any misstatement.  Some errors affect the performance of the policy while others have little effect.  Often misstatements change the premium cost of the policy but annuities typically do not have this concern since they are based on the amount earning interest, usually not the age of the insured.  In some cases, age does have a bearing however, since many annuities will not issue coverage to anyone above a specified age.  Misstated age can also affect the amount of systematic payments upon annuitization since age is a major factor in determining projected length and amount of those payments.

  Most policies address the issue of misstatements.  In an equity indexed annuity it might read similar to the following:

  “If the age of a person is misstated, payments shall be adjusted to the amount that would have been payable based on the correct age.  If payments based on the correct age would have been higher, we (the insurer) will immediately pay the underpaid amount in one sum, with interest, at the rate of __% per year.  If payments based on the correct age would have been lower, we (the insurer) may deduct the overpaid amount, with interest at a rate of __% per year, from succeeding payments and pursue other remedies at law or in equity.”

  Of course the interest rate will be filled in, but for our example we felt it best to leave it blank.

Required Reporting

  The state insurance departments probably have some requirement for notifying clients of changes in policy status or earnings.  Policies will state how often such reports will be issued to their policyholders.  Generally companies notify at least yearly of changes that will affect their policyowners.  The policy will state how reporting may be expected.  It might read similar to the following:

  “At least once each contract year, we (the insurer) will send you a report of your current values.  We (the insurer) will also provide any other information required by law.  These reports will stop on the earliest of the following dates:

1. The date that this contract is fully surrendered;
2. The annuity commencement date; or
3. The death benefit valuation date.

  The reports will be mailed to the policyowner’s last known address.  If permitted by law, in lieu of that we may deliver these and other required documents in electronic form.  The reported values will be based on the information in our possession at the time that we prepare the report.  We may adjust the reported values at a later date if that information proves to be incorrect or has changed.”

State Law

  Certainly states may have laws in place that affects how the annuity contract may be written and laws change from time to time.  It stands to reason that insurance companies must follow what ever laws are in place and any laws that come after the contract was written, if they affect the contract.  There is likely to be some statement in the equity indexed annuity regarding state laws; it may read similar to the following:

  “All factors, values, benefits, and reserves under this contract will not be less than those required by the laws of the state in which this contract was delivered.”

Claims of Creditors

  Some states will better protect against creditors than others.  The investor’s annuity will follow what ever the state dictates by law.  It may be stated as the following: “To the extent allowed by law, this contract and all values and benefits under it are not subject to the claims of creditors or to legal process.”

  The important part of that statement is “to the extent allowed by law.”  At any point creditors become an issue the insured should obtain legal advice from a competent attorney that specializes in contracts or consumer law.  Since laws do sometimes change the policyowner should not rely on information obtained at an earlier date.

Other Contract Items

  There will be other items covered in most contracts, such as Exclusive Benefit (who may benefit from the contract), liability issues, tax issues, incontestability and transfer by the company.  In all cases, agents must be fully aware of the products they are representing and selling.  Of course applicants have a responsibility to fully read the contracts but as every agent knows, they seldom do.  Instead they rely upon their agent to fully disclose all facts and figures.

  Even when an insurance producer believes he or she has fully disclosed all relevant facts and features of the product, there is no way to keep the information fresh in the buyer’s mind.  Since agents do not want lawsuits simply because the consumer forgot what he or she was told it is the wise agent who delivers the policy personally and goes over the features a second time.  It is an even wiser agent who obtains the buyer’s initials on all key points within the policy.  This can be done on a separate paper or form that the agent keeps in the client’s file at the producer’s office.  Having the policy initialed is fine as long as the agent has access to it in case of a lawsuit, but that is unlikely.

Additional Payments

  Some annuities will allow only one initial payment; others will allow additional payments.  Too often insurance producers do not think to inquire whether or not buyers might wish to make additional payments in the future.  It is an important question to ask since the buyer might simply assume he or she can do so.

  When a contract allows additional premiums (deposits) it will specifically state so.  The heading might vary, but should say something similar to “Purchase Payments” or “Additional Premium Payments.”  If additional premium payments are allowed it will state something similar to the following:

  “One or more purchase payments may be paid to us (the insurer) at any time before the annuity commencement date, so long as you (the buyer) are still living and the contract has not been full surrendered or annuitized.”

  Since annuitization locks in payments it would not be possible to make additional payments once annuitization was initiated.

  Most equity indexed annuities have minimum premium deposit requirements.  Many have a $10,000 initial deposit requirement, but that can vary even among policies of the same company.

  Some contracts may offer a purchase payment bonus.  If so, it will be specifically stated in the contract.

Surrender Values and Penalties

  Equity indexed annuities have surrender penalties just as traditional fixed annuities do.  The policy will state the terms of the surrender periods.  This is an important part of the contract and should not be minimized.

  Insurance policies are contracts.  As such, they have contractual provisions.

Contract Interest Rates

  Annuities are investments that pay a rate of interest on the principal.  An annuity is not a savings account; it is an investment with investment risks.  It is not possible to understand how a product will perform, including any risks, without knowing how interest rates will be earned and applied.

  Consumers think they understand interest; after all, they deal with interest in one way or another every day.  What many do not understand is that investments often do not use interest in the same way their mortgage does or their credit cards do.

  There is both simple interest and compound interest.  Simple interest credits growth only on the original deposit, called a premium in an insurance contract.  Compound interest credits growth to the total account value (meaning both the premium and past earnings that have been credited).  In some equity indexed annuities, interest is not credited until the end of the annuity term.  In these products, any withdrawals greatly impact the final earnings.

  Interest rates in fixed deferred annuities is generally the simplest to understand since they earn a rate of interest that changes from time to time, declared usually at each anniversary date.  The declared rate is determined by the insurer but since they must remain competitive, they are usually close from company to company on similar products.

  The current rate is the rate the company decides to credit to the contract at a particular time.  The company guarantees it will not change for some specified period of time.  In the past, these rates were scoffed at by professional investors as too low.  In today’s uncertain financial times, what was considered a disadvantage in the past is suddenly a product advantage – guaranteed growth rates.

  The initial rate is an interest rate the insurer credits for a set period of time after the product is first purchased, thus the name “initial” rate.  The initial rate may be higher than the guaranteed rate, depending upon current market conditions.  Sometimes this is referred to as a bonus rate.

  The renewal rate is the interest rate credited by the insurer after the end of the initial set period of time (at policy renewal).  The contract states how the insurance company will set this renewal rate.  It may be tied to some external reference or index, but not always.

  The minimum guaranteed interest rate is the lowest rate the annuity product will earn.  This is the rate stated in the contract, so it is contractual.

  Some annuity contracts have multiple interest rates that apply different rates to each premium paid, or premiums paid during the contract term.  Some annuity contracts have two or more accumulated values that fund different benefit options.  These accumulated values might use different rates of interest.  The investor may receive only one of the accumulated values depending on which benefit he or she chooses.

  Portfolio based interest rates are connected in some way to a market index.  It is doubtful that most investors realize the numerous definitions connected to portfolios.  Although there can be variations (investors should always look at contract terms in their policies) generally a portfolio based rate of interest is defined as the rate of return computed by first determining the cash flows for all the bonds in the portfolio and then finding the interest rate that will make the present value of the cash flows equal to the market value of the portfolio.

  There is also a concept called “old money/new money” interest crediting, which many life insurance companies use in fixed annuities and in certain life insurance policies that pay dividends or earn interest.  The insurer has a couple of goals: they want to make the product attractive so there will be buyers and they want to be able to pay agent commissions, overhead expenses, and make a profit (as all businesses hope to do).  It can be very difficult to meet both of these goals so in the 1990s some companies began to use an “old money/new money” approach.  In other words original deposits could earn a different rate than current contract deposits.  Usually, deposits (premiums) made more than twelve months ago would earn less than current deposits.  While contract wording might vary, it could say something similar to:

  The Current Interest Rate on New Money is 6.00%.  Current interest rates declared for new premiums include some bonus interest during the first twelve months. A different rate may be credited after the first twelve months.

  Although they use the word “may” if this is in the annuity contract it is very likely that different rates will apply.  Unless states mandate this notification, there is no guarantee that the annuity contract will state this fact regarding old and new money; some do not.

  Throughout the 1990s and beyond the gap paid on old and new money was distinct, with old money often earning a third less than new money.  Few investors will realize the great difference even when percentages are stated.  It is not easy to calculate the difference and few investors would even know how to do so.  Although this method began with annuities, it is also used for some cash value life insurance products.

  Some companies, in the absence of state requirements, do a better job than others in declaring the crediting differences.  For example, the following is an example of how another insurer stated old money/new money crediting:

  The following interest rate includes a 2.00% bonus which is only payable the first 12 months after receipt. For new premiums received [date inserted] interest will be earned at the rate of [% inserted]. For premiums received prior to [date inserted] interest is being earned at rates between __% and __% depending on when those premiums were received. The company may change the interest rate upon the expiration of the guarantee period. Interest is credited daily and compounded annually.

  While this language is certainly more detailed, it is unlikely that investors really understand what it means to the final earnings.

  While there are varying opinions on this crediting method, insurer actuaries justify it by arguing that the interest rate paid on an investment should be tied to the investments purchased with the premiums at the time the money comes in.  There is some logic to this since the investment an insurer is able to purchase with today’s premiums may not be available when tomorrow’s premiums are paid.  However, this logic is not totally logical.  Ten years ago interest rates were higher than they are today so it would seem that “old money” should be earning higher rates than “new money” – not the other way around.  Historically, insurance companies continually credit lower rates to old money, not higher rates, even when investments earned more in the past than they do in the present.  This is likely due to the fact that there is more “old money” (money deposited more than twelve months ago) than there is new money (money deposited within the last twelve months) so it is advantageous to companies to credit old money less than for new money.  At least that is the position of those who oppose this interest crediting method.

Current Interest Rate Environment

  Each of us, not just investors, is affected by current interest rates.  Interest rates affect whether we can afford to buy a home or take out a general loan.  Investments are certainly affected by interest rates.  As we know, investors are unlikely to earn 7% on an account if the current interest rate is 3%.

  While we cannot know where rates will go in the future, it is still better to invest something than nothing.  It is still better to get 3% on some quantity of money than wait for an offering of 7% before setting aside savings.

  Interest rates are not an exciting field of study and most people do not take the time to understand interest rates or how they are affected by inflation.  It is in the investor’s best interest, however, to at least understand the basics of what interest rates are and how they affect investments.  The term “interest rate” is defined as the rate that is paid on borrowed money.  This rate is applied to the principal of a loan and is usually calculated annually.  If the interest rate on your $1,000 dollar loan is 10%, at the end of the first year the bank will charge the borrower $100 dollars.  Interest rates fluctuate all the time and constantly affect how companies are growing which influences the price of stocks and other investment vehicles.

  Changes in interest rates influence the value of company stocks and shares because the risk of a particular investment increases as interest rates increase.  As risk increases the cost of stocks decline and investors lose money.  The converse is actually beneficial.  If the U.S. Reserve decides that the interest rate will be reduced, then stock prices typically increase, and investors make more money.

  An increase in interest rates will increase the cost of capital.  A company paying a higher interest rate on their loans will have to work harder to create increased returns.  If a company fails to generate sufficient returns the loan’s interest rate will take a chunk out of their profits affecting their overall financial situation.  As interest rates on loans increase, profits decrease and this causes the stock value to become reduced and the investor loses money.  It is important to keep in mind that companies have debts.  An increase in an interest rate means their monthly obligations go up in price.  If they cannot afford the increases, their viability could be in danger.

  An increase in interest rates is usually a good indicator of a slowing economy.  The higher interest rate deters people from purchasing things and it stops companies from investing in stock options that will help them grow which causes sales, profits, and stock prices to fall.  The role of interest rates in investing is complicated; it would take far more space than given in this text to fully cover, but in general, increasing interest rates are bad for investors because it is bad for the companies they are investing in.  It is important to have a basic idea of how interest rates affect investments in order to make educated investing choices.  When investors understand how interest rates affect their investments they can anticipate rises in the interest rate market and adjust their financial plan and investment portfolio accordingly.

  Most investors will assume they want the prime interest rate higher so their interest bearing investments will earn higher rates as well.  It is difficult for many investors to understand that higher loan rates mean losses to the very business stocks their investments rely on.  When rising rates are mentioned in the news, inflation is nearly always included in the comments.  The two nearly always are connected in some way.

  In the United States interest rates are decided by the Federal Reserve.  The Federal Reserve meets eight times each year to set short-term interest rate targets.  During these meetings the CPI (consumer price index) and PPIs (producer price index) are significant factors in the Federal Reserve’s decision.

  Interest rates directly affect the credit market and loans because higher rates make borrowing more costly.  By changing interest rates the Fed tries to achieve maximum employment, stable pricing, and good growth levels.  As interest rates drop consumer spending increases (they hope for this at least).  Increased consumer spending stimulates economic growth.  This is why our government initiated a stimulus package and issued checks to many Americans; they hoped to stimulate economic growth.

  Contrary to popular belief, excessive economic growth can also be detrimental.  At one extreme, an economy that is growing too fast can experience what is called hyper-inflation.  At the other extreme, an economy with no inflation has essentially stagnated.  The right level of economic growth, with some inflation, is somewhere in the middle.  It is the Federal Reserve’s job to maintain that balance.  A tightening, or rate increase, attempts to head off future inflation while keeping the country prosperous.

  Inflation is always an economic issue but it is not the only factor influencing the Federal Reserve’s decision making.  They might choose to ease interest rates during financial crisis to provide liquidity, meaning they might allow investment flexibility so businesses can pull money out of investments.

Issue Age Guidelines

  There can be both an annuity owner and an annuitant.  This is often the same person, but it does not have to be.  The owner is the individual who owns the “rights” to the annuity income.  The annuitant is the person whose life is measured by the annuity.  In a life insurance policy he or she would be called the insured but in an annuity product they are known as the annuitant.

  Insurance companies typically have age limitations on annuity applicants.  This is not surprising since lifetime annuitization options are affected by the anticipated longevity of the annuitant.  It has been a common practice for an individual who is beyond the allowed age to name someone else as the insured, or the annuitant.  The older-aged person could still be the contract owner, but the measured life would be a younger person who was named as the annuitant.

  Actual age limitations will depend upon the product, but it is common for the maximum age of the applicant to be between 75 and 85 years of age.  Most products will not issue a policy to individuals over the age of 80.  Minimum ages also vary.  Although annuities are routinely used for other purposes, the intent is to provide income at a later date, which is why they are often considered a retirement vehicle.  The federal government considers annuities a retirement vehicle and imposes a 10 percent penalty for withdrawing funds prior to age 59½ but of course the funds can be used for any purpose.

Annuity Date

  Most annuity contracts are “annuitant-driven” meaning provisions come into being if the annuitant dies, reaches a certain age, or becomes disabled.  Some contracts are “owner driven” meaning it is based on the policy owner rather than the insured.  Of course if the insured and the owner are the same person there is no difference.  Because an annuity is a contract it must state some date in the future for the owner to elect an annuity settlement option to begin receiving payments by way of annuitizing the contract.  The length of time before this must happen will vary, but all annuities have a date listed.  The owner will receive a letter from the company advising them of their settlement options when that date arrives.

  The annuity date and/or maturity date printed on the Policy Data Page is meaningless for many investors.  It does not mean that is the date the investor must wait to have access to his or her funds.  Nor does it mean that is the date the investor must wait to before annuity payments begin (annuitization).  Most contracts allow the owner to change the annuity date and most companies will allow their policyholders to annuitize the contract at any point after the first contract year.

  The actual date will generally appear on the Policy Data Page and may be listed as “Annuity Date” or “Start Date.”  Agents might be wise to specifically explain this date so clients are not confused or believe they do not have access to their funds until that time.

Withdrawal/Surrender Waivers

  Some equity indexed annuities may waive early surrender charges under specified conditions.  This should never be assumed however.  Consult the policy to see if the contract you are considering has this feature.  If it does, there will be specific conditions that must first be met.  Look for a heading similar to “Extended Care Waiver” or wording that is substantially the same.  While there may be variations it is likely to say something similar to the following:

“Upon your written request, we will waive the early withdrawal charges that may otherwise apply under your contract to a withdrawal, surrender, or annuitization if at the time of such withdrawal, surrender, or annuitization or within the immediately preceding ninety days of all the following conditions are met:

1. The insured is confined to an extended care facility or hospital;

2. The confinement is prescribed by a physician as being medically necessary;

3. The first day of the confinement was at least one year or more after the effective date of the contract; and

4. The confinement has continued for a period of time that is at least ninety consecutive days.”

  Proof will be required of the confinement and of course that proof must substantiate what the insured has stated.  Proof must be provided prior to withdrawal of funds, never after the fact.

Withdrawal and Surrender Charges

  A contract owner may take part or all of their annuity value at any time, but penalties may apply if they do so in the early years of the contract.  Usually penalties are figured as a percentage of the contract’s current value.  Typically withdrawal or surrender fees do not apply if the insured dies or annuitizes their contract for systematic income.  In some policies, if the interest rate paid by the insurer falls below a specified rate, the insured may withdraw all funds without any penalty; this is called a bailout option.  In multiple premium annuities, the surrender charge could apply to each premium paid for a certain time period; this is called a rolling surrender or withdrawal charge.

  Most annuities have features that allow up to 10% of cash values to be withdrawn without insurer penalty.  The Internal Revenue Service may impose a penalty however, if the withdrawal is made prior to age 59½.  Insurers have no ability to waive the IRS penalty no matter what the withdrawal circumstances.  Indexed annuities that credit interest earnings at the end of the term will not pay earnings on any amounts withdrawn.

  It would be unusual to see an annuity contract that did not have surrender fees imposed on early withdrawals and contract termination.  The length of the fees will vary, with seven to nine years being common.  The reason insurers can guarantee interest rates is because they expect to have the funds for a specified period of time.  To discourage early withdrawal of funds or a complete surrender of the contract insurance companies impose early surrender fees.  Surrender fees are a type of penalty for withdrawing money sooner than agreed upon at the time the contract was issued.

  In most cases, surrender charges start off high and decrease a percentage point each year. For example, in a nine year contract, the first year would experience a nine or ten percent penalty fee, and then decrease by one percentage point each year.  Surrender penalties might look like the following:

  When there is no longer a contract surrender fee the policy has reached what is called the “term” of the policy.  The term is sometimes mistakenly referred to as policy maturity, although actual maturity is not the end of the surrender period.  Most contracts state a specific age for maturity, such as age 100.  Since “maturity” is so often used for “term” many professionals use the two terms interchangeably, even though “maturity” actually means something else.

  Surrender penalties or fees do not apply if the contract is annuitized or when death benefits are paid due to the annuitant’s death.  If the contract is annuitized, an income stream begins and the contract is then “locked in” based on the payout option selected.  Once a payout option is selected and the first check has been cashed it is generally too late to make any changes; the contract owner cannot change their mind later on.  Whatever payout option was chosen determined length and amounts of systematic income.

  Although annuities are issued by life insurance companies, they do not insure against premature death as a life insurance policy would.  Annuities do have beneficiary designations but their intent is not to provide money for heirs; the intent is to provide income during the life of the contract owner.  As every agent knows, insurers measure risk.  For example, under a life insurance policy, the insurer “loses” if the insured dies prematurely (meaning they pay out funds prior to receiving the time they need to earn a profit) but “wins” if the insured lives longer than expected.  In an annuity where a lifetime income is selected, the insurance company retains any undistributed funds.  Therefore, under the lifetime annuitization option, the issuing insurance company “loses” if the measured life lives beyond his or her lifetime expectation (collecting funds beyond what was deposited into the account) and “wins” if the insured dies prior to collecting all the funds he or she deposited.  Unfortunately, many annuitants do not realize (so therefore fail to notify their beneficiaries) that lifetime annuitization selections eliminate beneficiary rights to unused annuity funds.  Since annuity products are intended for insureds – not for heirs – this should not be surprising but it continues to be overlooked and unexplained by agents.

  Some annuity contracts have provisions for early payout under specified conditions.  Typically these include such things as institutionalization in a nursing home, terminal illness, disability, or unemployment.  It is always necessary to look at the actual contract to determine if these waivers exist in the policy.  It would be unwise to simply take the word of an individual in place of reading the actual policy.

  Withdrawal penalty waivers may come under a variety of headings, but typically they will say something similar to “Early Withdrawal Charges,” “Disability Waivers,” “Long-Term Care Waiver” or other similar wording.  It is always important to read the requirements since there may be limiting conditions applied.  In all cases, proof of the circumstance must be presented to the issuing insurer.

Premium Payments

  There are various ways of paying annuity premiums.  Some of these have been discussed previously.  For example, in an immediate annuity, one payment is typically made so that the payout phase can immediately begin (thus the name).  In this case a single premium is paid and it is called a single premium annuity.

  Many annuity contracts allow for multiple payments made at various times, often systematically but not necessarily so.  Most financial planners would recommend systematic payments into the annuity so that accumulation can occur.  Obviously, if too little is saved the end goal is unlikely to be reached so systematic payments (such as payroll deductions) are more likely to be successful over the years.  Annuities that allow flexibility in how premiums are paid have what is called flexible premium options.  Even when these annuities are labeled flexible premium annuities that really only describes an option that is allowed in the contractual terms.  The actual annuity is still a fixed, variable or equity indexed annuity.  It has simply taken on the name of how payments may be made but “flexible premium annuity” is not really an accurate name.

  It is always better to save something, even if inadequate, than nothing at all.  In many ways it is better to have a contract that requires specific payments (premiums) be made at specific intervals because it increases the likelihood that money will be saved.  When the contract allows premiums to be paid on whatever basis the contract owner wishes, it is much more likely that adequate funds will not be saved.  Those elusive “extra dollars” just never seem to materialize.

Market Value Adjustments

  Some annuity contracts have a market value adjustment (MVA) feature.  If interest rates are different at surrender of the annuity than they were when it was purchased, a market value adjustment is made that might make the surrender value either higher or lower.  An annuity with a MVA feature might credit a higher rate than an annuity without this feature.

Contract Administration Charges and Fees

  It is not unusual for annuity contracts to have various fees, such as administration fees.  Names may vary in the contracts for these fees but typically they are listed somewhere.

  Administrative fees are charges that cover record-keeping and other administrative expenses of the insurer and may be charged as a flat account maintenance fee; usually this amount is $25 or $30.  It may also be a percentage of the account value.

A contract fee is a flat dollar amount charged either once, usually upon issuance of the contract, or annually upon contract anniversary dates.

  A transaction fee is a charge per premium payment of additional transactions beyond the first premium payment.

  A percentage of premium charge is a charge deducted from each premium paid.  The percentage may be lower after the contract has been in force for a specified number of years or after total premiums paid have reached a certain amount.

  Some states impose a tax on annuity contracts, usually called a premium tax.  The insurer pays this tax to the state.  The company may subtract the amount of the tax when the investor pays his or her premiums, when contract values are withdrawn, when the investor begins receiving income payments, or when the company pays a death benefit to beneficiaries.  Generally the exact time of the fee will depend upon the requirements of the state.

  A mortality and expense risk charge is equal to a percentage of the account value and compensates the insurance company for risks it assumes under the annuity contract.

  Underlying Fund Expenses are fees and expenses that are imposed by the underlying mutual funds investments in variable annuities.  These fees typically are paid indirectly by the investor, so he or she may not be aware of them.  These fees are taken annually as a percentage of the investor’s assets invested in the fund.

  There may be additional fees besides those listed here.  Special features offered by some annuities, such as stepped-up death benefits, a guaranteed minimum income benefit, or a long-term care insurance benefit may cause additional fees or charges to be levied by the contract and its issuing insurer.  In the case of the guaranteed minimum income benefit, it guarantees a particular minimum level of annuity payments, even if the investor does not actually have enough funds in the account to support the level of payments.  This is most likely in a variable annuity that has suffered an investment loss.

Withdrawal Privilege Options

  As we have said, most contracts do allow contract owners to withdraw some amount from the annuity values without penalty; again this would not apply to IRS penalties, only insurer penalties.  Typically stated as a percentage, most companies allow an annual 10% annuity value withdrawal without imposing surrender or early withdrawal fees.  In some products, withdrawing funds will reduce the final financial outcome since any funds withdrawn may not earn interest (indexed annuities primarily).

  There are primarily four ways to access annuity funds:

1. By annuitizing the contract.  When a contract is annuitized it begins the payout phase.  Once the contract has been annuitized there is no turning back.  Whatever was selected as the payout option once initiated and money has been received it is contractually set.

2. By taking a lump sum payout, which means surrendering the policy.  The lump sum distribution ends the annuity contract because there are no longer any funds in it.

3. By taking withdrawals, but not through annuitization.  As we said, most annuities allow for a yearly 10% withdrawal of the account values without any penalties.  However, contract owners can withdraw more than the 10% if they wish and are willing to pay any fees that might be imposed.

4. As a death benefit to the beneficiaries, assuming the annuity allows for that.  If the death occurs after annuitization has occurred there may not be any funds available for beneficiaries under some of the annuitization options.

  If the insured chooses to annuitize the contract, there is a table of guaranteed benefit rates in each annuity contract.  Most companies have current rates that are greater than the guaranteed benefit rates.

  Annuities have stated maturity dates.  When an annuity reaches its maturity date, the contract may automatically expire or renew.  Investors are given what is called a “window” to decide if he or she wants to renew or surrender the annuity.  If it is surrendered during the window there is no surrender charge.  If renewed, surrender and withdrawal charges could potentially begin again.

Annuitization Ramifications

  Annuitization is the even distribution of both principal and interest or growth of the annuity over a specified period of time.  That period of time is selected by the contract owner upon annuitization of the contract.  He or she may select a specified time period, such as twenty years or a lifetime income.  The payout option selected will impact any beneficiaries so it is important to understand all elements of the choice.

  There is a distinct advantage to annuitization inasmuch as the disbursements are tax-favored.  There would be no tax favor when withdrawals are sporadic.  When the annuity contract is annuitized the owner chooses how he or she wishes funds to be paid out, such as monthly, quarterly, semi-annually or annually.  Variable contracts and fixed rate contracts may both be annuitized.

  There can be a disadvantage to annuitization: once the process begins it cannot be changed except in very rare circumstances.  For variable annuities, the disadvantage is the lack of uniformity.  Since it is a “variable” annuity, the payments are also “variable” because they are based on the results of the sub-accounts selected and the amount of money allocated to these sub-accounts.  Variable annuities place the risk on the contract owner; fixed annuities place the risk on the issuing insurer.  The more aggressively the money is invested, the less predictable the payout stream will be.

  Many financial advisors feel fixed rate annuitization presents another disadvantage: the amounts of payout might depend upon the competitiveness of the issuing insurer.  Some simply offer better products than others and by the time annuitization is right it is too late to shop around in many cases.  Additionally the amount received from the fixed rate annuity will depend upon the current market rates, the duration of the withdrawals (ten years, twenty years, lifetime, or whatever option is selected) and the principal amount to be annuitized.  Obviously if too little is saved, the systematic payout will reflect that.

  The annuitant is the person named as the insured in the annuity; it is this person whose life is measured for the purpose of determining how much may be received in the annuitization process.  This is often called the “measuring life.”  Although it is possible to annuitize using the life of more than the annuitant, such as the joint-and-survivorship option, the vast majority of annuity vehicles are annuitized based on a single life.

  It is very important to select the proper payout option to avoid later selection remorse.  The lifetime payment option, for example, does not give unused funds to beneficiaries.

Qualified and Non-qualified Annuity Annuitization

  Annuities are used in all types of tax-favored retirement plans maintained by employers for the benefit of their employees.  This is especially true of qualified plans (401(k), tax-qualified defined benefit plans, 412(i) plans and employee stock ownership plans), governmental 457(b) plans and Section 403(b) arrangements.  Individual retirement arrangements (IRAs) are also considered workplace retirement plans, such as SEPs and SIMPLEs.

  The Internal Revenue Code gave preferential treatment in respect to taxes that favorably affected workplace retirement plans.  Of course there are requirements that must be met.

  There are differences between the plans, but all tax-favored plans have limitations on the contributions or benefits that may be made on behalf of any plan participant.  Primarily the use of benefits must be restricted to retirement purposes.  In addition, some tax-favored plans require minimum coverage and nondiscrimination rules that are intended to ensure the plan covers a cross-section of employees (it cannot be discriminatory) and provides meaningful benefits to covered employees.  The types of plans used by employers usually are attributable to their type of business.

  Section 403(b) arrangements (tax-sheltered annuities) may only be maintained by employers that are exempt from income taxes, and state and local government schools.  Governmental 457(b) plans may only be maintained by state and local governments and they differ from tax-exempt 457(b) plans.  Tax exempt plans are a type of nonqualified deferred compensation plan maintained by non-governmental tax-exempt entities, most notably charities and private universities.  Government 457(b) plans are a type of tax-favored retirement plan.

  Tax-qualified plans can be sponsored by all employers as a general rule but state and local governments cannot maintain 401(k) plans.  A 401(k) plan is a qualified plan that permits employees to make pre-tax salary reduction contributions (the employee can elect to have salary reduced in exchange for an employer contribution which must be equal to the reduction in salary).  Section 403(b) plan arrangements and governmental 457(b) plans are similar to 401(k) plans since they permit employees to make salary reduction contributions and all three plans receive the same preferential tax treatment.

  Normally, contributions to a tax-qualified plan, Section 403(b) or governmental 457(b) plans are excluded from an employee’s gross income and most state income tax laws if the contributions satisfy certain conditions and limits, and the earnings that are credited to the employee under the plan, accumulate on a pre-tax basis.  Contributions and earnings become taxable only when they are distributed, but once they are distributed, these amounts are taxable as ordinary income (unless they are rolled over to an IRS, qualified plan, a Section 403(b) program or governmental 457(b) plan).

  As of January 1, 2006, a qualified plan or a Section 403(b) plan (not a governmental 457(b) plan) may allow employees who make salary reduction contributions to designate some or all of the contributions as Roth IRA contributions.  This means that the earnings credited to the employee and attributed to the Roth contributions accumulate tax-free.  A distribution of an amount attributable to the specified Roth contributions, which includes earnings, is entirely excluded from the employee’s gross income under the IRS Code and most state laws.  Distributions that are attributable to Roth contributions are tax-free in most cases.  If, for instance, the taxpayer is in the same tax bracket at all times and tax rates do not change, then there is no real difference between the tax treatment of a pre-tax contribution and a Roth contribution, with the exception that a Roth contribution produces a larger ultimate benefit than would a pre-tax contribution of the same amount.

ERISA and Tax Favored Retirement Plans

  Primarily, the laws applicable to tax-favored retirement plans are part of the Employee Retirement Income Security Act of 1974 (ERISA) and the Tax Code.  State laws do not usually apply to ERISA-covered employee benefit plans since ERISA usually preempts all state laws that relate to ERISA plans; however, ERISA does not preempt state insurance, banking or securities laws, even if they do relate to an ERISA plan.  As a result state laws will apply to an annuity used in connection with an ERISA-covered retirement plan.  ERISA-covered plans must comply with federal securities and bankruptcy prohibitions on employment discrimination and other such laws and restrictions.  Governmental plans like 457(b) plans and Section 403(b) arrangements are not affected by ERISA, so governmental plans are regulated by state statutes and regulations.

Using Annuities in Tax Favored Retirement Plans

  There are three primary ways that annuities can be used for tax-favored retirement plans:

1. Funding a tax qualified plan, government 457(b) or Section 403(b) plan.

2. Funding held as assets in trusteed retirement plans, and

3. Annuities used to settle benefit obligations.

  Annuities can be used to fund a tax-qualified plan, a governmental 457(b) plan or Section 403(b) arrangement.  Usually the assets of tax-favored retirement plans must be held in trust by one or more trustees or in a custodial account with one or more custodians.  However, an annuity issued by an insurer that is qualified to do business in the state may be used instead of a trust or custodial account.  These plans are often called “non-trusteed plans.”

  Annuities may be held as an investment asset in a trusteed retirement plan.  For example, the plan could purchase and then hold in trust a group annuity contract that would provide a method for offering and making life contingent annuity payments to participants.  As a result the trustee would be the owner of the annuity contract.

  An annuity may be provided to the participant of a retirement plan with the participant as the named owner.  The insurer would then assume the obligations of the plan.

  The tax code does not specifically define “annuity” although it does require several requirements on annuity contracts.  Generally, the tax law requirements for annuity contracts do not apply when annuities are used with a tax-favored retirement plan, in which case there are some specific requirements:

• The annuity contracts that are used in qualified tax-retirement plans are exempt from the diversification requirements that apply to variable annuities.

• Annuities used in tax-favored retirement plans are exempt from the IRS Code that states the annual increase in an annuity held by a non-natural person is taxable to the owners, unless the contract is held as an agent for an actual person.  The effect of this is that the non-natural person owning the annuity is taxed on earnings from annuities under qualified plans unless there is an exception.

IRS Requirements for Annuity Funding

  Annuity funding for tax-qualified plans must be nontransferable.  The owner is not allowed to sell, assign, discount or pledge as collateral for a loan, as security for the performance of an obligation or for any other purpose, his interest in the contract to any person other than the issuer.  Additionally, the annuity contract must specifically contain provisions making the contract nontransferable.

  Other than the non-transferability of the contract, there are no other special requirements required for an annuity that funds a tax-qualified plan.  There are numerous regulations and requirements for the plan itself but since the annuity funding the plan usually does not have the qualifications for the applicable plan, the same thing is accomplished by separate plan documentation kept by the employer.

Taxation of Qualified Annuity Distributions

  When distributions are made from tax-qualified retirement plans it must first be determined if the plan was transferable.  If it was transferable, then the fair market value of the contract is taxable to the person receiving the distribution.

  If the annuity plan is nontransferable, and assuming the plan meets the qualification requirements applicable, the contract is tax deferred and tax is assessed only upon actual payments from the contract.  The right of an individual to surrender a nontransferable contract for value does not affect the taxation.  The cash surrender value is considered as income only when the contract is actually surrendered.

  The principal requirement of a distributed annuity is determination of taxability at the time of distribution.  If it is found to be taxable there are no particular requirements that apply to the contract, but if the distribution is not taxable because it is nontransferable, then the annuity is required to adhere to several tax-qualification requirements.

  The IRS or the Treasury Department have provided no specific requirements for an annuity distributed from a tax-qualified plan to adhere to and there are several unanswered questions regarding the status of a distributed annuity contract.  For example, it is unclear if loans are permitted from a distributed annuity contract or whether a distributed annuity can accept rollover contributions under IRS law.  The answers seem to depend on whether a distributed annuity is considered as a continuation of the qualified plan.  If it is, then probably the contract would have to satisfy all of the requirements of qualification and would then be entitled to the benefits of qualified plan status.

  It has been suggested that the distributed annuity contracts must satisfy some (limited) qualification requirements but are not subject to all of the qualification requirements.

  Most tax-qualified plans require the distributed annuity contract show the direct rollover requirements of Section 401(a)(31) and the spousal consent requirements of Section 401(a)(11) that requires the insurer to be responsible for obtaining spousal consent to certain distributions.  Also the distributed annuity must satisfy certain anti-cutback rules which specifies that benefits, which include some optional forms of payout, must be preserved in the distributed annuity to the same extent that they need to be preserved in a plan and minimum distribution rules of Section 401(a)(9).

  Annuitization works the same whether the annuitant or contract owner will owe taxes on the earnings or not.  What will be different between a non-qualified annuity and a tax qualified annuity is the taxation.  If the annuity is not a qualified annuity taxes will be due as the growth is paid out.  Under current tax status, the first money withdrawn is considered to be growth, with the last money withdrawn being principal.  In a non-qualified annuity the principal was taxed prior to deposit.

Annuitization Options

  Annuities are designed for pay-out after age 59½ since the Internal Revenue Service considers them to be retirement designated vehicles.  They may still be used for other goals, but primarily they are considered retirement vehicles.  Although annuities were designed for payout, they are overwhelmingly used for accumulation.  In other words, the majority of annuities are not annuitized (turned into an income stream).  Instead most investors accumulate funds in their annuity, and then simply withdraw the entire value or exchange it tax-free for another annuity, with the accumulation process starting over again.  Often annuities are simply left intact year after year, eventually going to heirs.

  Even though most annuities are not annuitized, it is always important for agents and their clients to understand the available payout options.  When annuities were created the issuers assumed lifetime income would be primarily used.  They were designed to pay a specified amount, based on the total dollars in the annuity, for the remainder of the annuitant’s life, regardless of how long he or she lives.  Under this arrangement, beneficiaries receive nothing even if the annuitant happens to die soon after annuitizing the contract.

For example:

  Annie Annuitant and Alvin Annuitant each have an annuity in their name of equal value (for this example let’s say each Annuitant has $50,000 in their annuity).  Annie and Alvin both choose lifetime income when they annuitize their contract and each receives the same amount each month.  Just to keep it simple, we will say that each Annuitant receives $1,000 per month (the actual figure might be far different, based on the age of each Annuitant and their “life” expectancy).

  Alvin begins receiving his $1,000 per month on January 1.  In June of that same year he becomes very ill, eventually dying three months later in September.  Alvin received a total of nine annuity payments totaling $9,000.  The remainder of his annuity ($41,000 plus accrued interest) will stay with the insurer that issued the policy; Alvin’s heirs will receive nothing.

  Annie also begins receiving $1,000 per month on January 1 just as Alvin did.  However Annie Annuitant lives to a very old age.  She eventually receives every penny of the $50,000 in her annuity, but she continues to receive the $1,000 monthly payment even though her own funds have been depleted (that’s what “income for life” means).  By the time Annie eventually dies she has received $75,000 from her annuity contract.  As a result, the insurance company paid out $25,000 more than it received.  However, the company also retained $41,000 from Alvin so the insurer still made a profit based on these two people. 

  Insurance companies use analysts to determine expected longevity of their policyholders because their goal is always to earn a profit.  While it is not possible to know for sure how long each person might live, there are indicators that suggest the likelihood of longevity.  Alvin’s beneficiaries are likely to be unhappy about the loss of the remaining $41,000 but Annie’s family will be very happy to see how her annuity paid out.

  Once an annuity contract is annuitized it cannot be changed; the annuitant or policy owner cannot change his or her mind down the road.  Usually the point of no return is when the first annuity payment is cashed or, if a direct deposit is used, the date the check is deposited.  Each contract may vary so it is important to consult the actual policy for details.  Since the payout option is locked in agents must be certain their clients understand the advantages and disadvantages of each payout option.

  It is very important to realize that all annuities may not necessarily offer all payout options.  If a particular payout option is important to the buyer, he or she will want to specifically examine the available payout options listed in the policy.  Any questions should be addressed prior to purchasing the annuity.

Nonhuman Payees Under a Settlement Option

  Many contracts require the payee under a settlement option to be a human being, meaning they will not make payments to an entity such as a business.  All settlement option payments during the life of the contract owner are typically made by check to the primary payee or by electronic transfer directly into their bank account.

Lifetime Income Payout Option

  Different contracts may call lifetime income by different names, such as “Life only”, “Annuitant Lifetime”, “Straight Life” or other similar names.  In each case, a definition will be in the policy.  As discussed, annuities were designed to provide a systematic income at some point in time.  When a policy owner annuitizes their contract, surrender penalties will not apply even if the contract is still in the early years of the surrender period.  Annuitization is the process of beginning systematic payments to the annuitant.  Some EIAs allow the investor to vary the frequency and amount of the payout to meet the investor’s particular needs.  Other than surrender charges, which are waived if the contract is annuitized, the only real limitation regarding payments applies to taxes.  It is necessary to wait until the attained age of 59 ½ to avoid a 10% early distribution federal tax.

  One of the most important benefits of deferred annuities is the ability to use the built up values during the accumulation period to provide income during the payout period.  Income payments are typically made monthly, but it is possible to choose some other systematic time period, such as quarterly or even annually.  Annually may allow the investor the ability to pay debts that occur only once per year, such as property taxes or some types of insurance (long-term care insurance for nursing home coverage for example).

  It is very important that annuitants and annuity contract owners realize that the lifetime income option does not consider beneficiaries.  However, since the insurer does not have to consider beneficiaries the payout option is often higher.  In other words, the systematic payment to the annuitant will be higher because, as in Alvin’s case, the insurer will keep any unused funds.

Life Annuity, Period Certain Payout Option

  The Life-Annuity-Period-Certain option will pay the annuitant less in each systematic payment than would have been received under the Lifetime Option.  That is because there is a specified time period involved (Period Certain).  Under this payout option the annuitant is guaranteed to receive a specified amount, as determined at the time of annuitization, for his or her lifetime regardless of how long he or she lives.  The annuitant is also guaranteed that if he or she dies prior to the stated time period his or her heirs will receive the remainder of the funds.

  In Alvin’s case, if he had chosen this option, he would have received less each month; he might have received $750 each month rather than $1,000 for example.  If he chose a ten-year period certain his beneficiaries would have received the remaining $41,000 because he did not reach the selected ten year time period.  The time period does not have to be ten years of course; the period of time will depend upon what is selected at the time of annuitization.  Many insurers will offer a variety of time periods, perhaps 5, 10, and 15 year periods.  The amount of money received on a systematic basis will reflect the “period certain” selected.  The longer the “period certain” the less the annuitant will receive as income each month.  That makes sense since the insurer increases its risk when longer periods are selected that guarantee beneficiaries will receive remaining funds.  Once the guaranteed period (period certain) expires beneficiaries will no longer receive any remaining funds.

  If the annuitant dies during the period certain, his or her beneficiaries will receive the remaining funds based on contract language.  In other words, the contract may state that a lump sum will be paid to the beneficiaries or it may state that the beneficiaries will continue to receive funds as the annuitant would have based on his or her income selection.  In Alvin’s case he was receiving monthly income (the most common selection) so his beneficiaries would continue to receive monthly installments if that was the beneficiary terms of the contract.  Many contracts allow the beneficiaries to make their own choice between two or three options, including a lump sum distribution.

Joint-and-Last-Survivor Payout Option

  When there are two people in the household, such as husband and wife, the joint-and-last-survivor payout option is often selected since it pays an income to two named individuals.  Of course they are not required to be husband and wife, but that is commonly who uses this payout option.  Since two people are guaranteed a lifetime income it is not surprising that the monthly installments are less for two people than they would be for a single individual.  In some annuity contracts utilizing this payout option, the amount of systematic income is reduced upon the death of the first named individual; others continue paying the same amount.  Some contracts offering this payout option will give a refund to heirs if both named individuals die within a stated time period.  If this is the case, the payout option might be called Joint-and-Last-Survivor-Period-Certain.  As with other payout options, there might be variances in the name the contract uses, but they will be similar enough to the name we have used that there should not be any confusion.  As always, the contract definitions will also state how the payout option works so agents and insureds should refer to their policy.

Required Distribution

  Most annuities have some point in time when the contract must be annuitized or closed.  The contract may be closed simply by withdrawing all funds.  Mandatory distributions will be after the surrender period has expired, so such penalties would not apply.  If the annuitant has not reached age 59½ the IRS early distribution penalty would apply on any funds that were withdrawn.

  Annuitants and contract owners could chose to simply roll the annuity into a new contract, which would meet mandatory distribution requirements of the contract but avoid any IRS penalties.  If the annuity was rolled into a new annuity contract new surrender periods would begin, since most annuities have them.

  Unfortunately some equity indexed annuities have mandatory annuitization, whether the investor wants to or not.  Generally financial advisors recommend against buying these products.

  As we continue to live longer we are justified in fearing we might run out of money before we run out of life.  In other words, Americans are at risk for having too little money set aside for the last years of their life.  As we continue to have smaller families we may not be able to count on our children to care for us both physically and financially in our last years.  A major cost to our Medicaid system is nursing home care for our nation’s elderly.  As our senior Americans spend all they have, they must turn to Medicaid (which is basically medical welfare) for their health care needs.  Few people are saving adequately for their retirement years so annuities, with lifetime annuitization options, make good sense.

Annuity Death Benefits

  The aspect of security and financial shelter that comes with annuities is one of the vehicle’s advantages.  Particularly for people who have reached their retirement phase, the concern of having some source of income becomes crucial.  Over the years, annuities have proven to be a reliable and dependable alternate source of steady income once earned income stops.

  An annuity is designed to make payments to the annuitant during the annuitant’s lifetime.  If the annuitant dies before the full contract value is paid out, an annuity death benefit may be paid to a beneficiary named in the contract, if the contract has not been annuitized; if annuitized it will pay death benefits to a beneficiary only if the payout option selected allows it.

  Most professionals recommend annuities be used for income – not death benefits for beneficiaries.  An annuitant can select a lump sum settlement but this really defeats the purpose of the annuity.  The instruments work best when they are annuitized at some point with the annuitant receiving systematic income for a determined period of time or for life.  Refer to the previous section for the payout options that are often available.

  There are various types of annuities and the annuity death benefit works differently depending on which kind of contract it is.  Generally, annuities are either fixed or deferred.  With immediate annuities, the annuitant starts receiving contract payments immediately.  If the annuitant dies before the full contract value is paid out, the beneficiary usually receives any remaining money.  To calculate the value of the annuity death benefit, interest is accrued until the date of the annuitant’s death.

  It is important to realize that not all payout options will have any benefit for the beneficiary.  Lifetime benefits, paying the insured up to the moment of death, will not forward any unused principal or interest funds on to a beneficiary.  This is true even if the insured dies soon after annuitizing his contract.

  Different annuities may have different death benefit assurance.  Selecting a payout option that includes beneficiaries will consider the beneficiary listed, but the insured must be willing to give guaranteed lifetime income up.  One option is the life annuity with guaranteed terms since it allows the contract owner to assign a beneficiary who will receive any unused funds following the annuitant’s death.

Principal Guarantees

  Annuities guarantee the annuity principal.  This is a major reason investors purchase them.  Annuities are an investment, issued by insurance companies that contractually guarantee all the premiums deposited into the annuity vehicle.  Those premiums constitute the principal.

  Actual contract guarantees depend on the contract purchased.  The guarantees depend on the issuing insurance company, and the type of annuity chosen.  There are three ways to categorize an annuity:

1. The type of annuity chosen (fixed rate or variable; indexed annuities are fixed rate);

2. When income is desired (immediate or deferred); and

3. Single or flexible premium vehicles.

  Traditionally annuities have been considered very safe.  Fixed annuities are the safest (they have the least risk).  Fixed indexed annuities represent moderate risk and variable annuities have the highest risk.

  Fixed annuities guarantee the entire principal (all premiums paid in) plus the contractually guaranteed minimum rate of interest stated in the contract.  Variable annuities, those representing the highest amount of annuity risk, will not have the same guarantees because performance is based on the stock index.  Investors could lose if the market performs poorly.

  An indexed annuity is different from other fixed annuities even though equity indexed annuities are fixed rate annuities.  Other fixed annuities credit a fixed rate of interest which the insurer guarantees.  Indexed annuities credit interest using a formula based on changes in the performance of an equity, bond or commodity index.  This formula determines how the interest, if any, is calculated and credited to the investor’s annuity.  Even so, the indexed annuity does offer a guarantee that a declared minimum interest rate will be credited on part of the initial premium if the investor surrenders the contract or if the index it is linked to performs poorly.  However, unlike traditional fixed annuities, this guarantee is not necessarily credited annually.  Many indexed annuities do not credit earnings until the surrender period ends.

  Some indexed annuities guarantee the minimum value of the annuity will not be less than 87.5% of the premiums paid in plus at least 3% interest, less any partial withdrawals.  Even if the investor surrenders the product, withdraws the full amount and pays any surrender penalties that are due, he or she will not receive less than the guaranteed minimum value.  An indexed annuity with a minimum guaranteed surrender value of 87.5% of premiums credited with 3% interest would provide a return of 101.43% at the end of a six-year term (87.5%x1.03%x5).  It would be higher for longer periods of time.  If the investor surrendered such an annuity before the fifth year, however, he or she would receive less than the premiums paid for the contract – a loss in other words.

  When it comes to equity indexed annuities, the floor is the minimum interest rate earned on the annuity.  All indexed annuities have a floor of at least 0% (zero percent).  This assures that even if the index decreases in value, the index-linked interest earned will be zero rather than a negative, preventing premium loss.

  As we previously stated, an equity-indexed annuity is a fixed annuity, not a variable annuity.  The investor deposits an amount of money, which the insurer will pay back to the investor at some future date, often through installment payments.  It is possible to take a lump sum at contract maturity but that would make little sense.  The point of an annuity is to provide income over a long period of time.  Taking a lump sum would defeat that goal.  Many annuities are never annuitized but they were designed with annuitization as the product’s final phase.

  Most equity-indexed annuities are a declared rate fixed annuity, meaning the annuity’s rate of interest is re-set each anniversary date.  For example, the first year might guarantee an interest rate of no less than 3 percent; the second year could adjust down or up, depending on current markets.  Whatever subsequent years might be, the declared interest rate can never be a negative number.  Like all annuities, as long as the investor holds the product to maturity, he or she will receive at least all they paid in; the investor will never lose principal, as can happen in stocks and mutual funds.  For many investors, the absolute guarantee of principal is the major reason annuities are chosen for retirement investing.  This might especially be true for those with past experience in the stock market.

  While annuity contracts are not all the same, generally EIAs do not have internal expenses, meaning there are no fees, or front-end or back-end loads that could retard the product’s performance.  While we must always stress that contracts can and often do vary, most equity indexed annuities have clarity in that what is presented by the insurer is what is actually charged.  This is different than variable annuities, mutual funds, and managed accounts that typically have various management fees and expenses.

  Typically equity-indexed annuities are deferred annuity vehicles because they do not begin providing income for several years.  An annuity that begins paying income within a year of contract origin is considered an immediate annuity.  The insurance companies need a period of time to earn a profit and the annuity needs a period of time to earn enough interest to adequately perform.  The period of time during which the annuity is growing, earning interest, and perhaps receiving additional deposits from the investor is called the accumulation phase.  Once systematic payments begin (upon annuitization), the contract moves into the distribution phase.

  Once the distribution phase begins, the annuity’s account value will be declining steadily, as monthly or quarterly payments are made.  Investors typically take distribution payments monthly or quarterly, but many contracts allow semi-annual or even annual payments through the annuitization process.

  What we have been discussing is true of all fixed rate annuities so why would an indexed annuity be better than any other fixed rate annuity?  If the stock market crashed or simply underperformed the equity-indexed annuity, like other fixed rate annuities, would simply continue to operate as they always do, paying the pre-set rate of interest on the investment exactly as the contract promises.  However, with an indexed annuity, if the stock market is performing well, the fixed equity-indexed annuity will earn more than it otherwise would.

  All EIAs track some specified stock market index; commonly it is Standard & Poor’s index of the stock values in 500 of the largest corporations known as the S&P 500.  The S&P 500 is a registered trademark of McGraw-Hill & Company.  Whatever index is used if it substantially increases during the term of the equity-indexed annuity, the annuity’s value will increase to the extent specified in the annuity contract.  It would be unusual for the equity-indexed annuity to grow exactly as the index it is based upon grows.  Most do not tract the index exactly and there are various methods used to correlate gains.  It should surprise no one that some contracts are more generous to the investor than others.  It is important to realize that this added value should be considered a “bonus” since there is no loss if the markets perform poorly.  No investor should buy with the expectation that there will always be bonus earnings either.  EIAs are first and foremost a fixed annuity product, but there may be additional earnings if the markets are favorable.

  While it may not be so prevalent today, at least initially, equity-indexed annuities were constantly compared to variable annuities.  They are not and never were variable annuities.  Critics of equity-indexed annuities may still try to compare them and that does a disservice to the product.  More importantly, it confuses investors.

  A variable annuity tracks the stock market directly so its values go up and down with the stock market.  That is not the case with an equity-indexed annuity.  Just like all fixed rate annuities they perform based on the contract with a bonus earning if the index it is based upon performs favorably.  Variable annuity values are determined by a separate account that holds various investments, often similar to mutual funds, for each contract owner.  Many allow contract owners to choose their own funds but in most cases it is important that the portfolio be well managed for maximum performance.  Variable annuities experience full stock market risk while equity-indexed annuities do not.  This distinction should not be taken lightly since it is a tremendous difference in product types.  Just as stock market managers are unable to provide long-term financial guarantees variable annuities cannot give long term performance guarantees either.  Experienced money managers may be able to forecast but it is just that: a forecast – not a guarantee.  Some variable annuities do guarantee the investor’s return of principle in the case of premature death or during a specified time following the contract’s issue date.  A variable annuity has the potential of total loss; that is, the investor could lose the entire amount he or she invested if the market takes a dive and remains down.  A fixed equity indexed annuity would not be affected by a market dive; the investor simply would not earn any “bonus” earnings.  As long as the investor holds the annuity contract past the surrender period (maturity date) he or she would receive all principal sums and any guaranteed interest earnings.

  Another important difference between variable annuities and fixed equity-indexed annuities are the fees charged.  While every contract can vary, typically variable annuities have several types of fees and expenses, many of which are tied to the buying and selling of stocks.  Obviously fees and expenses (often referred to in the contracts as management fees) will retard potential earnings.  Equity-indexed annuities generally do not have internal fees and expenses beyond what is prominently stated in the contract.  Any fees that do exist would be minimal so the investor knows exactly what his or her contract earnings are.

Guaranteed Rates of Return – a Complex Issue

  Fixed rate annuities, such as equity-indexed annuities, promise a guaranteed minimum rate of return.  This may be referred to as the “floor” rate since it is the lowest rate that will be paid.  The annuity might pay a higher rate than guaranteed, but never a lower rate.  Higher rates might be paid if market conditions were good.  At each anniversary the minimum rate is re-set, but that would not mean higher rates could not be credited if circumstances warranted it.  In the case of equity-indexed annuities, there is also the possibility of bonus earnings if the market index does well.

  Investors must always pay attention to the guaranteed or floor rate since it is the only return that is promised.  Higher rates or bonus returns are not guaranteed.  Some contracts do not give more than a zero percentage guaranteed rate of return.  In these contracts, there is no guaranteed rate but the principal is still guaranteed.  In other words, in the worst index situation the investor would not lose their principal but he or she might not gain any interest earnings.  Generally fixed rate annuities (that are not equity-indexed vehicles) would guarantee at least a couple percentage points in interest but equity-indexed annuities do not necessarily do so.  This is another good reason to compare products, although the guaranteed rate of return is only one element of the product and not always the most important.  In some cases, the investor is better off with a lower guaranteed rate since the contract may offer better participation in the index-linked return if the interest rate is lower – maybe even a zero floor.  The goal is an index-linked return that out-performs the guaranteed rate of return.

  How returns are credited to the annuity contract can be important as well as the actual rate of return earned.  Some contracts may credit guaranteed interest earnings quarterly while others do not credit them until the end of the surrender period (which could be ten years from the date of issue).  If they are not credited until the end of the surrender period, then any penalty-free withdrawals will not have earned even a penny of interest.  It will be as though the funds had never been deposited.  Even if no funds are withdrawn, actual earnings are likely to be lower than a contract that deposits quarterly or even just yearly.

  Insurance companies will make early withdrawals unattractive in many cases because the point of buying annuities is for long-term investing.  Agents should never deposit money the investor may need prior to the term of the annuity contract.  Annuities, including fixed equity-indexed annuities, are not suitable for anyone who may need to make large withdrawals prior to the end of the policy surrender periods.

  Most annuity owners and annuitants do not consider how rates are determined or credited; they largely prefer to have their agents select and present an appropriate and advantageous product for them.  Crediting of participation rates can be complicated even for agents who work daily with the products.  It might prove very difficult to fully explain the process to consumers.  Despite the fact that it can be complicated, how earnings are credited can significantly affect the end results so it is an important consumer topic.

  One might assume that each company will credit all their fixed annuity products the same but that is not always true.  Even within each company, different products might credit earnings differently.

  Some products will not apply the minimum guaranteed interest rate to 100 percent of the principal.  It is possible that only 80 percent to 90 percent of the principal amount will be credited with earnings.  Some EIA contracts give the insurer flexibility to even change its crediting rates, but most contracts specify certain minimum crediting rates that must be followed.  As with all insurance matters, it is important that the selling agent be fully and completely aware of the products he or she is marketing.  It doesn’t matter how sincere the selling agent was; if a major error is made it is the agent’s fault since he or she had an ethical duty to know the products he or she represented.

Important EIA Fact:

  While most fixed annuity products guarantee against loss of premiums paid in, that is not always the case.  Some equity indexed annuities do not make this guarantee of the full amount, guaranteeing only a percentage, such as 90% plus whatever minimum interest guarantees exist.  In these cases, if the investor does not receive any index-linked interest there could be loss of premiums.  Of course, if the EIA was surrendered during the penalty period, that could also result in a loss.

  In order to know how interest earnings will be credited, it is necessary to understand how the company credits premiums for the purpose of calculating interest payments.  You must also know if the issuing company has contract limitations preventing them from changing crediting methods.  So, first look to see how the insurer credits premiums and secondly, look to see if crediting methods may be changed.  This will be found in the policy.

Bonus Rates

  Some annuities that are not equity-indexed products will offer bonus rates for one year, maybe even several years.  Of course, if the investor surrenders his policy during the surrender period bonus rates will not apply.  Alternately, some EIA products will offer a bonus to an older non-EIA annuity in order to draw in the business to an equity-indexed annuity product.  If the bonus makes up for any early surrender penalties it may be worthwhile, but product replacement should never be considered without knowing all the facts.

  Sometimes we may see a financial journalist suggest that any annuity bonus inducements are questionable.  It suggests the insurer has an inferior product and is using the bonus to entice in customers they would not otherwise get.  We do not generally agree with this statement, although each product must be individually considered to give an adequate answer.  Just as department stores have sales to attract customers, insurers offer bonus points to attract customers.  The cost of offering such bonus points is figured in to overhead; insurers are typically very good at analyzing profit and loss.  After all, their business is based on risk factors.  Although bonuses can give an EIA product a strong performance start, it is important to also look at any limitations on performance that might affect the final returns.

  There can always be variations, although all products offered must comply with state and federal requirements.  State requirements can vary so what works in Oregon may not work in Iowa or Minnesota for example.

  If withdrawals are made, even if there is no surrender fee applied, it is likely that the amount withdrawn will not be credited with interest so this should always be considered prior to pulling money out of an equity-indexed annuity.  Of course, withdrawals made prior to age 59½ will incur an early distribution charge from the IRS as well.

Loan Provisions

  Many insurance companies allow loans to be taken from their annuity products, but there are reasons an insurer may not allow them.  The primary factor discouraging annuity loans is the Internal Revue Service since they have persuaded Congress to enact legislation restricting the amount and period of policy loans.  Additionally some companies require that a certain minimum be loaned out and that a certain amount remain in the vehicle after the loan in made (the annuity may not be depleted in other words).

  When a loan is available there may be some type of fee associated with the loan.  Some companies do not penalize investors who take out policy loans but this should never be assumed.  Some contracts will charge interest on the amount taken as a loan; other contracts will charge nothing.  Loan rates could be a flat fee or tied to some index rate.  Most companies do not allow second loans unless the first is fully repaid.

  Due to the potential adverse tax and penalty consequences of annuity loans, prospective borrowers would be wise to contact a tax specialist first and it might even be best to seek other avenues of cash before turning to their annuity.

  While loans from nonqualified annuity contracts are treated as taxable distributions, the loans from an annuity issued as part of a tax-favored retirement plan can be made on a tax-taxable basis if the loans are permitted under the plan and the loans satisfy IRS requirements.

  As a general rule, loans are permissible if it does not exceed the lesser of $50,000 less outstanding loans or the greater of half the present value of the participant’s nonforfeiture accrued benefit or $10,000.  The loan must be repaid within five years and must be amortized in substantially level payments.  There is an exception to the 5-year requirement for loans that are used to purchase a principal residence.

  If the IRS requirements are not met when the loan is made or later, such as in default because of failure to make timely payments, the loan is considered as a distribution for income tax and reporting purposes.  When the participant’s benefit is offset to repay the loan, then the loan amount is called a loan offset amount.

Common Contract Provisions

  Interest crediting provides a minimum return; index crediting provides the potential of a maximum return at the end of the term because it is measured in some specified way with the chosen index.  Although interest guarantees can be zero, it is likely that at least some amount of interest earnings may be guaranteed, even if only one percent.  If an investor was only interested in the guaranteed rate of interest earnings there would probably be no point in depositing funds into an equity indexed annuity contract; a traditional fixed annuity product would be sufficient.

  The National Association of Insurance Commissioners (NAIC) has published a buyer’s guide for equity-indexed annuities.  Although there are more elements to these products than just the potential maximum return, since consumers will be looking for products that produce greater returns, it is likely that this element is often the characteristic focused on.

  The NAIC does not endorse any company or contract; their publication is intended to help the general consumer understand equity indexed annuities so that they may make the most prudent choice for their particular circumstances.  Their publication states:

“What are equity-indexed annuities?  An equity-indexed annuity is a fixed annuity, either immediate or deferred, that earns interest or provides benefits that are linked to an external equity reference or an equity index.  The value of the index might be tied to a stock or other equity index.  One of the most commonly used indexes is Standard & Poor’s 500 Composite Stock Price Index, which is an equity index.  The value of any index varies from day to day and is not predictable.”

  Like all annuities, equity indexed annuities are insurance products and are issued by insurance companies.  The buyers of these products are not directly purchasing stocks.

  There are two very important aspects to equity indexed annuities: the indexing method and the participation rate.

  Equity indexed annuities are fixed annuities, either immediate or deferred.  They earn interest or provide benefits that are linked to an external equity reference or an equity index.  The index value will be tied to some particular index, such as stocks, often the S&P 500 Composite Stock Price Index.  This would be an equity index.  The value of any index changes often, perhaps daily or even hourly.  The changes cannot be predicted, so there is growth risk involved, although the principle is not at risk.

  The indexing method is the method used to measure the amount of change in the index.  While there is not necessarily going to be change, change is likely.  The most common indexing methods are annual reset, also called ratcheting, high-water mark, and point-to-point.  The original EIA used only a single method, usually the S&P 500.  There are now many ways to calculate contract values.

Participation Rates

  Participation rates can be a limitation on the base interest rate paid by the issuing insurance company.  They can also limit the index-linked return.  Since participation rates are primarily a function of equity indexed annuities consumers do not typically have experience with them and may lack understanding of an important product feature.

  A participation rate will determine how much the gain in the index will be when credited to the annuity.  How gains will be credited can be confusing.  The annuity company may set their participation rate at various amounts (depending upon the product); for example, it may state a participation rate at 80%, which means the annuity would only credit the owner with 80% of the gain experienced by the selected index (the S&P 500 for example).  If the calculated change in the index is 9 percent and the participation rate is 70% the index-linked interest rate would be 6.3%.  This is figured by multiplying 9% times 70%, equaling 6.3%.

  Participation rates for newly issued annuities can change daily.  As a result, initial participation rates will depend upon the date the insurance company issued the annuity.  Participation rates are usually guaranteed for a specified period of time so additional deposits may receive the same rate as the initial deposit.  When participation rates are guaranteed, they may range from one year on.  It is always important to check the actual policy since products do vary.

  Once the product period ends, the insurer will set a new participation rate for the next period.  Some annuities guarantee that the participation rate will never be set lower than a specified minimum or higher than a specified maximum.

  Participation rates offering less than full value (100%) protect the insurers in some situations and may allow them to offer higher interest rates or caps.  It may surprise consumers to learn that sometimes it is better to select products with less than full value (80% to 90% perhaps) in order to earn higher rates of interest.  Although critics may imply that less than full participation rates are a product disadvantage, in fact they are often beneficial.

  The NAIC states participation rates vary greatly from product to product and even from time to time within the same product.  It is certainly important for agents to fully understand how they work but consumers also need a basic understanding of them.  A high participation rate may be offset by other features, including simple interest, averaging, or point-to-point indexing methods.  Conversely, an annuity company may offset a lower participation rate while offering a valued feature such as an annual reset indexing method.

  An important note: Some EIA contracts allow the insurer to change participation rates, cap rates, or spread/asset/margin fees either annually or at the start of the next contract term.  If an insurer subsequently lowers the participation rate or cap rate or increases the spread/asset/margin fees, returns could be adversely affected.

Averaging

  Some equity-indexed annuities average the index (called averaging) based on the indexed-linked returns during the entire period rather than simply subtracting the beginning point from the end point.  Averaging can protect consumers from index crashes or greatly fluctuating indexes.  As is always the case in averaging, the highs and lows are smoothed out.  While it does smooth out the peaks and valleys, there is the risk that some return will be lost, especially if highs outnumber lows.  Averaging methods will vary.  Some companies average daily, while others average monthly.  The National Association of Securities Dealers (NASD) mentions in their brochure titled Equity-Indexed Annuities – A Complex Choice that averaging could reduce earnings.  They also state a major challenge when buying an equity-indexed annuity is the complicated methods used to calculate gains in the index the annuity links to; many investors and even agents never fully understand how they work.  Returns vary more than traditional fixed rate annuities but not as much as variable annuities (equity indexed annuities are not variable annuities; they are fixed annuities).  Because of the minimum guaranteed interest rates EIAs have less market risk than variable annuities.

  Index linked interest is determined by recording the index’s value on specific dates, such as monthly, and comparing the average of these values with the index value at the start of the term.  Potential interest is added to the annuity at the end of the year, subject to any participation, cap or spread rates.

Caps

  Some equity indexed annuities will have caps.  In other words, returns are capped or limited.  Usually caps are stated as percentages; these are the highest rates of interest that can be earned.  If the product’s index gained 9% but the cap was set at 6%, then 6% would be the most the investor could earn.  Not all equity indexed annuities will have a cap, but it is something that agents and investors must be aware of.

  Caps absolutely do affect how these products perform but that doesn’t necessarily mean investors must totally avoid them.  Annuities with caps may have other features the investor wants, such as annual interest crediting or the ability to make penalty-free withdrawals.  Caps often allow insurers to offer other benefits, such as higher interest rates.  A professional agent will help the investor to decide whether it is better for their particular situation to have higher participation rates or higher caps.

  The most common caps are annual caps and monthly caps but products vary so agents must view each contract individually.  Some contracts allow the issuing insurer to change caps based on specific market conditions.  If this is the case, investors need to be aware of the fact.

Spreads, Margins and Administrative Fees

  Some products will deduct a percentage from the gains in the form of various fees.  The percentage could be in addition to or in lieu of participation rates or caps.  The fees may come under different names, such as spread, margin or administrative fee.  These are not the only names it may come under, but they are the most common.  The fees may be in addition to or instead of a participation rate.  For example, an EIA might charge a 2% per year spread from the index-linked return.  Figuring the cost over time can be difficult or at least complicated, but over ten years, with the index performing at an average of 12% per year, there would be a 2% loss, so earnings would be 10% rather than 12%.  This is a simplification, but it does give the reader an idea of how it works.

Returns

  Equity Indexed annuities will be linked to such things as the stock market, but that does not mean returns will directly reflect a stock market purchase.  EIAs are linked to the performance of the index – not to the actual stocks that the index is based upon.  As a result, the annuity does not give credit for dividends that could have been reinvested if the actual stocks had been purchased.  The NASD states that most equity index annuities only count equity index gains from market price changes, excluding gains from dividends.  An investor that is not earning dividends will not therefore have the same gains he or she would have if he or she had directly invested in the stock market.  On the other hand, the investor also will not experience some of the losses that would have occurred with directly investing in the stock market.  Those who oppose investing in EIAs will point to this potential loss of growth, while those who support EIAs will point to the protection from principal risk.  The investor is trading the dividends that might have occurred for their safety of principal.  There is no investment that will be ideal.  High risk means potential high loss; low risk means less earnings.

  Most equity indexed annuities use something simple, such as the S&P 500 and do not take into account reinvested dividends.  While the loss in value of reinvestment of dividends can be significant, especially over a number of years, those who invest in these types of annuities are typically more concerned with the safety of their principal and are, therefore, willing to earn less.  Even without reinvested dividends, indexes still perform pretty well.  EIAs usually they do better than certificates of deposit or bond rates, although that is certainly not guaranteed.

  It should never be assumed that every client will appreciate the benefits of equity indexed annuities, especially if higher earnings are important to them.  It is always a question of suitability and risk.  Those who want higher earnings will probably not be happy with EIAs; such investors will probably want to benefit from dividends for example.  Some advocates argue that the loss of reinvested dividends is offset by the annual reset (ratchet) annuities that credit the index return with only a zero in negative years.  However, many feel it is unwise to push any investor into any vehicle that they seem unsure of.

  There are variables in equity indexed annuities; all products are not identical.  For example, an EIA that is back-tested does not ensure financial performance.  Back-testing means that the annuity was tested against historical returns, perhaps as far back as twenty years.  Future performance will not always mimic past performance.  We have seen our markets change dramatically and they are likely to remain unpredictable.  Additionally, there is no guarantee that the back-testing is reliable since reliability is often determined by those doing the testing.

  Back-testing can help to illustrate the annuity, so it is not without merit.  However, agents and investors must remain aware that past performance does not guarantee future performance.  Professionals generally prefer the use of Monte Carlo analysis, which uses multiple samplings of random hypothetical market returns.  This may present a more accurate visualization of the product and will not leave a false impression of how the annuity is likely to perform.

Indexing Crediting Strategies

  Fixed interest is associated with traditional fixed annuities rather than with equity indexed annuities.  The equity-indexed annuity, like other fixed annuities, promises to pay a minimum interest rate and this could be seen as the “fixed rate” element of the contract.  The rate that will be applied will not be less than this minimum guaranteed rate even if the index-linked interest rate is lower.  The value of the annuity generally will not drop below a guaranteed minimum, assuming withdrawals are not made.  For example, many single premium annuity contracts guarantee the minimum value will never be less than 90 percent (100 percent in some contracts) of the premium paid, plus at least 3% in annual interest (less any partial withdrawals).  The insurance company will adjust the value of the annuity at the end of each term to reflect any index increases.

  Equity-indexed annuities credit earnings differently than other fixed rate annuities.  Where traditional annuities state a rate of interest and then apply those interest earnings at specified intervals, an EIA calculates its return against the index to which it is linked.  This is called the indexing method.  Equity-indexed annuities credit interest using a formula based on changes in the index to which the annuity is linked.  The formula decides how the additional interest, if any is earned, is calculated and credited.  With traditional fixed annuities, interest gains are always earned, although how they are credited may vary.  EIAs do not necessarily have interest gains, since they are based on the indexing method.  The indexing method, or formula, decides how the additional interest, if any, is calculated and credited.  The amounts earned, and when they are paid, depend on the contract features.

  There are multiple formulas for indexing, with new methods appearing regularly.  New methods often are developed with the hope of attracting consumers, but in the end the amount earned is going to depend upon the performance of the index that is used.  Even professional analysts cannot accurately speculate on market performance over several years and annuities are long-term investments.

Combination Methods

  Many investors find having multiple equity-indexed annuities, with each using a different indexing method, advantageous.  By purchasing EIAs that use different indexing methods, the investor is likely to end up with good average performance between the various annuities.  Additionally many investors consider having multiple EIAs as a means of diversifying their annuity portfolio.  Some indexing methods work better under some conditions, and worse under others.  Diversification prevents being affected adversely with no other annuity investment to offset the adverse conditions.

  Some of the new equity-indexed annuities allow several indexing methods.  The designated indexing method on these annuities can be changed at certain times, usually on anniversary dates.  These allow consumers to select their indexing method at the time of purchase.  Some of the newer EIAs allow consumers to use several indexing methods simultaneously, allowing investors to do with one contract what usually requires several to achieve.

  Some equity-indexed annuities will allow the investor to see their progress (or lack of it) at specific times, usually annually.  These annuities have “reset” features that lock in gains on some specific basis, such as once per year so that the investor knows whether he or she gained during the year.  Generally EIAs held to maturity do not lose principal, but that does not mean it is guaranteed to have gains.  Other equity-indexed annuities do not have the ability to see what returns are until the EIA has run its entire term, which may be many years after purchase.  Investors who want to be able to view their returns should choose a reset product.

Annual Reset Indexing Method

  For investors wishing to see their returns annually the annual reset indexing method is typically the best choice.  Annual reset EIAs usually looks at the index at the end of each contract anniversary date and locks in gains made as of that date.  This is called the annual reset method or may be referred to as the ratchet method.  Under this method the gains posted at the end of the year (or at whatever point is in the contract) will remain even if the index goes down later.  The ratchet method compares the changes in the index from the beginning to the end of the year, with declines being ignored.  The advantage is a gain that is locked in each year.  The disadvantage is the possibility of lower cap rates and participation rates that might limit the amount of available gains.

  Under annual reset methods it is possible that there will be no gains.  If the index declined from the previous year, the contract simply credits zero for that period.  In the next contract anniversary year there is then no place to go except up.  The previous period’s end value for the index (not the annuity value) is used as the starting point for the new period, meaning that each period is looked at individually.  It does not matter whether there were gains in previous contract years and will not matter in coming years what gains, if any, were given in the current year.  Although there may be a lower contract cap rates and participation rates, investors choose this method for the locked in gains, meaning current profits will not be lost to bad years that may come in the future.  Even if the stock market were to crash, any past gains are retained in the annuity values.

  Investors often do not mind the lower cap and participation rates because they feel they will be offset by the fact that negative years result in zeros rather than value losses.  While we would all like to see our investments increase in value we also do not want to lose values.  A zero gain is better than an investment loss.

High Water Mark Indexing Method

  Another indexing method is the high water mark method.  It compares the index at various periods during the contract to the index level at the beginning of the term.  Although the time periods can vary, typically the contract’s anniversary date is the time measure used.  The high water mark indexing method takes the highest of these values and compares it to the index level at the start of the term.  While the investor may be credited with more interest under this method than other indexing methods and receive protection against declines in the index, the disadvantage is that the investor may not receive any index-link gain at all if he or she surrenders their EIA early.  That is because interest is not credited until the end of the contract term; if the contract is surrendered early, the contract term was not reached.  Some of these contracts will still give the investor interest based on the highest anniversary value to date under a vesting schedule.  Some high water mark indexing contracts might impose lower cap rates and participation rates.  As always, it is important for investors to know and understand all policy terms.  Certainly agents must know this as well.

  If it were not for participation rates and caps, the high water mark indexing method would give investors the highest risk-adjusted returns of any indexing method, but of course there are caps.  It is also important to realize that only the highs reached at the comparison periods count (usually policy anniversary dates).  If a high is reached midway they will not apply.  For example:

            A contract is issued on June 1, 2000.

            On June 1, 2001, the index had increased by 12 percent.

            On December 15, 2001 the increase rose to 42 percent.

            By June 1, 2002 it was down to 10 percent.

  Because only the anniversary dates apply, the 42% index rate will not apply.  Over the next ten years the percent at the anniversary date will be calculated.  At the end of the ten year term, the investor will receive the highest point recorded on an anniversary date during the term of the contract, up to any applicable participation or rate caps.  It is not unusual to have a participation rate that is less than 100%.

Point-to-Point Indexing Method

  The point-to-point indexing method compares the change in the index at two distinct points in time, such as the beginning of the contract and the end of the term.  Although the investor may enjoy a higher cap and participation rate, which credits more interest, the disadvantage is that it relies on a single point in time to calculate interest.  As a result, even if the index that the annuity is linked to is going up steadily during the contract’s term, if it happens to decline dramatically on the last day of the term, than part or all of the earlier gain can be lost.  Since gain is not credited until the end of the term, the investor may not receive any index-link gain if the policy is surrendered prior to the end of its term.

  To recap, the point-to-point index-linked interest, if any, is based on the difference between the index value at the end of the term and index value at the start of the term.  Interest is added at the end of the annuity’s term.

  Even though point-to-point contracts offer the potential for the best long-term returns the disadvantage is the inability to gauge the contract’s performance until the end of the contract’s term, which could be anywhere from five to ten years.  Until that time, the growth will appear to be zero even if the market is significantly up.  If the annuitant dies during the term, for purposes of measuring contract performance, the date of death will be used as the end of the term.

  The point-to-point method may be best for the longest-term EIAs since we can expect the best gains over the longest period of time.  However, since the ending value is based upon that specific point in time, a sudden or unexpected downturn could prove detrimental to the contract’s final value.

  Some point-to-point indexing contracts charge a spread, stated as a percentage, per year.  Others may limit participation to less than 100% or impose caps.  The contract may limit or alter the way the means of crediting based on point-to-point.  They may use the end point to average the index over the term of the contract and credit interest on a compounded basis based on the average rate, less some stated percentage defined in the contract.  As always, all contracts should be fully understood by the selling agent and the investor.

Multiple EIAs with Diversified Indexing Methods

  Diversification is not a new idea; agents and professional planners have been advocating that for years.  Annuities may also be subject to diversification, which is something many investors may not have previously considered.  Obviously we cannot know in advance which annuity indexing method will perform best over the coming years but investors who purchase several types of annuities are bound to average out their earnings.  This is especially true of equity-indexed annuity types.  Some indexing methods will do better in volatile markets and others will do best in steady markets.

  Many professionals feel the indexing methods of the EIAs are not nearly as important as other issues and features, such as selecting highly rated insurance companies.  While this is true, it is still important to understand the indexing feature chosen.  Also important is choosing a product with competitive interest rates, participation rates, caps and other features.  By purchasing several different EIAs with several different features the investor may minimize lower earnings due to market trends.  Even professional investors realize that it is not possible to guess which indexing feature will perform best in the coming years, since it will depend upon how the markets perform.  Therefore, buying different annuity products with different indexing methods is a good way to diversity within the annuity market.

Mid-Term Withdrawals

  It is always best to keep the premiums in the annuity, regardless of the type purchased.  In some annuities, however it can be critical to do so.  Equity indexed annuities often do not post returns until either the anniversary date or even at the end of the surrender period.  Any funds withdrawn prior to growth posting will not earn interest or gains of any type.

Minimum Non-forfeiture Interest Rate

“Minimum nonforfeiture amount” means the minimum value as required by the state’s insurance laws.  It reflects net considerations, the nonforfeiture rate, and other items as specified under insurance regulations.

“Nonforfeiture rate” means the interest rate used in determining the minimum nonforfeiture amount.  This will be determined at issue (initial nonforfeiture rate) and, if applicable, each subsequent re-determination period (re-determination nonforfeiture rate).

  Nonforfeiture values apply differently to annuities than they do to life insurance policies.  Basically in life insurance it is a provision that the insured may receive the equity in some form even if the policy is canceled.  In annuities it is the vested benefit usually to a retirement plan and is enforceable against the plan.

  Minimum guarantees in the contract are set by the issuing insurance company; the NAIC sets minimum non-forfeiture rates.  Although companies may set the minimum guarantees at any level they wish, it may not be less than the required non-forfeiture rate.  It can be higher however, if the insurer wishes to do so.

  The National Association of Insurance Commissioners works on model regulations that many of the states then adopt.  For deferred annuities a minimum interest rate indexed to the five-year Constant Maturity Treasurer (CMT) rate, minus 1.25 percent.  For equity-indexed plans, the minimum rate could be reduced by an additional 1 percent but is subject to guaranteed equity-indexed benefits of at least as great as the rate reduction.  The minimum interest rate must be the lesser of 3 percent or the rate determined by the 5-year CMT index, but it may never be less than 1 percent.    The interest rate can be re-determined at specific contract dates; the reset rate can be as of a single date or averaged over the most recent 15 months.  An annual charge of $50 can be recognized but no collection charge is allowed.  The net considerations are 87.5% for all products.  Premium tax can be reflected in the nonforfeiture law.  Of course, the states continue to have the authority to regulate annuities as they see fit.

Minimum Annual Credited Interest Rate

  Annuities, including indexed ones, pay a certain minimum guaranteed rate, so that no matter what happens with the index the investor will know with certainty the minimum amount of money that will be received at the end of the contract, assuming funds are not withdrawn early.  In indexed annuities, this minimum guarantee is called the “floor.”  The minimum annual credited interest rate is the only return the investor can actually count on.

  Insurers may pay more than this minimum guaranteed amount, and sometimes they do to remain competitive in the annuity markets.

  Those who purchase equity indexed annuities should not assume that 100% of their premiums will be credited with the guaranteed rate however.  That is not always the way these annuities work.  Some contracts will only credit interest against 90% or even just 80% of the principal amount.  Although companies have flexibility to change its crediting rates, most contracts specify certain minimum crediting rates that the annuity company must follow.

Historical Perspectives

  When computers came on the insurance scene some individuals saw an opportunity that did not previously exist.  Software programs allowed any number to be punched in to programs designed to show future values, with resulting figures that were simply too good to be true.  Most agents used only correct and realistic projections but some used whatever it took to sell the policy.  As these possibilities were recognized safeguards were put in place but not before some consumers bought policies under fraudulent conditions.

  It is probably not possible to prevent all unethical behavior; the states try but it is a difficult job to say the least.  Between state requirements and insurer mandates it has gotten better.  The bigger issue, say many financial advisors, is understanding how rates will renew, since the initial rate often has little influence on renewal rates.

  Annuity companies vary on how much they expect to earn on investments.  The desired returns can influence how they'll invest premiums and the renewal rates investors will receive.  Suppose an investor wants to purchase a tax-deferred annuity and has narrowed their choice down to four products in two categories: two fixed annuities and two index annuities.  Each annuity has the same initial interest rate, the same minimum guarantee rate, the same surrender charge and the same withdrawal features as the other in its category.  They appear to be virtually identical, but will they pay the same renewal rates when the initial rate term is up?  Not necessarily.

Fixed Annuities

  Regulations require annuity companies to invest most of their portfolios in bonds.  As a result, they won't have much in stocks, real estate, or other assets.  However, the companies still have flexibility on the quality and average maturity of those bonds. Consequently, they can alter the yield and the risk.

Yield vs. Ratings

  The higher a bond’s rating, the lower the yield.  Like all investments the level of risk determines, to some extent, the amount of return.  The return is less because there is less chance the bond issuer will experience financial difficulties and default.  As a result, the managers of a fixed annuity might buy only high-grade bonds, such as 'AAA' rated bonds and accept lower returns.  Another company might be willing to accept higher risk in return for higher renewal yields than its competitors.

Yield vs. Maturity

  Generally speaking, the longer a bond's maturity, the higher the yield is likely to be.  To keep the numbers easy to work with, let's say the two fixed annuities an investor is considering look like this:

• Annuity No.1: 10-year average maturity portfolio that pays a 5% initial rate

• Annuity No.2: 20-year average maturity portfolio that pays a 5% initial rate

  Suppose we look ahead to the next renewal year. The initial rate guarantee has now passed and prevailing rates have dropped.  Here is what the renewal rates might be:

• Annuity No.1: 4%

• Annuity No.2: 5%

  Annuity No.1's rate dropped because its bonds are close to maturity, and the money might have to be reinvested at the current, lower prevailing rates.  On the other hand, Annuity No.2's managers have time on their side; an extra 10 years, in fact.  As a result, they don't have to worry as much about reinvesting money right now.

  What happens if prevailing interest rates skyrocket over the first year?  For our example, the renewal rates could be:

• Annuity No.1: 6%

• Annuity No.2: 5%

  Because Annuity No.1's portfolio will have a number of bonds maturing soon, it will have cash to reinvest at the higher prevailing rates but Annuity No.2 will continue to pay the same rate based on its longer term portfolio.  Additionally, if it does not sell its long-term bonds to reinvest at higher rates, it might face a loss if those bonds drop in value.

Index Annuities

  Index annuities offer the potential to participate in the growth of an index, such as the S&P 500.  Index annuity managers have to consider issues that differ from fixed annuities when they calculate renewal rates.  When the initial rate has expired, investors might have to face changes in the following:

• Cap: The maximum interest rate you can earn

• Participating Rate: The percentage of the index's growth used to determine the interest credited for the year or for the index period

• Spread: The amount deducted from the index's growth to calculate the interest credited for the year or the index period

  The portfolio managers buy options to give index-linked growth potential, but the options can have several variations that could make a difference in annuity renewal rates.

Exchange-Listed Options

  Options that trade on an exchange can cost less than synthetic, over-the-counter options created by sellers.  Lower costs can mean higher caps or participation rates at renewal time.

Big Buyers

  There are discounts for annuity companies that buy large numbers of options.  If the index annuity's managers go in with $50 million in hand, they'll get more options for their money than they would with just $10 million and investors stand a better chance of higher caps or participation rates.

Dynamic Hedging

  The index annuity's managers might not even buy options.  Instead, they may try to duplicate an option's performance by putting together a portfolio of other investments. This could increase returns, which might lead to higher caps or participation rates.  It might also increase the risk however causing renewal rates to drop.

Rate Renewal History

  To help an investor through the decision process, the agent can ask their annuity company for its rate renewal history.  Agents could also try to find out what types of bonds are held and whether options are used.  However, it often just comes down to the people who manage the annuity because people, with their emotional biases, make the final decision on where to invest and ultimately set the renewal rates.

Annuity Riders

  Riders are more likely to be attached to life insurance products than to annuities, but as companies become more progressive or more competitive just about anything becomes possible.

Life Insurance Riders/Death Benefits

  Most annuities will not contain life insurance riders.  Those who need life insurance typically buy a life insurance policy, not an annuity with a life insurance rider.  Annuities may have guaranteed death benefits however.  Under annuity guaranteed death benefits, upon the death of the annuity owner, the beneficiary receives either the value of the contract or 100 percent of the contributions (principal), whichever is greater.

  Even though the annuity may have a guaranteed death benefit, it is unlikely that it would be sufficient to fulfill a family’s need for financial independence.  It really takes a life insurance policy to adequately do that.

Long-Term Care Benefits

  There are two types of annuities with long term care benefits; one requires health underwriting and one does not.  Both types are typically single premium fixed annuities with a long term care rider designed to cover long term care expenses.

  Life insurance products also offer long-term care riders and these usually have greater benefits than annuities do.  Universal life insurance with long term care riders provides more benefits (higher leverage) than the underwritten annuity with long term care riders.

  The annuity with no underwriting provides access to long term care benefits without depleting the vehicle’s principal, and without invasive medical questions; some may also offer in-home care.  Without underwriting anyone can get long term care benefits regardless of health but usually the applicant may not have previously needed or received care service within one year prior to the starting date.  Annuities that do not require underwriting will have a quick approval process but those requiring underwriting will have greater benefits because it is underwritten.  Both annuities will provide the applicant with financial security and long-term care benefits, sometimes with extended care protection.  The annuity with underwriting will have better leverage (benefits) than the annuity without underwriting, but if the investor cannot health-qualify it may be the only available choice.

  Most professionals feel those who want long-term care benefits are better off applying for an individual long-term care policy that is written specifically to cover this type of risk.  Costs can be high but coverage is more likely to be adequate.  Riders are seldom going to provide full coverage because the rider is not the focus of the policy; they are merely attachments to something else.

A Rider is not a Waiver

  A rider is different than a nursing home waiver of withdrawal charge.  The rider is providing nursing home or community care benefits while the other is merely waiving any surrender or early withdrawal fees that would otherwise apply to money removed from the annuity product.  Under the withdrawal penalty waiver the investor is removing money from his or her annuity and using the funds to directly pay for long-term care needs.  Under the long-term care rider, it is the rider that is paying some portion of the long-term care expenses, not the annuity funds.

Guaranteed Minimum Withdrawal Benefit Rider (GMWB)

  Unlike regular annuities, variable annuities are an investment product that involves risks and the possibility of loss.  Problems with variable annuities have given rise to the Guaranteed Minimum Withdrawal Benefit (GMWB), a rider that guarantees the holder of an annuity will always receive a specific amount of money for a certain number of years without surrendering the principal.

Definition:

  Variable annuities are also known as “mutual funds in an insurance wrapper.”  They combine some of the characteristics of a fixed annuity with some of the benefits of owning mutual funds.  Investor pay a premium to the issuing insurance company, similar to the one that they pay for a fixed rate annuity, and the insurance company then invests the premium in sub-accounts.

  A GMWB guarantees to return 100% of the premium, which constitutes the principal in an annuity, paid into the contract regardless of the investment's performance, through a series of annual withdrawals.  The withdrawals are limited to a percentage of premiums, typically 5-7% per year.  If the annual limit is 5%, for example, the investor would need to receive 20 annual withdrawals to recover 100% of their premiums.

  GMWBs usually must be elected when the contract is issued, and in some cases they are non-cancelable, which means their costs continue even if there is no chance they will ever pay off.  The cost is charged annually as a percentage of separate account assets, generally from 40 to 75 basis points.

  Suppose the stock market does exactly what we have seen lately and declines dramatically with the result of an annuity with terrible investment performance.  In this case, when will the GMWB recover its cost?

  Each year over a continuous period of many years, the contract holder must need and request withdrawals up to the maximum percentage allowed by the GMWB rider.  Deferring the start of withdrawals, skipping withdrawals or just plain forgetting to take them won't help the rider pay off.

  The contract owner must live long enough to take the required series of withdrawals. For example, if the owner dies 15 years after buying the annuity, the GMWB will have had little chance of paying off.  The annuity's guaranteed minimum death benefit rider, if one existed, may pay off in this case, but that is a separate contract feature and has no relation to the GMWB.

  The annuity’s tax deferral status is a major selling point of annuities, but GMWBs make little sense for buyers who are over age 65 and want tax deferral.  Older buyers would need to begin taking immediate and continuous annual withdrawals if they expect the rider to pay off in their lifetimes.  In most cases annuity withdrawals in the early years of contract ownership are 100% taxable.

  The contract owner should not plan to exchange or surrender the contract for many years (annuities are nearly always a long-term investment).  If a better annuity contract comes along, or if a large amount of cash is needed for an unexpected reason, receiving the GMWB may not have been advantageous.

  While the GMWB can protect 100% of premiums paid into the contract, it doesn't offer any inflation protection for retirement income.  On a present value basis, taking into account the time value of money, a GMWB actually guarantees to return only about 62% of premium value (assuming a 5% discount rate and 20-year withdrawal period)

  GMWBs can be useful for investors planning to invest through a variable annuity in somewhat risky stocks.  In this case, the insurance protection could pay off if a loss is suffered such as in the Nasdaq crash of 2000-2002.  However, for buyers who select living benefits, some insurance companies may not allow access to the most risky investment choices in their variable annuity menus.  Therefore, investing in GMWBs makes little sense for conservative investors who choose a balanced mix of blue chip stocks and bonds.

  One final word of caution: in some contracts, the amount protected under the GMWB can “step up” to a higher contract value after the contract is issued.  If investment performance is good in the early years, this type of GMWB can protect more than 100% of premiums.  For example, an investor purchases a variable annuity for $50,000 and five years later it is worth $60,000, at which time the investor elected to step up his or her GMWB protection.  In this case, the investor would be guaranteed to receive at least $60,000 through a series of annual withdrawals (starting after the step-up date).  However, it is important to note that exercising this step-up feature can (in some cases) permanently increase the cost of the GMWB.

Guaranteed Minimum Income Benefits (GMIB)

  At a continuing cost that ranges from 50 to 75 basis points of contract value, a GMIB rider guarantees the right to annuitize an annuity contract into a payout program with a specified minimum periodic income, after a waiting period, regardless of the annuity investment performance.  For example, an investor puts $50,000 into his or her contract; the GMIB guarantees that he or she can annuitize it into monthly payments of at least $420 per month, with these payments starting at a time of the investor’s choosing after 10 years.  This establishes what is referred to as a “floor” of future retirement income into which the contract can convert at the holder's option.

  There are specific circumstances that must be met before the GMIB floor will pay off, which may include:

  The investor will have to live long enough (and hold his or her contract long enough) to be able to use the annuitization option.  Typically, a 10-year waiting period after the annuity is purchased is required although it is always important to refer to the contract for actual details.

  Later in retirement, if the investor decides annuitization is a better choice than continuing to accumulate money in the contract or cashing it in there may be some important contract elements to consider as a result of the GMIB.  Some contracts limit GMIBs to annuitization methods that include a lifetime payout.  For people with poor health during retirement, a lifetime payout may not be attractive since their expectation of longevity may not be promising.  Remember that lifetime annuitization options do not forward remaining funds to beneficiaries because they remain with the insurer.

  Most importantly, for the GMIB to pay off, it should guarantee more periodic income than can be obtained (at the time of annuitization) from a comparable insurance carrier. Today's immediate annuity industry is highly competitive.  Quotes can easily be obtained from many companies and payouts are constantly changing based on prevailing interest rates and other contract factors, such as company mortality experience and how anxious companies are to attract new business.

  A competent agent or financial planner may be able to convert annuity quotes into an equivalent interest rate.  For example, suppose a person wants to annuitize an annuity with a balance of $100,000 into a lifetime income of $640 per month at age 65.  If a standard mortality table indicates that this person's life expectancy is 19.2 years, the internal rate of return of this payout over this life expectancy is approximately 4.3%. Generally, if a variety of different contracts are analyzed at once, it becomes clear that:

1. Among insurance companies with comparable financial strength, interest rate quotes on annuity payouts commonly can vary by 1-2%.

2. The floor rates built into GMIBs often do not offer the most attractive payouts available in a competitive market.

  The bottom line of annuitization is that it pays to shop around.  The GMIB can only recover its cost if the investor is willing to give up his or her right to shop and take the payout plan guaranteed (long in advance) by their annuity insurer.

  Annuity living benefit riders are not necessarily the “seat belts” they are advertised as. They involve separate purchase decisions (apart from the annuity itself) that should make sense based on their own merits.  GMWBs and GMIBs always generate extra continuing costs, and they can only repay this cost many years in the future, under specific circumstances that may depend more on the buyer's needs and circumstances than on stock market performance.

  Much can change during retirement years.  If health declines several years from now, or if the investor has opportunities that make exchanging or cashing in their annuity contract advisable, all of the cost of these riders may be wasted.

  For the riders to make sense, investors must plan to hold their annuity for at least twenty years with a GMWB rider or for the required waiting period, such as ten years, with a GMIB rider.  These riders need to also be compatible with other income tax planning strategies.  A tax advisor may be able to give insight into whether or not these riders make investment sense.

  Riders are often sold as “peace of mind” functions, but that is not always true.  The idea that having them will provide comfort even if they don’t pay off just doesn’t make sense.  Investors wouldn’t buy an extra car just in case their car was stolen.  Why should they pay extra dollars out when it may not be necessary?  Don't accept the argument that these riders will help your clients sleep better, even if they don't pay off.  If losing sleep is an issue, choose investments (inside or outside an annuity) that will help the buyers feel secure on the investments own merits.  None of the basic benefits of an annuity are compromised by refusing to pay extra for riders.

Guaranteed Minimum Death Benefit Riders (GMDB)

  Variable annuities have a death benefit.  If the investor dies before he or she has started making annuity withdrawals, their beneficiary is guaranteed to receive a specified amount – typically at least the amount of the purchase payments (principal).  The beneficiary will get a benefit from this feature if, at the time of the investor’s death, the account value was less than the guaranteed amount.

  Some people in the insurance industry feel the guaranteed minimum death benefit rider helps maintain the death benefit coverage despite the potential risks associated with variable life insurance products.  The GMDB rider guarantees that the death benefit protection of the annuity policy won't lapse even if the cash surrender value is insufficient to cover monthly deduction charges.  In short, the policy's death benefit is guaranteed, no matter how the market is performing.

  The GMDB rider:

• Helps protect the policy's death benefit from potential market risks;

• Offers protection for the base policy's face amount and for eligible riders that are included with the policy; and

• Offers a choice of GMDB rider coverage periods (each with a required premium level) to meet your individual needs.

Required Premium

  The monthly premium for a policy with the Guaranteed Minimum Death Benefit rider is determined when the policy is issued, and the investor must make premium payments for at least this amount to pass a monthly “GMDB premium test.”  As long as the investor does so, the GMDB rider's death benefit protection remains intact.

How the Rider Works

  On any monthly deduction day when the policy's cash surrender value is not sufficient to cover the required monthly deduction charges, the GMDB rider is activated to pay these charges - which are necessary to maintain the policy's death benefit protection.  If any part of the monthly deduction charges exceeds the policy's available cash surrender value, the GMDB rider covers these charges, as well as the charges for the rider itself and any other riders included with the policy.  By doing this, the GMDB rider protects the policy's death benefit even if market fluctuations reduce the policy's cash surrender value.

  Separate account charges⁴ are not covered by the GMDB rider.  They are deducted from the fund returns before returns are credited to the policy.

Available Benefit Periods

  Investors have a choice of rider coverage periods.  The GMDB rider must be elected for a minimum of ten years. The longer the coverage period selected, the greater the required premium for the rider.

Policy Loans

  To maintain the guaranteed death benefit provided by the GMDB rider, limitations on policy loans exist.  If a loan is taken during the first two policy years, the rider ends.  After the first two policy years, loans are permitted but may be limited.  If the amount of the loan would cause the GMDB rider to end, the investor will be notified before the loan is processed.

The GMDB rider ends:

• On the policy anniversary when the insured covered under the policy reaches the age on the rider benefit period you've selected;

• If the GMDB premium test is not satisfied on a monthly deduction day, and any required payment is not received by the next monthly deduction day;

• If a policy loan is taken during the first two policy years, or if a loan is requested after the first two policy years in excess of the available amount; or

• If the policy is terminated, surrendered, or cancelled by the policyowner.

Annuity Advantages and Disadvantages

  It is unlikely that any one type of financial vehicle would be sufficient to comprise a fully adequate financial plan.  Equity indexed annuities must be part of a portfolio that considers all types of investment vehicles so that the investor’s goals and aspirations are fully satisfied.  Assets must be logically divided among several types of financial vehicles so that the investor’s full needs are met.  An agent or financial planner that merely divides the client’s assets among an array of annuities, even if diversified among several indexes and annuity types, is probably not doing an adequate job of protecting his or her clients.  Generally it takes several types of investments to appropriately address possible future returns and investment risks.

Advantages

There are specific advantages to using annuity vehicles, including:

1. Guarantee of principal (the premiums paid in will never be lost);

2. Tax-deferred growth: in nonqualified plans the earnings are not taxed until withdrawn;

3. Income distribution: the contract owner can annuitize the annuity to receive income in whatever manner he or she chooses.

4. Retirement goals: both accumulation annuities and single premium annuities work very well with retirement goals.  They also blend well with other investment products aimed at retirement.

5. Probate avoidance: as long as the listed beneficiary is not the estate proceeds will pass directly and quickly on to the listed individuals.  There is an exception to this: the lifetime annuitization option does not pass on unused funds (the insurer keeps them).

  While equity indexed annuities might be classified with cash and cash-equivalents because of their high level of safety they tend to offer some additional advantages:

• Some EIAs offer a minimum interest rate that could be compared to that offered by CDs and money market funds.

• The interest earned on equity indexed annuities is tax-deferred.  This offers a substantial gain over a period of growth years.  If withdrawals are taken when the investor is in a lower tax bracket this could be a substantial advantage over other types of investments.

• EIAs offer the ability for equity-like participation in the stock market according to the index linking feature.  Obviously money market accounts and certificates of deposit cannot do this.  Most financial advisors feel this could offer a greater chance of beating inflation.

Disadvantages

  There are also specific disadvantages to annuities, including:

1. Perhaps the most often cited disadvantage is the fact that, upon withdrawal, earnings are taxed as ordinary income.

2. Once an annuity is annuitized (changed to payout mode) it becomes contractual, meaning it cannot be changed.  It doesn’t matter if circumstances or needs change once annuitized, whatever option was chosen remains intact.

3. In equity products, there is limited participation, meaning the earnings from the index can only go to the limits stated within the policy.

4. Inflation can affect the annuity once it is annuitized.  Because the income payments are contractual and based upon the date of annuitization (current financial conditions for that time period) there are no inflation adjustments.

5. There are surrender periods and penalties on annuities.  Annuitization does not incur surrender periods or penalties.

6. IRS will impose a 10% early withdrawal fee if money is withdrawn from the annuity prior to age 59½.  The insurer cannot waive these fees since they are imposed by the IRS.

Guaranteed Principal: a Big Advantage

  Most annuities (with the exception of variable annuities) are considered safe financial investment vehicles.  Equity indexed annuities could be classified with cash and equivalents such as Certificates of Deposit and money market accounts because they are made up of fixed annuities, which are traditionally safe.  The risk is small that the investor will not receive at least the minimum returns.  While we would all like to see huge growth, safety of principal is typically the primary concern. 

Tax Deferred Growth-Another Big Advantage

  Nonqualified annuities will be taxed on their growth when the funds are withdrawn.  Principal is withdrawn last; gains are withdrawn first.  Annuities are “tax-deferred” meaning the tax on gains is “deferred” until withdrawal.

  Delaying growth taxation allows a long-term vehicle, such as annuities, to grow faster than one that loses value each year to taxation.  Most annuities pay compound interest so growth is based on the total account values, not just on the premiums paid in.  The longer the annuity is held, the more potential there is for growth.

  A taxable investment pays the tax on the gains in the year in which they are earned, so there is no deferral of taxation.  Deferring taxation allows the investor to “manage” their taxation, taking gains in a favorable tax year.

  Some annuities might be tax free.  This would be the case, for example, if a Roth IRA (individual retirement account) used an annuity as its investment vehicle.  Because the Roth IRA is granted a special tax status by the IRS fund growth is not taxable when withdrawn; this is called a tax qualified vehicle.  Tax qualified annuities (and other investments as well) are tax free; nonqualified financial vehicles are taxed on their growth.

Tax-Deferral Exception

  Not all annuities are tax-deferred; they must be held for a natural person or in trust for the benefit of a natural person.  An annuity that is held in a corporation, limited partnership, LLC, or other business entity might not be able to grow tax deferred.  Even placing an annuity into a family-limited-partnership might cost the investors their tax deferral status.  In such cases it really makes sense to hire a tax specialist.

Inflation Risk

  The biggest risk is not loss of premium (principal) but rather that the growth will be too small to match or exceed the rate of inflation.  It is possible that loss of buying power could occur with annuities.  In other words, while the principal is maintained the interest earned is too small to maintain the same level of buying power ($100 may only buy 80% or $80 of what it once could buy).  This is the same risk that all conservative financial vehicles face.  Lower financial risk also means lower rates of interest earnings, so lower rates of growth.

  Fixed annuities promise a guarantee that a certain amount will be available at some point in time (depending on contract terms) but they do not promise that the returns will keep up with rates of inflation.  Even though equity indexed annuities are not liquid financial vehicles, they do promise that at least the principal will be available at some specified date.

Probate Avoidance

  Annuities bypass probate procedures (although annuity values must still be listed during probate for taxation purposes).  Most people are not wealthy enough for probate to be a severe issue, but if the investor believes probate may become slow or cumbersome, annuities may be a good investment choice.  Since they have a beneficiary designation, they go directly to the person or people named in the policy.  The same is true for life insurance policies.  Any type of vehicle that has beneficiary designations may be able to pass the assets on to the named individuals outside of probate.

  Since individuals have individual circumstances, it is very important that an attorney be consulted.  In many cases, both an attorney and a tax specialist should be part of the decision making process.  There are many mistakes that can be made in the attempt to protect assets; whatever it costs to involve these individuals may be well worth the cost.

Laddering Some Types of Annuities

  Many investors like to “ladder” their investments, with some coming to maturity each year during retirement or at least during the early years of retirement.  Many investors stagger their investments to reach maturity in five-year increments.  The goal is to provide continual income during retirement; as one investment is used to fund retirement costs, the next investment matures and takes up where the last investment ended.

For example:

  Rachel Retiree has given lots of attention to her retirement planning.  She has Social Security income, which is too small to live on, but no pension from her working years.  Knowing that she would not receive a pension she saved regularly throughout her working years.  With the help of a financial planner she knows approximately what her living costs will be in retirement.  The only unknown factor was the rate of inflation so she tried to have more than she thought would be necessary available from her investments.  If inflation is greater than anticipated she hopes the “extra” will cover the rising costs of living.  On the other hand, if inflation is not as great as she thought it would be she will have extra funds, which of course is what Rachel is hoping for.

  In year one of her retirement a Certificate of Deposit matures and is used to fund the first five years of Rachel’s retirement. 

  In the fifth year of Rachel’s retirement, a fixed rate traditional annuity is annuitized to provide monthly income for the next five years.  Because it will pay out all funds over just a five year period Rachel will actually be able to put part of the income into a liquid savings account to cover unforeseen emergencies, such as health care needs or dental costs.  This expectation of extra funds may not materialize if inflation soars but if it does not she will be over-funded.  Although she could use the extra money for travel or other pursuits Rachel is wise enough to realize the future may cost more than the present.

  In the tenth year, when Rachel is 72 years old (she retired at age 62 when she could begin collecting Social Security benefits) an equity indexed annuity matures.  This annuity promised better returns than her traditional fixed rate annuity so she chose to have it mature when she was older.  She felt it may give her more income at a time when living costs would possibly be higher due to inflation.  By this time she also hopes her modest stock investments will have grown sufficiently to produce any additional funds that she might need for such things as higher insurance premiums on her health insurance or medical needs associated with growing older.  Rachel knows she took on an extra risk when she chose not to buy long-term nursing home insurance.  She felt she would not be able to pay the potentially rising premium rates of such insurance.  Rachel hopes she will not need nursing home care even though historically she is likely to, if just from the frailty that comes with aging (especially for women who make up the majority of nursing home residents).

  In the 15^th year of Rachel’s retirement, when she is 77 years old, her final investment will be utilized, a bond fund.  Obviously Rachel does not know how long she will live but Americans continue to live longer than those before them.  It is certainly possible that Rachel could live to be 100 years old.  She can only hope her money will last as long as she does.  Rachel could have chosen lifetime income from her annuities to guarantee funds for as long as she lives.  She chose to receive income for shorter periods of time because she felt lifetime payments would be too small to cover her expenses.  Rachel can only hope she made the best choices for herself.

Settlement Options

  Annuitants and contract owners are not required to annuitize their contracts, and many never do, but they were designed with that in mind.

  Income for life, called a Straight Life Annuity, provides income for the annuitant until he or she dies.  Even if the individual outlives the funds in the annuity it will continue to provide a systematic income.  Most people choose to receive the income on a monthly basis.  If the annuity has been annuitized for a life option, upon the death of the annuitant, payments cease; nothing will be paid to beneficiaries even if there are funds remaining in the annuity account.

  Another annuitization option guarantees that payments will continue to someone (either the annuitant or a named beneficiary) for a specified period of time.  This annuitization option is called Period Certain or Life with Period Certain.  It guarantees income for the life of the annuitant but if he or she does not live until all funds are dispersed (paid out), then the remainder will go to the designated beneficiary.

  Annuitization options that pay for a specified period of time are called Period Certain annuitization options.  The “period certain” will depend upon the selection; it might be for ten years, fifteen years, twenty years, or whatever else might be available.  Many of these options will pay longer than the specified period of time (again, depending on what the insurer made available) but they will never pay for a shorter period of time, even if the annuitant dies prematurely.

  Life Income with Refund annuity offers two types: cash refund and installment refund.  Sometimes the subgroups (cash refund and installment refund) are listed as the payout options, but both are actually subgroups of the Life Income with Refund annuitization option.  In either subtype somebody is going to get an amount at lest equal to the total dollars paid in as premiums.  The company will continue to pay the guaranteed amount of monthly income for as long as the annuitant lives.  If the annuitant dies the insurer promises to pay the difference between what was paid to the annuitant and the amount left (plus interest) to the beneficiaries.  This payment will be either a lump sum cash settlement or a continuation of the annuitant’s installment payments.

  Joint and Survivor payout options insure two people, usually a husband and wife, but not necessarily so.  Beginning on the date set in the contract, payments are paid to the annuitants.  Payments are guaranteed to continue to the surviving spouse upon the first spouse’s death.  Depending on the terms, the continuing payments will either be in the same amount as when both lived or be reduced.  Income will be less for two lives than for one of course, since the “risk” to the insurer is higher on two lives than it is for one.

Product Comparisons

  It is easy to see why professionals who are familiar with equity indexed annuities might choose them over CDs and money market funds.  Still most people tend to keep more money in certificates and money markets than they do in EIAs, probably because so few people really understand and appreciate the features of equity indexed annuities.

  Agents may sometimes see equity indexed annuities compared to some types of bonds.  Investment returns may be similar, although most bonds do not enjoy the tax deferral that annuities enjoy.  Even so, if withdrawals may be needed before the EIA would mature bonds are a better choice for the investor.  However, if liquidity is not a concern, it is typically better to invest in the equity indexed annuity because:

• The annuity will be tax deferred; some types of bonds may also enjoy this feature (municipal bonds for example) but they usually have very low returns.

• Bond values can go down if interest rates go up.  This would mean holding the bonds to maturity to get the full values from them.

• Bonds are subject to market risks, such as inflation and speculation.

• Equity indexed annuities may do better than minimum rates if the index they are linked to perform well.  That would mean better performance than bonds are capable of.

  This does not mean that bonds have no place in the investor’s financial portfolio since they do offer liquidity that is not available in annuity products.  Bonds are used for liquidity and EIAs are used for long-term performance.  Bonds might also be the investment choice if funds will be needed prior to age 59½ since annuities would be subject to IRS early distribution penalties for withdrawal prior to that age.  As we previously noted, it is always an issue of product suitability.

  There is another difference between bonds and equity indexed annuities: investors cannot wait for EIAs to decline in price and then buy them.  Since bonds can go up and down and price, investors might wait for bond prices to go down before they buy them.  Equity indexed annuities can only go up in value and have only positive correlations to the asset classes that overlap the index the product is linked to.

Retirement Savings

  Obviously, it is necessary to set aside funds for retirement.  By this time we should all know that Social Security is not sufficient to support anyone.  There is also much concern about the government’s ability to continue providing Social Security under its current provisions.

Investors Age 65 and Older

  In some ways, the same rules apply regardless of age, but in other ways age has a tremendous effect on investments.  The most obvious effect on investments is the inability to make up principal losses.  Those who are in their earlier years will certainly be disappointed in a major financial loss, but they have time on their side; they can eventually make up the loss in one way or another.

  Once a person reaches age 60 (50 for investors who leave the workforce early) the ability to make up losses is dramatically reduced since they are unlikely to work past age 65.  Of course this is very individual and each person must look at their own situation.  Even so, most people cannot afford to loss their principal as they age.  That is the beauty of relatively safe investments like fixed rate annuities, which includes indexed products: the principal is guaranteed if all requirements of the investment contract are met.  In many of the indexed products growth is not included until the end of the contract term so it is very important to know the details of the investment prior to withdrawing funds.

  Although age 65 is considered the so-called “normal” retirement age, this has not always been the case.  Prior to the enactment of Social Security people worked until they could no longer do so physically.  Only the wealthy could afford to spend their time leisurely, as retirees now do.  Some feel we are headed back to longer working lives as those entering their 60s realize they have too little funds available for the remainder of their lives if they stop earning a paycheck.  To compound the problem many nearing retirement age are caring for elderly parents; some are also financially helping for their children.  Clearly these individuals are facing retirement hardships.

  There are many varied methods for determining how much needs to be set aside for retirement.  Knowing how to figure the amount of money needed may be a mute point however sine far too people (some say as many as 60%) will have far too little set aside for their retirement years.  For these Americans, it doesn’t matter if they can compute what they should have saved because it is already too late to achieve the needed amount.

  Annuities work well for retirement because they have the ability to provide lifetime income.  That does not mean annuities will provide adequate lifetime income however.  Only if sufficient dollars have been put in the annuity will it provide adequately.

Fixed Life Insurance Products

  A whole life insurance policy, also referred to as permanent insurance, involves coverage effective for the entire life of the insured.  It pays a death benefit when the policyholder dies regardless of his or her age.  The contract provides a fixed amount of life insurance coverage and a fixed premium amount.  Benefits are payable upon the death of the insured or on the maturity date (often the insured’s 100^th birthday).  Coverage can increase only with the purchase of an additional policy or through additional riders or dividends, if offered.  Coverage is for the life of the insured.  Premiums are paid at a fixed rate throughout the insured’s lifetime, if the policy remains active.

  Cash values accumulate from premiums paid into the whole life policy and increases over the years.  The earnings for tax purposes include only the amount accumulated in excess of the premiums paid.  The policyowner may owe taxes on these earnings if he or she surrenders the policy.  In most cases, the insured will not owe taxes on the earnings if he or she does not surrender the policy but it is always smart to check with a tax specialist.

  Policies with cash values include provisions allowing the insured to take out loans on their policies for up to the cash value amount.  The loans accumulate with interest but repayment is not necessarily required prior to death.  If the insured dies and the loan has not been repaid, the amount owed plus interest will be deducted from the death benefits paid to beneficiaries.

Participating Whole Life

  Some whole life policies are called “participating” or “par” policies.  This means they earn dividends.  Policy dividends can be taken in cash, used to pay premiums or used to buy more insurance.  They are essentially refunds of excess premiums, so they are usually not taxable but as always, it is wise to check with a tax specialist.

  A policy that is surrendered early, especially during the first or second, year, may not return any cash to the contract owner.

Interest Sensitive Whole Life

  Interest sensitive whole life is also known as either excess interest or current assumption whole life.  The policies are a mixture of traditional whole life with universal life features.  Instead of using dividends to augment guaranteed cash value accumulation, the interest on the policy's cash value varies with current market conditions.  Like whole life, death benefits remain constant for life.  Like universal life, the premium payment might vary, but not above the maximum premium guaranteed within the policy

Universal Life

  Universal life is often thought to be a specific type of life insurance but in fact it is merely a variation of cash value contracts, in this case a whole life policy.  This product is known for its flexibility.  Universal life allows the insured to increase or decrease the “face amount” of the insurance, within policy limitations of course.  If increasing the coverage, it may be necessary to prove insurability.

  Policyholders can decide, within policy guidelines, on the amount of premiums and the schedule of payments.  There may be limits on premiums because of tax laws however.  Insureds may select a policy that is interest sensitive or one that has a guaranteed rate.

  Universal life products are often used to meet various financial obligations, such as protection for family members in case of the insured’s premature death.  Interest sensitive products put the least amount of risk on the insured.

Term Life

  A term life insurance policy, as the name indicates, involves a “term” of death coverage.  It covers the insured for a specified period of time (or term) and pays a death benefit only if the insured dues during that term.

  Term life products do not provide cash benefits.  Such products provide more life coverage per dollar than do cash value products because all premium dollars go to the coverage rather than cash reserves.  Benefits will be paid only if the insured dies during the coverage period.  Once the policy period ends, all contractual guarantees end also.  This is the type of life insurance traditionally recommended for young families that need lots of coverage but cannot afford a large premium.

Indexed Life

  Indexed life is a policy with a face value that varies according to a prescribed index of prices; otherwise benefits provided are similar to ordinary whole life.  The death benefit is based on the particular index, such as the Consumer Price Index (CPI).  The policyowner has the choice of having the index applied either automatically or on an elective basis. With an automatic index increase, the premium remains level since it has already been loaded to reflect the automatic increase.  If the policy allows for an optional index increase, an extra premium is charged when this option is exercised by the policyowner.  Regardless of which index is selected (automatic or optional) the increased death benefit does not require another physical examination or other evidence of insurability.

  Equity indexed life insurance, like all permanent life insurance, generally offers three distinct tax advantages that in combination are not found in any other insurance or cash accumulation product.  These include:

1. Tax deferred accumulation of cash values;

2. Potential for tax managed income for retirement or other goals; and

3. Tax free proceeds transferable at death.

  Equity indexed universal life insurance offers a unique combination of affordable life insurance with the ability to accumulate cash values that grow with the upward movement of a stock index without the normal downside risk associated with the equities market.  Combine the benefits of upside cash value growth potential with the tax deferred benefits associated with life insurance and a minimum guaranteed interest rate and buyers have an optimum vehicle for accumulating cash.

Whether the individual’s objective is to obtain a flexible low cost life insurance policy, to maximize retirement income in the most tax efficient way or to provide liquidity in estate planning, equity indexed life insurance can help meet goals in many cases.

Variable Life Insurance Products

  There are two kinds of variable life products: (1) scheduled premium variable life, with set payment times and amounts and (2) flexible premium variable life insurance that allows changes in payment time and amount.  An individual who sells variable life products, whether it happens to be life insurance or annuities, must typically be registered as a representative of a broker-dealer licensed by the National Association of Securities Dealers and be registered with the U.S. Securities and Exchange Commission.  Of course he or she must also be a licensed insurance agent.

Variable Life

  Variable life is defined as a form of permanent life insurance that has both a death benefit as well as an investment component called a “cash value.”  Policy owners have the option of investing a percentage of their insurance premium in an investment account.  This percentage can be invested in bonds, stocks, money market funds and other securities in the insurer's portfolio, thereby building a cash value in the life insurance policy.  There is a definite element of risk to this option, because the policy's face value at any moment depends on how successfully these investments are performing.

  Like other cash-value policies, the policy can accumulate a substantial cash value over time.  With this benefit comes the risk that if the investment component performs poorly, the cash value and/or death benefit will shrink proportionally.

  The policy owner can borrow the accumulated funds without having to pay any taxes on the borrowed gains.  So long as the policy remains in force, he or she does not need to actually repay the borrowed funds, although there may be interest charged on the policy’s cash value account.

  Another benefit of the variable life policy is that the policy owner can apply their gains toward paying premiums, which may lower the amount he or she has to pay out-of-pocket.  On the other hand, if the invested funds don't perform successfully, the policy owner may have to pay more out-of-pocket in order to keep the policy in force.

Variable Universal Life

  Variable Universal Life Insurance (often shortened to VUL) is a type of life insurance that builds a cash value.  In a VUL, the cash value can be invested in a wide variety of separate accounts, similar to mutual funds.  The policy owner may choose from the available separate accounts when investing.  The “variable” component in the name refers to this ability to invest in separate accounts whose values vary; they vary because they are invested in stock and/or bond markets.  The “universal” component in the name refers to the flexibility the owner has in making premium payments.

  The premiums can vary from nothing in a given month up to maximums defined by the Internal Revenue Code for life insurance.  This flexibility is in contrast to whole life that has fixed premium payments that typically cannot be missed without lapsing the policy (although the policy owner may exercise an Automatic Premium Loan feature, or surrender dividends to pay a Whole Life premium).

  Variable universal life is a type of permanent life insurane because the death benefit will be paid if the insured dies any time as long as there is sufficient cash value to pay the costs of insurance in the policy.  With most if not all VULs, unlike whole life, there is no endowment age (which for whole life is typically 100).  Some professionals consider this an important advantage of VUL over Whole Life, but not all agree with this assessment.

  With a typical whole life policy, the death benefit is limited to the face amount specified in the policy, and at endowment age, the face amount is all that is paid out.  Therefore, with either death or endowment, the insurance company keeps any cash value built up over the years.  However, some participating whole life policies offer riders that specify that any dividends paid on the policy be used to purchase “paid up additions” to the policy which increase both the cash value and the death benefit over time.  With a VUL policy, the death benefit is the face amount plus the build up of any cash value that occurs (beyond any amount being used to fund the current cost of insurance.)

  If investments made in the separate accounts out-perform the general account of the insurance company, a higher rate-of-return can occur than the fixed rates-of-return typical for whole life.  The combination over the years of no endowment age, continually increasing death benefit, and if a high rate-of-return is earned in the separate accounts of a VUL policy, this could result in higher value to the owner or beneficiary than that of a whole life policy with the same amounts of money paid in as premiums.

Comparing Indexed Life and Indexed Annuities

  When two products share the same characteristics there will certainly be similarities, in this case indexed annuities and indexed life insurance.

  Fixed indexed products, called FIPs, are issued by life insurance companies.  FIPs generally offer the same array of benefits as non-indexed products but they are more complex.  Indexed annuity products offer accumulation ability, pay-out options and death benefits.  Indexed life insurance products have the same general features, but offer death benefits significantly higher than the annuities are able to offer.  Since annuities offer growth on the premiums paid in they are benefits designed for living; life insurance, with their higher death benefits, are designed of benefits following the insured’s death.

  FIPs differ from other insurance products in that part or all of the appreciation in benefits are determined by reference to independent indexes.  Generally, the dollar value of benefits can vary up or down as derived from the increases and decreases in the performance of the indexes.  However, the dollar value of benefits cannot fall below specified levels guaranteed by the insurance companies.

  With today’s products, the dollar value of benefits on an interest determination date cannot be lower than the value of the preceding determination date.  In other words, the dollar value of benefits cannot move downward, but only upward relative to the index. As a result, FIPs offer owners an opportunity to benefit from rates of interest derived from favorable changes in the financial markets, while assuring that the owner’s value will not decrease at all in most designs and will not decrease below specified levels in any design.

Terminology

  Whether it is life insurance or annuities many terms that relate to indexes will be the same.

Cap: A cap adjustment is a maximum limit on the index value change percentage.  For example, if the index value change percentage is 8% and the cap is 10%, then the interest credit is 8%.  In no case would a credit for any interest term be higher than 10%, no matter what the index value change percentage is.

Adjusted Change: The change in the Index Value for a segment, with adjustments as described in the indexed interest rate provision.

Adjustments: Nearly all fixed indexed annuities and life products make provisions for an adjustment factor to modify the index value percentage change.  The purpose of the adjustment is to allow the insurance company to balance the amount that it has available to spend for an interest credit with whatever it costs the insurance company to provide the index percentage change method.  For example, if an insurance company would normally credit a fixed interest rate of 4% per year, this roughly becomes the budget for purchasing or constructing a financial hedge which will provide the interest credit promised in the policy, regardless of what index changes occur.

Annual Reset Indexing Method: Index-linked interest, if any, is determined each year by comparing the index value at the end of the contract year with the index value at the start of the year.  Interest is added to the annuity each year during the term.

Annuity Benefit: The payments that may be made under the “benefit on annuity commencement date” of the contract.

Averaging: Some annuities use an average of an index’s value rather than the actual value of the index on a specified date.  The index averaging may occur at the beginning, the end, or throughout the entire annuity term.

Beneficiary/Beneficiaries: The person or people entitled to receive death benefits if the annuitant should die prior to withdrawing all annuity funds, unless annuitized for a lifetime benefit, in which case beneficiaries receive nothing even if the annuitant did not use all premiums deposited.

Cap or Cap Rate: Some contracts will state an upper limit, called a cap, on the index-linked interest rate.  This is the maximum rate of interest the annuity will earn.  It is the highest Adjusted Change for each segment of the indexed strategy.

Code: The Internal Revenue Code of 1986, as amended, and the rules and regulations that are issued under it.

Commencement Date: The annuity commencement date if an annuity benefit is payable; the death benefit commencement date will be shown on the contract specifications page.

Contract Anniversary Date: the date each year that is the annual anniversary of the contract effective date, shown on the contract specifications page.

Contract Year: A contract year is each twelve (12) month period that begins on the contract effective date or on the contract anniversary.

Death Benefit Commencement Date: the first day of the first payment interval for a death benefit that is paid as periodic payments or the date of payment that is paid as a lump sum if periodic payments will not be made.

Death Benefit Valuation Date: Although contracts may vary, typically it is the earlier of:

1. The date that the insurer has received both Due Proof of Death and a written request with instructions as to the form of death benefit (lump sum or systematic payment); or

2. One year form the actual date of death.

Due Proof of Death: Due proof of death is typically one of the following:

1. A certified copy of a death certificate, or

2. A certified copy of a decree that is made by a court of competent jurisdiction as to the findings of death (this is generally only used when the person or person’s body cannot be located).  Companies may accept other types of proof in some circumstances.

Floor: The lowest Adjusted Change for each segment of an index strategy is called the “floor.”  It is the lowest point on equity index-linked interest.  It is the minimum index-linked interest rate the investor will earn.  The most common floor is 0% (zero).  While that looks like a bad thing, it actually assures that even if the index decreases in value, the index-linked interest will not go negative, losing money.  Yes, no interest would be earned but neither would any principal be lost.  Not all contracts have a stated floor on index-linked interest rates but fixed annuities will have a minimum guaranteed value.

High-Water Mark Indexing Method: The index-linked interest, if any, is decided by looking at the index value at various points during the term, typically the yearly anniversary date of purchase.  The interest is based on the differences between the highest index value and the index value at the start of the term.  Interest is added to the annuity at the end of the term.

Index: An index is the specified index that will apply to an Indexed Strategy for the term shown in the equity indexed annuity contract, usually on the specifications page.  If the index is no longer published or its calculation is changed, the insurer may substitute a suitable index at their discretion.  Insurers should notify their policyholders if a substitution is made.  Sometimes the insurers are required to first get approval of the substitution from the state insurance department.

Index Value: The index value is the standard industry value of the index.  The index value for a particular date is the value of the index as of the close of business on that date.  For any date that the New York stock Exchange is not open for business, the index value will be determined by the insurer and stated in the policy, but often it is the index as of the close of business on the most recent day on which the Exchange was open prior to that date.

Indexing Method: The indexing method is the approach used to measure the amount of change, if any, in the index.  Some of the most common indexing methods include annual reset, or ratcheting method, high-water mark method and the point-to-point method.

Index Spread: An amount by which the Index Change is reduced when computing the Adjusted Change.

Index Term: The index term is the period over which index-linked interest is calculated.  In most product designs, interest is credited to the annuity at the end of the term, which may be ten years although the average term is more likely around seven years.  Products may offer a single term or multiple consecutive terms.  Those with multiple terms usually have a window at the end of each (generally 30 days) during which the policyowner can withdraw his or her funds without penalty.  For installment premium annuities, the payment of each premium may begin a new term for that premium.

Index Value: The standard industry value of the index is the index value.  The index value for a particular date is the value of the index as of the close of business on that date or the most recent date the Exchange was open.

Interest Compounding: Some annuities pay simple interest during an index term.  That means index-linked interest is added to the original premium amount but it does not compound during the term.  Others pay compound interest during a term so that the index-linked interest hat has already been credited earns additional interest.  In either case the interest earned in one term is usually compounded in the next however.

Participation Rate: The participation rate is the portion of the index change that is used to compute the adjusted change.  It decides how much of the increase in the index will be used to calculate index-linked interest.  It is the portion of the index change that is used to compute the Adjusted Change.  Note the definition of “adjusted change” above.  Participation rates are typically guaranteed for stated amount of time, but the company will change the rates after that time.

Point-to-Point Indexing Method: The index-linked interest, if any, is based on the difference between the index value at the end of the term and the index value at the start of the term.  Interest is added to the annuity at the end of the term.

Segment: Segment is the period of time over which the change in the index is measured for an indexed strategy.  A segment may never be longer than the term of that strategy.  The initial segment begins on the first day of the term.  Subsequent segments begin upon the expiration of the preceding segment.  Daily segments that end on a day that the New York Stock Exchange is closed are often disregarded.

Term: For a declared rate strategy, the period of time during which the interest rate is declared; for an indexed strategy, the period over which an indexed interest rate is calculated.  The initial term begins on the first interest strategy application date.  Subsequent terms begin upon the expiration of the preceding term.

Valuation Date: A date on which the index value is measured to compute the Index Change.  If an indexed strategy uses valuation dates that are daily, then dates on which the New York Stock Exchange is closed are disregarded.  If an indexed strategy uses valuations dates that are other than daily, the valuation dates are the dates within a month that correspond with the first day of the term.

Vesting: Some annuities do not credit any of the index-linked interest, or only part of it, if the investor withdraws their money before the end of the term.  The percentage that is bested, or credited, general increases as the term comes closer to its end and is always 100% vested by the end of the term.

Product Mechanics

  Introduced in 1995, equity indexed products are relatively new to the financial services world.  Purchasing equity indexed products, however, first means understanding what they are, how they are designed to work and for whom they are tailored.

  As it applies to life insurance, the most significant advantage of Equity Indexed Life (EIL) is that it combines most of the features, benefits and security of traditional life insurance with the potential to earn interest based on the upward movement of an equity index.  This is also true of annuities.  Instead of the Company declaring a specific interest rate or dividend as with traditional life insurance, interest earnings are credited based on increases in value of a specific equity index.  The Standard & Poor’s 500® Composite Stock Price Index* (excluding dividends) is used for many of the indexed products for both life and annuity products.  The S&P 500 Index is currently the most commonly used index for EILs.  Credited interest is linked to increases in the S&P 500 Index without the downside risks associated with investing directly in the stock market.  Because EILs are permanent life insurance plans, they provide features that give a sense of stability through:

• A guaranteed minimum interest rate;
• Tax-deferred interest accumulation; and
• Access to cash value through withdrawal and loan provisions.

  In addition, the equity indexed link in EIL products offers important benefits:

• Equity index-linked returns with the potential to beat inflation
• Protection in the contract against downside market risk

Basic Interest Crediting Strategy

  Net premium is initially paid into a basic interest strategy, from which insurance and administrative charges and policy expenses are paid.  The strategy earns interest (as declared by the company) and, as long as premiums continue, certain amounts will be held in this strategy to cover future insurance and administrative charges.  The premiums in any basic interest strategy will earn an interest rate that could fluctuate on a daily basis, but will never be less than the minimum rate guaranteed in the contract.  Depending on the contract, the investor might elect how other values are directed to available options under the contract.

Five-Year Fixed-Term Interest Strategy

  Each premium directed to a strategy creates a distinct fixed-term segment.  Over time, the investor might have a number of fixed term segments within their plan.  The interest rate for a five-year fixed-term strategy, for example, might not be guaranteed.  The insurer’s current practice must suit the investor’s needs and goals.

Five-Year Equity Indexed Strategy

  In equity indexed fixed rate strategies, interest earnings are linked to growth in an index, such as the S&P 500 and are subject to a participation rate that is typically guaranteed to be 100% for the life of the contract.  There may be a maximum earnings rate that can change annually for each segment.  In addition, an equity indexed strategy might include specific features, such as principal protection and locked in growth.

Principal Protection

  Premiums paid into fixed rate equity annuities are protected from a downturn in the index; that is the point of using fixed rate annuity products in many cases.

Annual Lock In of Earnings

  In some cases, each premium directed to an indexed annuity may be linked to interest earnings that are calculated and credited each 12 months on the funds in a segment.  In effect, the insurer locks in any index-linked interest earnings every 12 months within a segment and protects them from potential future downturns in the equity index.

Interest Rate Guarantees

  Products vary; it is always necessary to know the product being considered.  Interest is typically guaranteed for a specified time, such as annually.  Premiums (less any withdrawals or deductions) may be compounded annually at the minimum guaranteed interest rate for example.

Guarantees Among Strategies

  Various companies will offer various strategies, with the following three interest crediting strategies being common.  Each strategy and each segment within that strategy, typically works independently from other strategies and segments.

Equity Indexed Life Insurance Loans/Withdrawals

  When properly structured, the cash accumulation in a cash-value life insurance policy can be accessed through policy loans or withdrawals on a tax free basis under tax law that has been in place for decades.  Equity index life insurance may be the fastest growing type of universal life insurance because cash in the policy is credited interest based on stock market performance with no risk of declines.

  Most equity indexed universal life insurance (EIUL) policies credit interest based on the performance of the S&P 500 index (or some other major market index or indexes) subject to a cap on annual crediting as well as a floor of interest credits (usually 0%-2%) when the index itself has a negative performance.  When the index performs positively but below the cap, the cash in the policy will be credited with that same amount of interest.  If the index performs better than the cap, the policy would be credited with the interest amount subject to the cap.  In years when the index is negative, the policy would be credited with the “floor” amount of interest but the cash accumulation does not go backwards due to the negative performance.

  In 2008, when the S&P 500 index lost some 37%, investors in indexed life products were credited with zero interest so there were no earnings, but neither were there principal losses.  Zero growth is easier to live with than principal loss.

  Another reason for the shift towards some types of life insurance is that (just like ROTH IRAs) there are no minimum required distributions with an equity indexed universal life insurance policy.  Perhaps more importantly, regardless of one’s income level, one can fund a policy to almost any amount of money that they wish to.  So for those who earn more than the ROTH income limits as well as those who don't want to be limited in their annual retirement funding, they can put $10,000-$100,000 or perhaps much more away for their retirement.

  It should be noted that we are not recommending life insurance products for retirement funding; there are many good vehicles for that purpose.  Life insurance should always be used for its intended purpose: protection against premature death.  However, for some individuals, an equity indexed life policy has a place in their overall portfolio.

  Equity indexed policies come with a death benefit like all life insurance policies.  Some policies structure the contract for cash accumulation, but purposely minimize the death benefits to the lowest level the IRS allows to keep the policy mortality charges as low as possible.  If the insured dies prematurely the death benefit could be substantially greater than the cash in the policy.  Some professionals consider this an advantage of the life insurance policy over a ROTH, but not all agree.  Each product has a place in retirement planning if appropriately used.

Paying for the Life Insurance Contract

Single Premium

  A Single Premium universal life policy (UL) is paid for by a single, substantial, initial payment.  Some policies do not allow more than the one premium contractually, and some policies are casually defined as single premium because only one premium was intended to be paid, even though more premiums will be accepted.  The policy remains in force so long as the COI charges have not depleted the account.  These policies were very popular prior to 1988, as life insurance is generally a tax deferred plan, and so interest earned in the policy was not taxable as long as it remained there.  Further withdrawals from the policy were taken out principal first, rather than gain first and so tax free withdrawals of at least some portion of the value were an option.  In 1988 changes were made in the tax code, and single premium policies purchased thereafter were “Modified Endowment Contracts (MEC)” and subject to less advantageous tax treatment.  Policies purchased previous to the change in code are not subject to the newer tax law unless they have a “material change” in the policy (usually this is a change in death benefit or risk).  It is important to note that a MEC is determined by total premiums paid in a 7 year period, and not by single payment.  The IRS defines the method of testing to determine whether a life insurance policy is a MEC.

  In a MEC, the premiums and accumulation will be taxed just like an annuity upon withdrawing.  The accumulations will grow tax deferred and will still transfer tax free to the beneficiary under Internal Revenue Service Code 101a under certain circumstances.

Fixed Premium

  Fixed Premium UL is paid for by periodic premium payments associated with a no-lapse guarantee in the policy.  Sometimes the guarantees are part of the base policy and sometimes the guarantee is an additional rider to the policy. Generally these payments will be for a shorter period of time than the policy is in force.  For example, payments may be made for 10 years, with the intention that thereafter the policy is paid-up.  It can also be a permanent fixed payment for the life of policy.

  Since the base policy is inherently based on cash value, the fixed premium policy only works if it is tied to a guarantee.  If the guarantee is lost, the policy reverts to its flexible premium status.  If the guarantee is lost, the planned premium may no longer be sufficient to keep the coverage active.  If the experience of the plan is not as good as predicted, the account value at the end of the premium period may not be adequate to continue the policy as originally written.  In this case, the policyholder may have the choice to either:

1. Leave the policy alone, and let it potentially expire early (if COI charges deplete the account), or
2. Make additional or higher premium payments, to keep the death benefit level, or
3. Lower the death benefit.

  Many universal life contracts taken out in the high interest periods of the 1970s and 1980s faced this situation and lapsed when the premiums paid were not enough to cover the cost of insurance.

Flexible Premium

  Flexible Premium UL allows the policyholder to vary their premiums within certain limits.  Inherently UL policies are flexible premium, but each variation in payment has a long term effect that must be considered.  In order to remain active, the policy must have sufficient available cash value to pay for the cost of insurance.  Higher than expected payments could be required if the policyholder has skipped payments or has been paying less than originally planned.  It is recommended that yearly illustrative projections be requested from the insurer so that future payments and outcomes can be planned.

Monthly Life Insurance Deductions

  The cost of a life insurance policy is determined by the insurer, which calculates the policy prices based on anticipated claims to be paid and administrative costs.  Obviously the insurer wishes to make a profit in the process.  The cost of insurance is determined using mortality tables calculated by actuaries.  Actuaries are professionals who employ actuarial science based on probability and statistics.  Mortality tables are statistically-based tables showing expected annual mortality rates to determine life expectancy estimates.

  In the past, the three main variables in a mortality table have been age, gender, and use of tobacco products in some way.  More recently in the US, preferred class specific tables were introduced.  The mortality tables provide a baseline for the cost of insurance.  Other life style habits are included when an individual applies for a life insurance policy, such as whether or not they exercise or keep their weight within recommended guidelines.  Mortality tables used in conjunction with health and family history determine premiums and insurability.

Premium Load

  A premium load is a monetary amount deducted from each life insurance premium payment, which reduces the amount credited to the policy.

No-load policies allow cash values to accumulate faster inside the policy because of their lower cost.  However, although its lower cost allows no-load life insurance to provide an affordable alternative to lower-income policyholders, carriers of no-load policies should be examined for financial stability.  No-load policies typically offer very little in the way of customer service since they have less money to contribute to wages and other costs of running their business.

  “No-load” or “low-load” life insurance policies have fewer expenses built into them, such as agent commissions and fees, than other life insurance policies.  This can mean low cost life insurance.  For variable life insurance, these lower expenses mean a higher percentage of the premium goes to work for the investor right away, allowing him or her to build cash values quicker.

  Not many companies sell no-load or low-load policies.  No-load policies can be purchased mainly through financial advisors who charge flat fees rather than collecting commissions from insurance companies.  Such policies may not be available in all states.

  When a person buys a life insurance policy, his or her premium and the cash value of the policy can be affected by a wide variety of fees and charges.  These are often referred to as the “load” with some policies considered “low-load” because the fees and commissions paid by the investor are relatively low.  Other life insurance policies might be considered “high load” because the commissions, administration fees and other charges are higher than other product types.

  Certainly agents must become familiar with policy charges and fees associated with the products they offer.  It is also important to know how and when these expenses are charged; some are deducted from the premium payment and others are deducted from the policy values.

  Insurance agents, brokers and other investment professionals earn their money three ways:

1. Commission: Money paid to the agent for selling you the policy, which is usually calculated as a percentage of the premium

2. Fee-based: When life insurance salespeople or brokers charge a flat fee for their services

3. Fee plus commission: Occurs when you pay a fee to meet with an investment professional and a commission if you purchase a product they've recommended

According to the Insurance Information Institute, most agents and brokers are paid by commission but some also work on a fee basis.  No matter how one is paid, however, it is their responsibility to know the products being recommended.

  The agent's commission is just the beginning of the fees and charges that go into a life insurance policy.  Here is a breakdown of some additional charges that may be in a policy:

• Administration fees: The amount deducted from the policy to pay for the marketing, accounting and record-keeping expenses associated with the policy. Administration fees usually are deducted from the policy value once each month.

• Mortality and expense risk charges: This compensates the insurance company for the risk it assumes.  For example, there is a risk that the insured individual might pass away sooner than the insurer anticipated.

• Cost of insurance: This actual cost of insurance protection is based on the insured person's age, gender, health and the amount of the death benefit.

• Surrender charges: The amount deducted from cash values if the insured cashes in or surrenders the policy early, while the surrender charge period is in effect. The amount varies among insurance companies, but in many cases the amount of the surrender charge drops annually until it disappears altogether

• Monthly per thousand charge: Although there may be variations, this monthly fee is based on the insured person's age, gender and underwriting classification.

• Fund management fees: These are paid to investment fund managers for selecting investments, and doing all the paperwork needed.  The fees are typically taken from the price paid for the shares of underlying fund options, not from the investor’s cash values.  Fee amounts vary by company.

  Some insurance companies prefer investors to pay their life insurance premiums annually (once per year) and give a discount for doing so.  If it is difficult for the policy owner to budget for one large payment and prefers paying monthly or quarterly, he or she may face what is known as a “fractional premium” or “convenience charge” added on to monthly, quarterly, or semi-annual payments.  The amount, like many fees, varies by company.

Bands in Life Insurance Policies

  There are premium bands or groupings that almost all life insurance companies use.  This creates pricing issues that agents may not be aware of.  Certainly consumers are unlikely to be aware of them.  These bands vary by the type of policy as well as company.  They are most prevalent in term insurance policies.

  Life insurance companies band premiums by policy size.  An example of banding would be:

• Band 1: $100,000-$249,99
• Band 2: $250,000-$499,999
• Band 3: $500,000-$999,999
• Band 4: $1 million and above

  The premium per $1,000 of coverage decreases as the amount of coverage purchased moves into the higher bands.  Consider it similar to buying in bulk at the local warehouse store.  The previous example is not necessary exact to any particular company.

Similar to Break Points

  Most people are more familiar with mutual funds than insurance premium methods.  Think of premium bands as break points.  With ‘load’ funds the consumer pays a sales charge - usually at purchase.  The most popular and widely used ‘load’ funds are called “A” shares.  These have the highest upfront load with the lowest annual expenses.  The typical upfront load for “A” shares is 5.75% of the purchase price.  As you buy or own larger quantities of “A” shares within a mutual fund family the investor receives a discount, or reduced load.

  Life insurance companies work much the same way.  As the buyer purchases larger amounts of insurance he or she qualifies for reduced rates.  However, life insurance is not as clear cut as mutual funds in that premiums within each band vary by gender (male/female/unisex), issue classification, issue age and policy year.

  How does this affect the insured?  If the insured is nearing a band then it will most likely be cheaper to purchase a larger amount of insurance.  From the example of bands above, it is probably cheaper to purchase $100,000 of coverage rather than $87,000 for example.  It is also probably cheaper to purchase $250,000 of coverage than $229,000.

Consumer Awareness

  It is important to understand the depth of understanding your insurance buyer has.  As we know, equity indexed products are complex but it applies to other areas as well.  Even calculating the amount of insurance an agent feels his client needs must be understood.  A confused person may not buy a product, or even if he buys it, may not keep it long term.

  When determining an amount of insurance, if a calculator is used be prepared to round up or down as needed and explain why this is significant to the insurance buyer.  If the number comes up as $962,000 for example, understanding banding will help the buyer decide the actual amount of insurance he or she may want to purchase, going up or down as needed.  When a company is being chosen, part of the decision might even involve how they band their life insurance and the costs in relation to the amount of insurance it purchases.  It is sometimes more important to understand where a company’s bands are than some other features.  In the case of our $962,000 example, if the company has a band at $1 million of coverage then it will most likely be cheaper to purchase $1 million of coverage than to buy less.

Policyholder Risks

  There is always risk in investments; always.  Sometimes the risk is on the issuing insurer; sometimes the risk is on the policholder.  Some are just higher than others; some are just easier to recognize than others, but there is always some amount of risk.

Interest Rate Risk

  Universal life (UL) is a complex policy with risk to the policyholder.  Its flexible premiums include a risk that the policyholder may need to pay a greater than planned premium in order to maintain the policy.  This can happen if the expected interest paid on the accumulated values is less than originally assumed at purchase.  This happened to many policyholders who purchased their policies in the mid 1980's when interest rates were very high. As the interest rates lowered, the policy did not earn as expected and the policyholder was forced to pay more to maintain the policy. If any form of loan is taken on the policy, this may cause the policyholder to pay a greater than expected premium, because the loaned values are no longer in the policy to earn for the policyholder. If the policyholder skips payments or makes late payments, it is possible that this will need to be made up for in later years by making larger than expected payments.  Market factors relating to the 2008 stock market crash adversely affected many policies by increasing premiums, decreasing benefit, or decreasing the term of coverage.general life insurance

No Lapse Guarantees or Death Benefit Guarantees Risk

  A well informed policyholder should understand that the flexibility of the policy is tied irrevocably to risk to the policyholder.  The more guarantees a policy has, the more expensive its cost.  With UL, many of the guarantees are tied to an expected premium stream.  If the premium is not paid on time, the guarantee may be lost and cannot be reinstated.  For example, some policies will offer a “no lapse” guarantee, which states that if a stated premium is paid in a timely manner, the coverage will remain in force, even if there is not sufficient cash value to cover the mortality expenses.  It is important to distinguish between this no lapse guarantee and the actual death benefit coverage.  The death benefit coverage is paid for by mortality charges (also called cost of insurance).  As long as these charges can be deducted from the cash value, the death benefit is active. The “no lapse” guarantee is a safety net that provides for coverage in the event that the cash value isn't large enough to cover the charges.  This guarantee will be lost if the policyholder does not make the premium as agreed, although the coverage itself may still be in force.  Some policies do not provide for the possibility of reinstating this guarantee.  Sometimes the cost associated with the guarantee will still be deducted even if the guarantee itself is lost (those fees are often built into the cost of insurance and the costs will not adjust when the guarantee is lost).  Some policies provide an option for reinstating the guarantee within certain time frames and/or with additional premiums (usually catching up the deficit of premiums and an associated interest).  No Lapse guarantees can also be lost when loans or withdrawals are taken against the cash values.

Transfer Provisions

1035 Exchanges

  A Section 1035 exchange permits a policyowner to transfer the cash value from one life insurance or annuity contract to another without income tax consequences, provided proper procedures are followed and the policyowner does not receive any money (property) in the exchange.  The goal is typically to move the funds without having them “touch” the contract owner.  In other words, one holding institution moves the funds to another without the physical involvement of the contract holder.

  Even if there is no gain in the policy to be exchanged, a 1035 exchange permits the adjusted cost basis of the old policy to be carried over to the new policy. To qualify, however, it is very important to remember that the insured and owner must be the same on both policies.

  Section 1035 IRS policy exchanges are used to exchange one life insurance contract for another life insurance contract or for an annuity contract if the insured no longer desires the death benefit element.  An annuity may also be moved to another annuity using the 1035 exchange.

   An exchange of an annuity for a life insurance policy is not a 1035 exchange and may result in income tax consequences.  The exchange of two single life policies for a single policy insuring two lives (survivorship policy) does not qualify as a non-taxable exchange.  However the IRS has permitted an exchange of a survivorship policy where the first insured has died for a single life policy insuring the life of the surviving insured.  

An endowment contract may be exchanged for an annuity contract in many cases.  Oddly, an endowment to endowment is not allowed by IRS 1035 rules.

Important 1035 Exchange Procedures

1. Non Citizen Rule: Theses rules do not apply to any exchange having the effect of transferring property to any non-United States person.

2. New Product Requirements: In order to accommodate the transfer of values, the life insurance product must be able to accept unscheduled deposits.

3. Loans: The product for an exchange of a policy "with no outstanding loan" would be best suited into a new Universal Life plan.  There may also be a carrier who will allow an individual to transfer a policy loan into their product, but this type of 1035 exchange may be questioned by the IRS.

4. Underwriting: Full evidence of insurability based on age and amount still applies in most exchange products now available.

5. Replacement Compliance: Full compliance with appropriate state replacement regulations always applies

6. Agent Procedures: In order to process an exchange, an FSI representative or associated representative will obtain:

1. The completed state-specific application with wording in the "Special Instructions" section to indicate “This is a 1035 exchange.”

2. Evidence of insurability based on the insured’s age and amount applied for.

3. The applicable new carrier 1035 Exchange Form should be signed (original signatures only) by the owners, collateral assignee, or whoever it involves.  This agreement contains a number of conditions and should be read carefully by the owners before signing.  It serves as a legal “assignment with limited power of attorney rights” for direct cash value transfer purposes.

4. If the owner is a corporation or other business entity, the full name of the entity must be provided followed by the signature and title of the authorized party.  If the owner is a trust, the full name of trust and trust date must be provided, followed by the signatures of the trustees.  A copy of the trust agreement may also be required.

5. The old policy or policies should be returned with the applicable Exchange Form.

6. All state-specific replacement paperwork is always required.

7. Money down on application depending on product and circumstances.  If so, a Conditional Insurance Receipt or Temporary Insurance Receipt (issued on a state specific basis) will be issued for any money taken with the application.  Money would not necessarily be required or necessary.

8. A copy of any sales proposal, study used to make a decision to re-issue any policy or terminate any policy as well as a copy of any sales illustration used to predict future values on new plans implemented is typically required.

  Upon receipt of the above requirements, the following will generally occur:

1. If the insurer approves the new policy for insurance in a standard or better rating class, or in a rated class that had previously been requested and accepted in writing, the company will automatically request a surrender of the old policy or policies.

2. If the new policy is approved with a rated premium, the insurer likely will await the confirmation of acceptance by the owner prior to beginning the surrender process.

3. The insurer will issue the new policy for delivery upon receipt of the 1035 proceeds.

4. If surrender cannot be affected, the old policy will be reassigned to the policy-owner and the insurer’s obligations under the exchange agreement will terminate.

5. If the policy-owner declines acceptance, or returns the new policy under the "Free Look" provision (state specific for time to return a policy purchased), the insurer will, in its discretion, either cooperate with the policy-owner in attempting to reinstate the policy with the prior insurer or deliver all payments made with respect to the new policy to the policy-owner.  Tax trouble can result in cases of cash values exceeding premiums paid and then changing their mind after the fact.

  Approximate processing time for exchanges is 30 days from receipt of paperwork in good order at the company that issued the contract to be exchanged.  Clearly, conservation will be attempted, so investors and agents should be prepared for a significant delay before the surrender proceeds are received and applied to the new policy.

  The new insurer will not pay premiums if any become due on the old policy.  If the insured wishes assurance that there is no break in coverage before issue of the new policy, he or she should be instructed to pay the premiums on the in-force policy, although it might be prudent to pay the minimum modal amount permitted.

  Some insurance carriers will not transfer the outstanding loan balance on life insurance products.  These insurers will surrender the loan first, with the balance of the funds transferred to the new policy.  This treatment may create an adverse tax consequence.  A pre-request to any carrier with a policy loan is a smart step prior to requesting a re-issue via 1035 provisions.

  While 1035 exchanges allow for tax-free treatment, some situations can result in immediate taxation.  For example, the receipt of any cash or “boot” not poured into the new contract will result in income tax to the extent of any gain in the contract.

  All involved parties would be wise to seek the independent advice of a competent tax advisor before proceeding with any 1035 life insurance exchange.  This is true even when the insurers involved are cooperating fully.

Withdrawal Tax Treatment

  Over the years, Congress has recognized the importance of life insurance by enacting legislation that gives it a number of favorable tax attributes.  These tax attributes and the important risk management features of life insurance make it an excellent financial planning tool.  Here is a short overview of the favorable tax aspects of life insurance.

Income Tax-Free Death Benefit

  As a general rule, when the insured dies and the beneficiary of the insurance policy receives the proceeds, the proceeds are not subject to income taxation.  In contrast, when the proceeds of a retirement plan are distributed to a beneficiary following the death of the retirement plan participant, the proceeds are almost always subject to income taxation at ordinary rates.

Income Tax-Free Internal Buildup

  With many types of permanent life insurance, such as whole life and universal life, there is a buildup of cash value over time inside the policy. All income and capital gains generated inside the life insurance policy are excluded from the policyowner’s income.  With investments in mutual funds, for example, the income generated inside the fund are currently taxable to the owner even if the owner does not make withdrawals from the fund. At the death of the insured, as discussed above, generally there also is no income tax assessed on the proceeds.

Withdrawals of Cash Value

  A portion of the cash value of certain types of permanent insurance can often be withdrawn by the owner while still keeping an insurance death benefit in place.  The amount that is protected depends on how long the policy has been in existence and certain other rules, such as how much premium has been paid and how much gain has accumulated inside the policy. When considering the withdrawal of the cash value of any insurance policy, the wise owner will consult his or her income tax advisor to make sure the income tax consequences are fully considered.

Estate Taxation

  Life insurance death benefits are subject to estate taxes if the insured’s estate is large enough.  However, planning techniques of various kinds can make a great difference.  It is relatively simple to structure the ownership of life insurance so that its death benefits will not be subject to estate taxation upon the insured’s death.  Knowledgeable advisors can provide advice as to how to properly plan life insurance so that it will not be subject to estate tax.

  Investing in life insurance has the ability to manage risk in many cases and financially protect those we love by providing a predetermined death benefit.  The death proceeds of most policies are income tax-free.  For more affluent clients with an estate tax concerns, ownership of life insurance can be structured to avoid estate taxes. Finally, through careful planning, the owner of permanent life insurance may access some or all of the cash value buildup for immediate needs without incurring income tax liability on the amounts withdrawn.  In all cases when dealing with life insurance, it is imperative that the insured/owner work with highly-trained and experienced financial professionals.

Annuities and Taxation

  Tax Deferred Annuities issued by life insurance companies have for years been a popular alternative for people who want growth and tax relief at the same time.  In the last 20 years, billions of dollars have been moved into annuities by savers seeking safety with predictability, competitive interest rates and favorable tax treatment.  Annuities are not perfect, but they do offer many features that investors want.

  One important feature of fixed rate annuities is the tax deferral.  By eliminating the current tax cost of accumulation, investors can build a much larger account value than with a typical interest bearing vehicle such as bank CDs.  When this feature is combined with a slightly higher interest rate than might be found in bank saving accounts, it is easy to see why tax-deferred annuities are so popular.

  Annuities allow the investor to safely accumulating money to be used at some future date to enhance income.  It must be understood, however, that when the investor begins to withdraw annuity money he or she must then pay taxes on the gains.  The manner in which the income is taken will determine the method used to calculate taxable income.  A simple partial withdrawal is usually the most desirable method, but it is treated as interest first, which often means the entire withdrawal will be taxable.  Only if the investor sets up a systematic annuity income payment will he or she get some tax relief by spreading out the taxable gain over the anticipated number of years that annuity payments will be made.  This does not reduce the amount that will ultimately be taxable, but it does spread it out making the burden easier to plan for.

The Unknown Tax Trap

  No investor wants an unpleasant surprise associated with his or her financial vehicles but if the investor is not fully educated in the taxable investment events, it can happen.  It is at the time of the total withdrawal of funds, which most often occurs upon the death of the annuitant or owner that, in this case, the surprise occurs.

  A deferred annuity is the only asset an investor can own that does not get a “step-up in basis” at the time of death.  It is quite common today to see real estate and stocks that have been owned for years and that have appreciated ten fold to a hundred fold be passed on to heirs upon the death of the owner with no income tax whatsoever.  An annuity does not enjoy this tax feature.  Specifically excluded from the step-up in basis rule, the entire gain in the annuity is subject to income tax when received by the beneficiary.

  Since a vast majority of the billions of dollars now residing in annuities is destined to be passed on to the children of the annuitants, the tax bills will come as a tremendous shock to many.  In fact, it is not uncommon to see proceeds from an annuity that has been accumulated and tax deferred in a relatively low tax bracket (15% or 20%), incur taxes of 33% or more when added to the existing income of the beneficiary.  This, of course, was not the intent of the contract owner who failed to realize annuities were not intended for beneficiaries; they were intended to produce income during the annuity owner’s life.  The majority of annuities are not annuitized, so the majority fails to do what they were created for: provide income.

Withdrawals

  Most Universal Life Policies come with an option to withdraw cash values rather than take a loan.  The withdrawals are subject to contingent deferred sales charges and may also have additional fees defined by the contract.  Withdrawals will permanently lower the death benefit of the contract at the time of the withdrawal.

  Withdrawals are taken out premiums first and gains second, so it is possible to take a tax free withdrawal from the values of the policy (this assumes the policy is not a MEC).  Withdrawals are considered a material change and cause the policy to be tested for MEC.  As a result of a withdrawal, the policy may become a MEC and could lose its tax advantages.

  Withdrawing values will effect the long term viability of the plan.  The cash values removed by loan are no longer earning the interest expected, so the cash values will not grow as expected.  To some extent this issue is mitigated by the corresponding lower death benefit.  An illustration showing the effect of a withdrawal is recommended in order to assess the outcome of this change.

Bucket Investing

  From 2007 to 2010 we witnessed significant and historic market fluctuations.  There is little doubt that many investors are re-thinking their portfolios and strategies, but not everyone is.

  Diversification, proper income planning, and using a “buckets of money” strategy can help ease people’s negative emotional reaction to their financial situation and volatility in the market.  Some refer to it as “bucket planning” because it is essentially educating investors on having at least four different buckets of money:

• One for immediate income and
• Three others that grow and provide income down the road.

  At least one of the buckets should be guaranteed income the client cannot outlive.  Ideally it would also pass any remaining money on to children, grandchildren or charities.  As it relates to annuities, the lifetime income option will provide income that cannot be outlived but it will NOT pass anything on to beneficiaries.

  Despite market declines when investments are properly diversified, there will be some measure of market protection; although no investment is completely guaranteed since inflation can erode even a good investment.  A good bucket strategy can be the difference between a significant decline and increase in an investor’s portfolio.

  When multiple annuities are used in diversification, it is often called laddering.  Laddering is the technique used in investments where the investors purchase multiple financial products at a time that have separate maturity dates.  Since they mature at different times, the investors have continual income, often without utilizing lifetime income options.  Because lifetime income payout options are not used, beneficiaries will receive any left over funds.

“Laddering” or “Buckets of Income”

  There will always be different views on investing.  The “bucket” strategy was developed in many cases by examining a variety of fixed indexed annuities and comparing the results to the S&P 500.  Other investments must also be considered for appropriate diversification.  Many fixed indexed annuities perform quite well.  In fact, they tend to do as well or better than the other alternatives often considered for investing, but often without the level of risk.  Many industry professionals feel this has been backed up by a recent Wharton School of Business study titled: “Un-Supermodels and the FIA - Guaranteed Living Income Benefit Insurance Products,” by Dr. David F. Babbel.

  There are multiple bucket strategies and every investor or financial planner will probably have his or her favorites.  It is important to differentiate one strategy from another.

  One might be referred to as is the “buckets of income” strategy.  This strategy involves using four different fixed or fixed indexed annuities, all with unique terms and benefits. This means the investor is unlikely lose money, is always gaining money, and will always have guaranteed income.  The mainstream media has caught wind of this strategy so readers may be able to read additionally on the subject.  For example, Kiplinger’s Personal Finance magazine ran an article on bucket strategies in its Nov. 2009 issue.  As a result, many people are curious to see what utilizing this type of strategy could mean for them.

  One way to understand this approach is to think of a well for obtaining water.  It is a well that is always providing water, and, if set up properly, the water automatically flows right to the investor and never runs dry.  The buckets represent stages in the investor’s life, with a bucket of money for each stage.  If appropriately funded, the water never runs out.

  The main goal is to provide the investor with an annual stream of income for 15 years.  At the end of that 15-year period, the final bucket still contains an income account with a value equal to or greater than the total amount the investor began with.  The final bucket is always built with a guaranteed income withdrawal benefit option to carry the investor the rest of the way. This will help investors enjoy a predictable and guaranteed yearly income.

  It is important to utilize annuities from highly rated and quality insurance companies, (which may not be the ones that pay the highest commissions).  A wise agent or financial planner will always put the client first and their commissions second.  Think of the peace of mind investors will enjoy by not having to worry about their retirement income vanishing into thin air because of market shrinkage and the peace of mind agents will have knowing the likelihood of a lawsuit will be low when proper investment tools have been put in place.

  Some people like the water wheel analogy. The first bucket in the wheel is pouring out water (income).  There are more buckets right behind the first one and they are continuing to fill up, preparing to pour water (income) once the first bucket empties.  This example shows there is constant motion and consistent and predictable cash flow as one bucket empties and another full bucket follows behind it.

  As we know, some investors have a greater risk tolerance than others and are willing to take more of a gamble than others.  For those willing to dabble in risk, it is often recommended that they create four or five buckets, with a couple of the later buckets reserved for accounts with some risk attached.  When risk vehicles are utilized it is best not to depend on the income they hold, at least no totally.  There should be other funds to back the “risk buckets” up in case they do poorly, perhaps even losing principal.

  Because each client is different, agents must problem-solve in order to help their clients build, preserve, and transfer their wealth in the way desired, with the goal of having the money they need, when they need it.  Multiple types of investment vehicles will likely be used, including IRAs of various types (especially Roth IRAs), annuities, probably some life insurance to protect those who need financial protection, employer-sponsored plans if they exist, plus any other type of vehicle that is appropriate.

Strategy Development

Strategies for Buying Equity Indexed Universal Life Insurance

  With equity indexed universal life insurance, a clear strategy, or policy objective, should always be identified before making any purchase.  Premiums for all universal policies are flexible, so the policyholder’s objective has a significant impact on how the policy is funded.  There are a number of different strategies for buying an indexed universal life policy including paying the minimum premium, paying the no-lapse premium to guarantee the policy for the insured’s lifetime, or paying the maximum premium also known as over-funding.  The strategy selected will be determined by the investor’s personal goals and objectives, but the strategy most effective for equity-indexed universal life insurance is the retirement income strategy or over-funding strategy.

Over-funding an Equity Indexed Life Policy

  To “over-fund” an indexed universal life insurance policy means to maximize the policy’s cash value growth potential and minimize its net insurance costs over time.  When the maximum premium is paid into the policy, cash values grow faster so it leverages the net amount of life insurance at risk.  The net amount of life insurance at risk is the difference between the actual face amounts of the policy less the current cash value. With all universal life policies, insurance costs are calculated based on the amount of life insurance at risk at any given point in time.  As the net amount of insurance at risk decreases, the costs of insurance decrease and a higher portion of the premium payment can be directed to the indexed account.  By over-funding the policy, cash values can leverage the cost of insurance thereby maximizing the cash value growth potential.

The Internal Revenue Code and Over-funding Life Insurance

  To better grasp the powerful concept of “over-funding” a life insurance policy, one must clearly understand the IRS regulations that must be met to avoid unnecessary taxation.  Some of the legislation affecting the strategy of over-funding indexed universal life includes Internal Revenue Code Section 7702A, the Deficit Reduction Act of 1984 (DEFRA), and the Technical and Miscellaneous Revenue Act of 1988 (TAMRA).

  Internal Revenue Code Section 7702A describes the seven-pay test requiring that cumulative life insurance premiums over any seven year period cannot exceed the seven-pay premium limitation.  The seven-pay premium limitation is the maximum cumulative gross premium payment over any seven year policy period.  Seven-pay premiums are calculated based on the specific insurance company’s cost structure and the insured’s age, health class, sex and benefit amounts.  If the policy is over-funded up to or within the seven-pay premium requirements, then it will meet the Internal Revenue Code and policy cash surrender values may be accessed at any time tax-free.  If premiums exceed the seven-pay test maximum, the life insurance policy becomes a modified endowment contract (MEC) and may incur taxes on distributions of cash values.

The Technical and Miscellaneous Revenue Act of 1988 (TAMRA)

  The Technical and Miscellaneous Revenue Act of 1988 (TAMRA) first defined a modified endowment contract (MEC) as a life insurance policy that fails to meet the premium limitations established under the seven-pay test.  Once a policy is classified as a MEC, any policy cash value distribution above the policy’s premium basis will trigger a taxable event which includes a 10% penalty tax on any gain received prior to the policy holder’s age 59½.  The policy’s premium basis is usually the sum of all premium payments less any dividends received.  Policy distributions are any surrenders, withdrawals or policy loans.  The intention of over-funding any universal life policy is to access cash values at some point in the future, so a MEC should be avoided at all costs with this strategy.

The Deficit Reduction Act of 1984 (DEFRA)

  The Deficit Reduction Act of 1984, DEFRA, sets the minimum policy death benefit based on the sum of the premiums paid and the age and gender of the insured.  Sometimes referred to as “the cash value corridor test” or “guideline premium test” this requirement in effect limits the amount of premium payments for a given minimum face amount of insurance.  Complying with DEFRA limitations is required for a policy to maintain its status as life insurance.  If over-funding an indexed universal life policy is a strategy being considering, DEFRA will in effect establish the minimum death benefit based on any maximum premium payment.

How to Over-fund Equity Indexed Universal Life Insurance

  Over-funding is a life insurance cash accumulation strategy that leverages the maximum allowable policy premiums with the smallest life insurance death benefit to achieve highest return on premium payments net of policy costs over a given time period.  There are essentially three steps to determining the combination of maximum premiums and minimum death benefits necessary to selecting the most leveraged indexed universal life policy:

1. The first step is to determine the maximum premium commitment over the given time horizon.  The premium amount selected should be an amount the buyer can consistently and easily make without interruption.  Universal life insurance polices offer the capability for flexible premium payments, but to get the maximum leverage the buyer must stick to his or her premium commitment for a given face amount of insurance.

2. Secondly, the buyer must determine the minimum insurance face amount for the DEFRA commitment and age and gender.  The insurance company’s sales illustration will provide the actual premium amount limits that meet the DEFRA minimum requirements.

3. Finally, determine the maximum premiums allowable under Internal Revenue Code 7702A and the TAMRA seven-pay premium limitation. As long as the total premiums or any seven year period are equal or less than the maximum allowable premium for the seven-pay test, cash surrender values may be accessed ay any time tax-free.

  Once each of the IRS regulations above are met, the maximum premium allowable for the minimum death benefit is defined and the equity indexed universal life policy can be constructed with the optimum policy premium for the over-funding strategy.  By choosing the over-funding approach, a policy holder can take complete advantage of all tax advantages of the life insurance policy and with reasonable index interest credits accumulate a significant cash value that may be access in retirement tax-free.

  Like annuities, equity indexed universal life insurance policies should be considered a long term strategy.  Because of the insurance costs and expenses associated with buying equity indexed universal life policies and the likely fluctuations in indexed interest credits, the time horizon for growing and accessing cash values should be at least ten years or longer. It will take some time for the leveraging effect to reduce the costs of insurance and thereby increase the net rate of return on policy premiums.  Keep in mind, policy costs are a necessary evil to maximize tax advantages and the bottom line is return over time on the premium payments.

Monthly Life Insurance Deductions

  All monthly policy deductions are first deducted from the basic interest strategy.  If sufficient values are not maintained in the basic interest strategy, deductions are next taken from the five year fixed term strategy.  Deductions are made starting with the most recently established segment to the oldest segment, then from the five-year equity indexed strategy segments in order of the most recent to the oldest.  If sufficient plan values are still not available and any minimum premium requirements have not been met, the plan will lapse.

  There are fees and charges for life insurance contracts.  Before buying a life insurance policy consumers should understand these, and certainly agents should understand them. Insurance companies deduct some industry standard fees from premiums and cash values. Charges vary by product so al the charges and fees we have listed do not necessarily apply to all products.

Some common life insurance fees include:

1. Premium loads/sales charges: these compensate the insurance company for sales expenses, state and local taxes. These charges are deducted from your premium payment before it is applied to the policy.

2. Administration fees: these are used to pay the costs of maintaining the policy, including accounting and record keeping. Administration fees usually are deducted from your policy value once a month.

3. Mortality and expense risk charges: when a policy is issued, the insurance company assumes the insured person will live to a certain age based on their current age, gender and health conditions. This charge compensates the insurance company in the case the insured person doesn’t live to the assumed age. It is generally charged once a month.

4. Cost of insurance: this is the cost of actually having insurance protection. It is based on the insured person’s age, gender, health and death benefit amount. Cost of insurance is also usually charged once a month

5. Surrender charges: this charge is deducted from your cash value if you surrender (terminate) your policy during your surrender charge period. Be sure to check the length of your surrender charge period when evaluating a policy to buy.

6. Monthly per thousand charge: this charge is based on the insured person’s age, gender, and underwriting classification, and is assessed monthly.

7. Fund management fees: these charges compensate the fund managers for their work. Fund management fees are usually deducted from the price paid for the shares of underlying fund options, and not directly from your cash value.

  Since not all fees are assigned to all policy types each contract should be individually considered.  Any type of indexed product will have fees specific to those types of contracts, but all life insurance products will have some basic similarities, such as mortality tables and rates.

Liquidity and Transfer Provisions

  Annuities, as we know, are intended to be long-term investments.  As such, they are not suitable for continuous cash needs.  Annuities are not considered to be “liquid” vehicles but rather long-term “accumulation” accounts.  Of course, any funds withdrawn will face taxation in the year they are withdrawn, unless it is a tax qualified vehicle.

  It must also be noted that any time funds are taken from an annuity, especially in an indexed product, the death benefit will be reduced by the amount withdrawn, as well as the interest growth it would have realized.  Some indexed products do not apply earnings until the end of the term and then they are applied on current values held in the annuity.  Having said that, it is possible to access to some degree the cash values in the annuity.

Access to Cash Values through Policy Surrenders

  Although it is seldom recommended, investors and contract holders may access their life policy’s cash value of their policy by surrendering either all or part of the policy.  The contract owner may surrender his or her policy for the total surrender value at any time after the policy has been issued.  The surrender is a taxable event.  As a general rule, the policy owner is responsible for paying ordinary income taxes on the difference between the surrender value and the premiums paid.  If the policy is classified as a MEC, any surrenders prior to age 59½ will also be subject to a 10% penalty.  A partial surrender will reduce the Accumulation Value by the amount of the surrender and will reduce the total death benefit and the guaranteed death benefit proportionately.

Withdrawals: Impact on Death Benefits

  Annuities typically allow withdrawals, such as 10 percent of account values per year, without surrender fees or penalties being levied.

  Both annuities and life insurance (except for term policies) have cash values.  A cash withdrawal from a life insurance policy reduces the death benefit by the amount of the withdrawal plus interest earned.  When a cash withdrawal is made from an employee benefit, such as a pension plan, the employee usually forfeits all benefits purchased on the employee's behalf by the employer.

  Some types of cash value life insurance policies  may not allow withdraws from the values.  If the policy does allow such withdrawals, any withdrawal made will typically be tax free up to the basis in the policy.  The basis is the amount of premiums paid into the policy, minus any prior dividends paid or previous withdrawals.  The owner already paid income tax on those dollars once, so they won't be taxed again when withdrawn from the policy.

  The policy's cash value consists of the basis in the policy, plus any earnings.  Because the earnings grow tax deferred while inside the policy, they will be subject to income tax when withdrawn.  If multiple withdrawals are made over and above the policy’s basis in the policy, a portion of the withdrawal will be considered taxable income.  Withdrawals are generally treated as coming out of the policy basis first.

  Consider a life insurance policy with a cash value of $18,000.  The basis in the policy in this example is $12,000.  If the owner makes a withdrawal of $12,000 or less, there will be no income tax consequences.  However, if he or she withdraws $15,000 from the policy, income tax on $3,000 will be due (at ordinary income rates, not at capital gains rates).

  Surrender charges may also apply when a withdrawal is made from a policy, even if the owner withdraws only the basis.  One way to avoid this and still access policy money is to take a policy loan from the insurance company, using the cash value in the policy as collateral.

Obtaining Cash Through Policy Loans

  Policies can vary on how they handle loans; it will also be determined by the type of annuity or life insurance product.  Generally contract owners may take a policy loan of up to 75% of the surrender value in the first three years or 90% of the surrender value thereafter.  Policy loans are charged interest at an annual rate of 6%.  An amount equal to the amount borrowed is maintained separately from the contract’s invested cash values and continues to earn 4% interest, resulting in a net cost to the owner of only 2%.  For tax purposes, loans are considered distributions from the policy and are subject to ordinary income tax.  If the loan is made prior to age 59½, a 10% penalty may also apply.  A policy loan may cause additional taxation if it causes the policy to lapse.  This could occur if market conditions caused the cash value of the policy to fall below the outstanding loan amount.  An outstanding policy loan will be subtracted from the total death benefit in the event of the death of the insured and will be subtracted from the total surrender value in the event the policy is surrendered.

  To avoid surrender charges, the policy owner can take a policy loan rather than simply withdrawing cash from the policy.  The amount borrowed is generally not treated as taxable income as long as the loan is repaid.  There are no surrender charges because the owner is not actually withdrawing any money; he is borrowing from the insurer using the policy as collateral.  The owner will have to pay interest on the loan, which is not tax deductible.

  For the most part, the owner of a life insurance policy can borrow some or all of the cash value in the policy at no or very little interest.  The amount borrowed is not subject to income taxation, except for certain types of policies.  The ability to borrow the cash value tax-free can be an important element of financial, estate, and risk planning.  As in any transaction involving life insurance, the owner should always work closely with his or her Financial Consultant and other advisors to understand the impact of borrowing the cash value.  The borrowing can affect the amount of proceeds that are received on the death of the insured, as well as premiums.

  The common belief is that an insurance policy can only be used to shield the policy holder against losses upon its maturity.  However, policy holders can benefit from their insurance policies even before they reach their maturity stage.

  People opt for policy loans because of the relatively low interest as compared to other loans.  Some people borrow on their policies with lower interest rates and then repay other loans that are high interest-bearing with the funds.  Some individuals borrow on their policies so they will get more dividends when the time for dividend distribution comes and they have paid up their loans.  It is always easier to borrow under a policy loan because of the hundred percent approval-rating provided the amount loaned is not greater than the total cash value of the life insurance or the premiums paid.  Taking an insurance policy loan is usually the fastest way to get a loan and there are no restrictions as to how the funds are spent.

  In most cases, taking a policy loan is better than terminating the insurance policy to obtain existing cash values.  Besides maintaining the policy, terminating the policy might cause a taxable event.

  While policy loans may have some advantages, there are also disadvantages for the policy holder.  If he or she does not know the basic rules on policy loans it can result in a greater financial problem.  Policy loans are just like regular loans in the sense that the borrower has to repay the funds at a specified period.  If the contract owner does not repay the policy loans with the total cash value it will result in a lower or even zero cash value in the long run.  When this happens, the insurance company can terminate the insurance contract and the owner will be forced to either pay the policy loans or surrender the policy.  The latter choice will result in more financial problems since it requires the contract owner to pay charges as well as taxes.

  Some people who can no longer pay their premiums resort to taking a policy loan and allowing their insurance policies to be terminated.  This is not necessarily the best choice.  Taking a policy loan is advisable only when absolutely necessary and should not be done without good reason.  Cash values should not be used for vacations, luxuries or any purpose that is not an emergency.

  Borrowing on an insurance policy should not be done capriciously because it can endanger coverage potentially leaving dependents vulnerable if the insured dies prematurely.  When taking a policy loan, the policyowner must make sure he or she can repay it.  Otherwise there is the risk of having cash values depleted, the insurance policy terminated, or the family’s lifeline reduced or even removed when needed due to the insured’s death.

Life Insurance Riders

  Life insurance tackles numerous needs at different stages in one’s life.  With increased income and a much higher standard of living, it becomes crucial to maintain the most suitable insurance protection for the insured and his or her family.  Individuals should avoid purchasing excessive insurance however.  To cut premium costs, some professionals advise the purchase of a rider if the rates are economical.  Riders provide several kinds of insurance protection and they are not necessarily right for everyone.  Of course, the applicant must meet the rider's underwriting conditions.

What is an Insurance Rider?

  Riders are additional benefits purchased from the issuing insurer and added to a basic insurance policy.  These options allow the insured to increase their insurance coverage or limit the coverage set down by the policy.  Riders can be blended, for an additional cost, according to the owner’s present and future insurance needs.  However, buying a rider means paying an extra premium for this supplementary benefit.  Generally, this premium is low because relatively little underwriting is required but it may also not fully cover the risk it is intended for.  This might especially be true for such things as long-term care medical needs.

  When a claim for the rider’s benefits is made, it can result in the termination of the rider, while the original policy continues to insure as usual.  The insurance coverage available, premium rates, terms and conditions of riders is likely to differ from one insurer to another.  Those who selling products and those interested in buying them are wise to do some comparison shopping.

Here are the most common life insurance riders and what agents need to know about them.

Guaranteed Insurability Rider (Renewal Provision)

  This rider allows the insured to purchase additional insurance coverage along with his or her base policy in the stated period without the need for further medical examination. This rider is most beneficial when there has been a significant change in the insured’s life, such as the birth of a child, marriage, divorce or an increase in income.  This rider can be a big advantage if the insured’s health declines with increasing age; the insured will be able to apply for extra coverage without giving any evidence of insurability.  Sometimes this rider may also provide a renewal of the base policy at the end of its term without medical checkups.  This rider may end at a specified age.

Spouse Insurance Rider

  As the name suggests, this rider offers term insurance (no cash values) for the insured’s spouse for an additional premium. 

Accidental Death or Double Indemnity Rider

  This rider pays out an additional amount of death benefit if the insured dies as a result of an accident.  Normally, the additional benefit paid out upon death due to accident is equivalent to the face amount of the original policy, so it doubles the benefit.  The insured's family ends up getting twice the amount of the policy.  That's why this rider is called a double indemnity rider.  There are typically restrictions on this rider, however, since many insurance companies limit the meaning of the term “accident.”  For those who are the sole income provider for the family, this rider is ideal because the double benefit is typically inexpensive to buy and can potentially double the death benefits if death is due to an accident.

Waiver of Premium Rider

  The waiver of premium rider is used in many types of insurance contracts.  In life insurance policies future premiums are waived if the insured becomes permanently disabled or loses his or her income as a result of injury or illness prior to a specified age.  Disability of the main income-earner can have the most crippling effect on a family.  In these circumstances, this rider exempts the insured from paying premiums due on the base policy until he or she is ready to work again.  This rider can be valuable, particularly when premiums on the policy are high.  Without this rider, the insured is at risk of lapsing their life insurance policy because of the inability to continue paying premiums. Again, the definition of the term “totally disabled” is vital.  It may vary from one insurer to another, so agents need to be aware of the terms and conditions of this rider.

Family Income Benefit Rider

  In case the insured dies, this rider will provide a steady flow of income to family members. When buying this rider, you need to determine the number of years your family is going to receive this income benefit. The merit of having this rider is obvious: In case of death, the surviving family will face fewer financial difficulties thanks to the regular monthly income from the rider.

Accelerated Death Benefit Rider

  An insured person can use the death benefits under this rider if he or she is diagnosed with a terminal illness that will considerably shorten the insured's lifespan.  While it varies, often insurers advance 25-40% of the death benefit of the base policy to the insured.  Insurance companies may subtract the amount received, plus interest, from the death benefits.  This may eventually reduce the death benefit under the policy.  Most often, a small amount of premium or, in some cases, no premium is charged for this rider. Different insurers come out with different versions of the definition of “terminal illnesses” unless the term is dictated by the state where the policy is issued.  Agents are wise to check what the rider has to offer before recommending it to their clients.

Child Term Rider

  This rider provides a death benefit in case a child dies before a specified age.  After the child attains maturity, the term plan can be converted into permanent insurance with coverage multiplying up to five times the original face amount without the need for medical exams.

Long-Term Care Rider

  In the event that the insured's bad health compels him or her to stay at a nursing home or receive home care, this rider offers monthly payments.  Although long-term care insurance can be bought individually, insurance companies also offer riders that take care of some long term care costs.  In this instance, the problem may be one of offering false security.  Seldom would the LTC riders be sufficient to cover a long-term illness that often lasts two to three years (that’s why it is called “long term”).  Most health insurance professionals recommend that individuals purchase a separate policy to cover these costs.

Return of Premium Rider

  The primary goal of this rider is to give back most of the premiums paid into the policy.  Under this rider, the insured has to pay a marginal premium and at the end of the term, the premiums are returned back in full.  In the event of death, beneficiaries will receive the paid premium amount.  Insurers sell this rider with many variations so verify the phrasing of the rider to minimize misunderstandings with clients.

Other Riders

  Besides those we have mentioned, there are many other riders on the market.  Agents can analyze policyholder circumstances to help them chose appropriate riders for their circumstances.

Does your Policy Owner Understand the Purchase?

  There is no way to know the number of policies that are purchased by people who have no idea what they actually bought.  Sometimes the selling agent has no idea the buyer does not understand the product; other times the agent knew but didn’t care.  An agent who does not understand indexed products should never sell them and a buyer who does not understand indexed products should never buy one.

Life Insurance Illustrations Model Regulations

  The purpose of the Life Insurance Illustrations Model Regulations is to provide rules for life insurance policy illustrations that will protect consumers and promote consumer education.  It provides illustration formats, prescribes standards to be followed when illustrations are used, and specifies the disclosures that are required I connection with illustrations.  The goal is to use materials that are understandable by the normal person without a background in insurance products.

  This regulation applies to variable life insurance, individual and group annuity contracts, credit life insurance and life insurance policies with no illustrated death benefits on any individual exceeding $10,000.

LIFE INSURANCE ILLUSTRATIONS MODEL REGULATION

Section 1: Purpose

  The purpose of this regulation is to provide rules for life insurance policy illustrations that will protect consumers and foster consumer education.  The regulation provides illustration formats, prescribes standards to be followed when illustrations are used, and specifies the disclosures that are required in connection with illustrations.  The goals are illustrations that do not mislead purchasers of life insurance and make illustrations more understandable.  Insurers will, as far as possible, eliminate the use of footnotes and caveats and define terms used in the illustration in language that would be understood by a typical person within the segment of the public to which the illustration is directed.

Section 2: Authority

  This regulation is issued based upon the authority granted the commissioner under state laws corresponding to Section 4 of the NAIC Unfair Trade Practices Act.

Section 3: Applicability and Scope

  This regulation applies to all group and individual life insurance policies and certificates except:

1. Variable life insurance;
2. Individual and group annuity contracts;
3. Credit life insurance; or
4. Life insurance policies with no illustrated death benefits on any individual exceeding $10,000.

Section 4: Definitions

  For the purposes of this regulation:

“Actuarial Standards Board” means the board established by the American Academy of Actuaries to develop and promulgate standards of actuarial practice.

“Contract premium” means the gross premium that is required to be paid under a fixed premium policy, including the premium for a rider for which benefits are shown in the illustration.

“Currently payable scale” means a scale of non-guaranteed elements in effect for a policy form as of the preparation date of the illustration or declared to become effective within the next ninety-five (95) days.

“Disciplined current scale” means a scale of non-guaranteed elements constituting a limit on illustrations currently being illustrated by an insurer that is reasonably based on actual recent historical experience, as certified annually by an illustration actuary designated by the insurer. Further guidance in determining the disciplined current scale as contained in standards established by the Actuarial Standards Board may be relied upon if the standards:

1. Are consistent with all provisions of this regulation;

2. Limit a disciplined current scale to reflect only actions that have already been taken or events that have already occurred;

3. Do not permit a disciplined current scale to include any projected trends of improvements in experience or any assumed improvements in experience beyond the illustration date; and

4. Do not permit assumed expenses to be less than minimum assumed expenses.

“Generic name” means a short title descriptive of the policy being illustrated such as “whole life,” “term life” or “flexible premium adjustable life.”

“Guaranteed elements” and “Non-guaranteed elements”

“Guaranteed elements” means the premiums, benefits, values, credits or charges under a policy of life insurance that are guaranteed and determined at issue.

“Non-guaranteed elements” means the premiums, benefits, values, credits or charges under a policy of life insurance that are not guaranteed or not determined at issue.

“Illustrated scale” means a scale of non-guaranteed elements currently being illustrated that is not more favorable to the policy owner than the lesser of:

1. The disciplined current scale; or
2. The currently payable scale.

“Illustration” means a presentation or depiction that includes non-guaranteed elements of a policy of life insurance over a period of years and that is one of the three (3) types defined below:

1. “Basic illustration” means a ledger or proposal used in the sale of a life insurance policy that shows both guaranteed and non-guaranteed elements.

2. “Supplemental illustration” means an illustration furnished in addition to a basic illustration that meets the applicable requirements of this regulation, and that may be presented in a format differing from the basic illustration, but may only depict a scale of non-guaranteed elements that is permitted in a basic illustration.

3. “In force illustration” means an illustration furnished at any time after the policy that it depicts has been in force for one year or more.

“Illustration actuary” means an actuary meeting the requirements of Section 11 who certifies to illustrations based on the standard of practice promulgated by the Actuarial Standards Board.

“Lapse-supported illustration” means an illustration of a policy form failing the test of self-supporting as defined in this regulation, under a modified persistency rate assumption using persistency rates underlying the disciplined current scale for the first five years and 100 percent policy persistency thereafter.

“Minimum assumed expenses” means the minimum expenses that may be used in the calculation of the disciplined current scale for a policy form.  The insurer may choose to designate each year the method of determining assumed expenses for all policy forms from the following:

1. Fully allocated expenses;
2. Marginal expenses; and
3. A generally recognized expense table based on fully allocated expenses representing a significant portion of insurance companies and approved by the National Association of Insurance Commissioners or by the commissioner.

  Marginal expenses may be used only if greater than a generally recognized expense table. If no generally recognized expense table is approved, fully allocated expenses must be used.

“Non-term group life” means a group policy or individual policies of life insurance issued to members of an employer group or other permitted group where:

1. Every plan of coverage was selected by the employer or other group representative;
2. Some portion of the premium is paid by the group or through payroll deduction; and
3. Group underwriting or simplified underwriting is used.

“Policy owner” means the owner named in the policy or the certificate holder in the case of a group policy.

“Premium outlay” means the amount of premium assumed to be paid by the policy owner or other premium payer out-of-pocket.

“Self-supporting illustration” means an illustration of a policy form for which it can be demonstrated that, when using experience assumptions underlying the disciplined current scale, for all illustrated points in time on or after the fifteenth policy anniversary or the twentieth policy anniversary for second-or-later-to-die policies (or upon policy expiration if sooner), the accumulated value of all policy cash flows equals or exceeds the total policy owner value available. For this purpose, policy owner value will include cash surrender values and any other illustrated benefit amounts available at the policy owner’s election.

Section 5: Policies to Be Illustrated

  Each insurer marketing policies to which this regulation is applicable shall notify the commissioner whether a policy form is to be marketed with or without an illustration. For all policy forms being actively marketed on the effective date of this regulation, the insurer shall identify in writing those forms and whether or not an illustration will be used with them. For policy forms filed after the effective date of this regulation, the identification shall be made at the time of filing. Any previous identification may be changed by notice to the commissioner.

  If the insurer identifies a policy form as one to be marketed without an illustration, any use of an illustration for any policy using that form prior to the first policy anniversary is prohibited.

  If a policy form is identified by the insurer as one to be marketed with an illustration, a basic illustration prepared and delivered in accordance with this regulation is required, except that a basic illustration need not be provided to individual members of a group or to individuals insured under multiple lives coverage issued to a single applicant unless the coverage is marketed to these individuals. The illustration furnished an applicant for a group life insurance policy or policies issued to a single applicant on multiple lives may be either an individual or composite illustration representative of the coverage on the lives of members of the group or the multiple lives covered.

  Potential enrollees of non-term group life subject to this regulation shall be furnished a quotation with the enrollment materials. The quotation shall show potential policy values for sample ages and policy years on a guaranteed and non-guaranteed basis appropriate to the group and the coverage. This quotation shall not be considered an illustration for purposes of this regulation, but all information provided shall be consistent with the illustrated scale. A basic illustration shall be provided at delivery of the certificate to enrollees for non-term group life who enroll for more than the minimum premium necessary to provide pure death benefit protection. In addition, the insurer shall make a basic illustration available to any non-term group life enrollee who requests it.

Section 6: General Rules and Prohibitions

  An illustration used in the sale of a life insurance policy shall satisfy the applicable requirements of this regulation, be clearly labeled “life insurance illustration” and contain the following basic information:

1. Name of insurer;

2. Name and business address of producer or insurer’s authorized representative, if any;

3. Name, age and sex of proposed insured, except where a composite illustration is permitted under this regulation;

4. Underwriting or rating classification upon which the illustration is based;

5. Generic name of policy, the company product name, if different, and form number;

6. Initial death benefit; and

7. Dividend option election or application of non-guaranteed elements, if applicable.

  When using an illustration in the sale of a life insurance policy, an insurer or its producers or other authorized representatives shall not:

1. Represent the policy as anything other than a life insurance policy;

2. Use or describe non-guaranteed elements in a manner that is misleading or has the capacity or tendency to mislead;

3. State or imply that the payment or amount of non-guaranteed elements is guaranteed;

4. Use an illustration that does not comply with the requirements of this regulation;

5. Use an illustration that at any policy duration depicts policy performance more favorable to the policy owner than that produced by the illustrated scale of the insurer whose policy is being illustrated;

6. Provide an applicant with an incomplete illustration;

7. Represent in any way that premium payments will not be required for each year of the policy in order to maintain the illustrated death benefits, unless that is the fact;

8. Use the term “vanish” or “vanishing premium,” or a similar term that implies the policy becomes paid up, to describe a plan for using non-guaranteed elements to pay a portion of future premiums;

9. Except for policies that can never develop nonforfeiture values, use an illustration that is “lapse-supported”; or

10. Use an illustration that is not “self-supporting.”

  If an interest rate used to determine the illustrated non-guaranteed elements is shown, it shall not be greater than the earned interest rate underlying the disciplined current scale.

Section 7: Standards for Basic Illustrations

Format:

  A basic illustration must conform to the following requirements:

1. The illustration shall be labeled with the date on which it was prepared.

2. Each page, including any explanatory notes or pages, shall be numbered and show its relationship to the total number of pages in the illustration (e.g., the fourth page of a seven-page illustration shall be labeled “page 4 of 7 pages”).

3. The assumed dates of payment receipt and benefit pay-out within a policy year shall be clearly identified.

4. If the age of the proposed insured is shown as a component of the tabular detail, it shall be issue age plus the numbers of years the policy is assumed to have been in force.

5. The assumed payments on which the illustrated benefits and values are based shall be identified as premium outlay or contract premium, as applicable. For policies that do not require a specific contract premium, the illustrated payments shall be identified as premium outlay.

6. Guaranteed death benefits and values available upon surrender, if any, for the illustrated premium outlay or contract premium shall be shown and clearly labeled guaranteed.

7. If the illustration shows any non-guaranteed elements, they cannot be based on a scale more favorable to the policy owner than the insurer’s illustrated scale at any duration. These elements shall be clearly labeled non-guaranteed.

8. The guaranteed elements, if any, shall be shown before corresponding non-guaranteed elements and shall be specifically referred to on any page of an illustration that shows or describes only the non-guaranteed elements (e.g., “see page one for guaranteed elements.”)

9. The account or accumulation value of a policy, if shown, shall be identified by the name this value is given in the policy being illustrated and shown in close proximity to the corresponding value available upon surrender.

10. The value available upon surrender shall be identified by the name this value is given in the policy being illustrated and shall be the amount available to the policy owner in a lump sum after deduction of surrender charges, policy loans and policy loan interest, as applicable.

11. Illustrations may show policy benefits and values in graphic or chart form in addition to the tabular form.

12. Any illustration of non-guaranteed elements shall be accompanied by a statement indicating that:

1. The benefits and values are not guaranteed;

2. The assumptions on which they are based are subject to change by the insurer; and

3. Actual results may be more or less favorable.

  If the illustration shows that the premium payer may have the option to allow policy charges to be paid using non-guaranteed values, the illustration must clearly disclose that a charge continues to be required and that, depending on actual results, the premium payer may need to continue or resume premium outlays. Similar disclosure shall be made for premium outlay of lesser amounts or shorter durations than the contract premium. If a contract premium is due, the premium outlay display shall not be left blank or show zero unless accompanied by an asterisk or similar mark to draw attention to the fact that the policy is not paid up.

  If the applicant plans to use dividends or policy values, guaranteed or non-guaranteed, to pay all or a portion of the contract premium or policy charges, or for any other purpose, the illustration may reflect those plans and the impact on future policy benefits and values.

Narrative Summary:

  A basic illustration must include the following:

1. A brief description of the policy being illustrated, including a statement that it is a life insurance policy;

2. A brief description of the premium outlay or contract premium, as applicable, for the policy. For a policy that does not require payment of a specific contract premium, the illustration shall show the premium outlay that must be paid to guarantee coverage for the term of the contract, subject to maximum premiums allowable to qualify as a life insurance policy under the applicable provisions of the Internal Revenue Code;

3. A brief description of any policy features, riders or options, guaranteed or non-guaranteed, shown in the basic illustration and the impact they may have on the benefits and values of the policy;

4. Identification and a brief definition of column headings and key terms used in the illustration; and

5. A statement containing in substance the following: “This illustration assumes that the currently illustrated non-guaranteed elements will continue unchanged for all years shown. This is not likely to occur, and actual results may be more or less favorable than those shown.”

Numeric Summary:

  Following the narrative summary, a basic illustration shall include a numeric summary of the death benefits and values and the premium outlay and contract premium, as applicable. For a policy that provides for a contract premium, the guaranteed death benefits and values shall be based on the contract premium. This summary shall be shown for at least policy years five (5), ten (10) and twenty (20) and at age 70, if applicable, on the three bases shown below. For multiple life policies the summary shall show policy years five (5), ten (10), twenty (20) and thirty (30).

1. Policy guarantees;

2. Insurer’s illustrated scale;

3. Insurer’s illustrated scale used but with the non-guaranteed elements reduced as follows:

1. Dividends at fifty percent (50%) of the dividends contained in the illustrated scale used;

2. Non-guaranteed credited interest at rates that are the average of the guaranteed rates and the rates contained in the illustrated scale used; and

3. All non-guaranteed charges, including but not limited to, term insurance charges, mortality and expense charges, at rates that are the average of the guaranteed rates and the rates contained in the illustrated scale used.

  In addition, if coverage would cease prior to policy maturity or age 100, the year in which coverage ceases shall be identified for each of the three (3) bases.

Statements

  Statements substantially similar to the following shall be included on the same page as the numeric summary and signed by the applicant, or the policy owner in the case of an illustration provided at time of delivery, as required in this regulation.  A statement to be signed and dated by the applicant or policy owner reading as follows: “I have received a copy of this illustration and understand that any non-guaranteed elements illustrated are subject to change and could be either higher or lower. The agent has told me they are not guaranteed.”

  A statement to be signed and dated by the insurance producer or other authorized representative of the insurer reading as follows: “I certify that this illustration has been presented to the applicant and that I have explained that any non-guaranteed elements illustrated are subject to change. I have made no statements that are inconsistent with the illustration.”

Tabular Detail

  A basic illustration shall include the following for at least each policy year from one (1) to ten (10) and for every fifth policy year thereafter ending at age 100, policy maturity or final expiration; and except for term insurance beyond the 20th year, for any year in which the premium outlay and contract premium, if applicable, is to change:

1. The premium outlay and mode the applicant plans to pay and the contract premium, as applicable;
2. The corresponding guaranteed death benefit, as provided in the policy; and
3. The corresponding guaranteed value available upon surrender, as provided in the policy.

  For a policy that provides for a contract premium, the guaranteed death benefit and value available upon surrender shall correspond to the contract premium.  Non-guaranteed elements may be shown if described in the contract.  In the case of an illustration for a policy on which the insurer intends to credit terminal dividends, they may be shown if the insurer’s current practice is to pay terminal dividends. If any non-guaranteed elements are shown they must be shown at the same durations as the corresponding guaranteed elements, if any. If no guaranteed benefit or value is available at any duration for which a non-guaranteed benefit or value is shown, a zero shall be displayed in the guaranteed column.

Section 8: Standards for Supplemental Illustrations

  A supplemental illustration may be provided so long as:

1. It is appended to, accompanied by or preceded by a basic illustration that complies with this regulation;

2. The non-guaranteed elements shown are not more favorable to the policy owner than the corresponding elements based on the scale used in the basic illustration;

3. It contains the same statement required of a basic illustration that non-guaranteed elements are not guaranteed; and

4. For a policy that has a contract premium, the contract premium underlying the supplemental illustration is equal to the contract premium shown in the basic illustration. For policies that do not require a contract premium, the premium outlay underlying the supplemental illustration shall be equal to the premium outlay shown in the basic illustration.

  The supplemental illustration shall include a notice referring to the basic illustration for guaranteed elements and other important information.

Section 9: Delivery of Illustration and Record Retention

  If a basic illustration is used by an insurance producer or other authorized representative of the insurer in the sale of a life insurance policy and the policy is applied for as illustrated, a copy of that illustration, signed in accordance with this regulation, shall be submitted to the insurer at the time of policy application. A copy also shall be provided to the applicant.

  If the policy is issued other than as applied for, a revised basic illustration conforming to the policy as issued shall be sent with the policy.  The revised illustration shall conform to the requirements of this regulation, shall be labeled “Revised Illustration” and shall be signed and dated by the applicant or policy owner and producer or other authorized representative of the insurer no later than the time the policy is delivered. A copy shall be provided to the insurer and the policy owner.

  If no illustration is used by an insurance producer or other authorized representative in the sale of a life insurance policy or if the policy is applied for other than as illustrated, the producer or representative shall certify to that effect in writing on a form provided by the insurer. On the same form the applicant shall acknowledge that no illustration conforming to the policy applied for was provided and shall further acknowledge an understanding that an illustration conforming to the policy as issued will be provided no later than at the time of policy delivery. This form shall be submitted to the insurer at the time of policy application.

  If the policy is issued, a basic illustration conforming to the policy as issued shall be sent with the policy and signed no later than the time the policy is delivered. A copy shall be provided to the insurer and the policy owner.  If the basic illustration or revised illustration is sent to the applicant or policy owner by mail from the insurer, it shall include instructions for the applicant or policy owner to sign the duplicate copy of the numeric summary page of the illustration for the policy issued and return the signed copy to the insurer. The insurer’s obligation under this subsection shall be satisfied if it can demonstrate that it has made a diligent effort to secure a signed copy of the numeric summary page.  The requirement to make a diligent effort shall be deemed satisfied if the insurer includes in the mailing a self-addressed postage prepaid envelope with instructions for the return of the signed numeric summary page.

  A copy of the basic illustration and a revised basic illustration, if any, signed as applicable, along with any certification that either no illustration was used or that the policy was applied for other than as illustrated, shall be retained by the insurer until three (3) years after the policy is no longer in force. A copy need not be retained if no policy is issued.

Section 10: Annual Report; Notice to Policy Owners

  In the case of a policy designated as one for which illustrations will be used, the insurer shall provide each policy owner with an annual report on the status of the policy that shall contain at least the following information:

  For universal life policies, the report shall include the following:

1. The beginning and end date of the current report period;

2. The policy value at the end of the previous report period and at the end of the current report period;

3. The total amounts that have been credited or debited to the policy value during the current report period, identifying each by type (e.g., interest, mortality, expense and riders);

4. The current death benefit at the end of the current report period on each life covered by the policy;

5. The net cash surrender value of the policy as of the end of the current report period;

6. The amount of outstanding loans, if any, as of the end of the current report period; and for fixed premium policies.

  For fixed premium policies:

  If, assuming guaranteed interest, mortality and expense loads and continued scheduled premium payments, the policy’s net cash surrender value is such that it would not maintain insurance in force until the end of the next reporting period, a notice to this effect shall be included in the report; or

  For flexible premium policies:

  If, assuming guaranteed interest, mortality and expense loads, and the policy’s net cash surrender value will not maintain insurance in force until the end of the next reporting period unless further premium payments are made, a notice to this effect shall be included in the report.

  For all other policies, where applicable:

1. Current death benefit;
2. Annual contract premium;
3. Current cash surrender value;
4. Current dividend;
5. Application of current dividend; and
6. Amount of outstanding loan.

  Insurers writing life insurance policies that do not build nonforfeiture values shall only be required to provide an annual report with respect to these policies for those years when a change has been made to non-guaranteed policy elements by the insurer.

  If the annual report does not include an in force illustration, it must contain the following notice displayed prominently:

“IMPORTANT POLICY OWNER NOTICE: You should consider requesting more detailed information about your policy to understand how it may perform in the future. You should not consider replacement of your policy or make changes in your coverage without requesting a current illustration. You may annually request, without charge, such an illustration by calling [insurer’s phone number], writing to [insurer’s name] at [insurer’s address] or contacting your agent. If you do not receive a current illustration of your policy within 30 days from your request, you should contact your state insurance department.”

  The insurer may vary the sequential order of the methods for obtaining an in force illustration.

  Upon the request of the policy owner, the insurer shall furnish an in force illustration of current and future benefits and values based on the insurer’s present illustrated scale. This illustration shall comply with the requirements of Section 6A, 6B, 7A and 7E. No signature or other acknowledgment of receipt of this illustration shall be required.

  If an adverse change in non-guaranteed elements that could affect the policy has been made by the insurer since the last annual report, the annual report shall contain a notice of that fact and the nature of the change prominently displayed.

Section 11: Annual Certifications

  The board of directors of each insurer shall appoint one or more illustration actuaries.  The illustration actuary shall certify that the disciplined current scale used in illustrations is in conformity with the Actuarial Standard of Practice for Compliance with the NAIC Model Regulation on Life Insurance Illustrations promulgated by the Actuarial Standards Board, and that the illustrated scales used in insurer-authorized illustrations meet the requirements of this regulation.

  The illustration actuary must be a member in good standing of the American Academy of Actuaries; be familiar with the standard of practice regarding life insurance policy illustrations and not have been found by the commissioner, following appropriate notice and hearing to have:

1. Violated any provision of, or any obligation imposed by, the insurance law or other law in the course of his or her dealings as an illustration actuary;

2. Been found guilty of fraudulent or dishonest practices;

3. Demonstrated his or her incompetence, lack of cooperation or untrustworthiness to act as an illustration actuary; or

4. Resigned or been removed as an illustration actuary within the past five years as a result of acts or omissions indicated in any adverse report on examination or as a result of a failure to adhere to generally  acceptable actuarial standards;

  Additionally the illustration actuary must not ail to notify the commissioner of any action taken by a commissioner of another state similar to that under Paragraph (3) above; disclose in the annual certification whether, since the last certification, a currently payable scale applicable for business issued within the previous five (5) years and within the scope of the certification has been reduced for reasons other than changes in the experience factors underlying the disciplined current scale. If non-guaranteed elements illustrated for new policies are not consistent with those illustrated for similar in force policies, this must be disclosed in the annual certification. If non-guaranteed elements illustrated for both new and in force policies are not consistent with the non-guaranteed elements actually being paid, charged or credited to the same or similar forms, this must be disclosed in the annual certification; and disclose in the annual certification the method used to allocate overhead expenses for all illustrations:

1. Fully allocated expenses;

2. Marginal expenses; or

3. A generally recognized expense table based on fully allocated expenses representing a significant portion of insurance companies and approved by the National Association of Insurance Commissioners or by the commissioner.

  The illustration actuary shall file a certification with the board and with the commissioner annually for all policy forms for which illustrations are used; and before a new policy form is illustrated.

  If an error in a previous certification is discovered, the illustration actuary shall notify the board of directors of the insurer and the commissioner promptly.

  If an illustration actuary is unable to certify the scale for any policy form illustration the insurer intends to use, the actuary shall notify the board of directors of the insurer and the commissioner promptly of his or her inability to certify.

  A responsible officer of the insurer, other than the illustration actuary, shall certify annually that the illustration formats meet the requirements of this regulation and that the scales used in insurer-authorized illustrations are those scales certified by the illustration actuary; and that the company has provided its agents with information about the expense allocation method used by the company in its illustrations and disclosed as required.

  The annual certifications shall be provided to the commissioner each year by a date determined by the insurer.  If an insurer changes the illustration actuary responsible for all or a portion of the company’s policy forms, the insurer shall notify the commissioner of that fact promptly and disclose the reason for the change.

Section 12: Penalties

  In addition to any other penalties provided by the laws of this state, an insurer or producer that violates a requirement of this regulation shall be guilty of a violation of the state’s unfair trade practices act.

Section 13: Separability

  If any provision of this regulation or its application to any person or circumstance is for any reason held to be invalid by any court of law, the remainder of the regulation and its application to other persons or circumstances shall not be affected.

Section 14: Effective Date

This regulation shall become effective [January 1, 1997 or effective date set in regulation, whichever is later] and shall apply to policies sold on or after the effective date.

Legislative History (all references are to the Proceedings of the NAIC).

1995 Proc. 4th Quarter 11, 19, 779, 781-789 (adopted).

Illustrated Rates for Indexed Crediting Strategies

  Many professionals feel indexed universal life insurance is the near-perfect life insurance product.  It is permanent, it can never lose value as a result of market declines, and it has the potential to earn greater interest than traditional UL products.  However, some sometimes some alarming “illustrated rates” are given to potential buyers that are less than accurate or probable.  No one has a crystal ball but professional agents do know what the future could bring and what illustrations are logical versus fantasy.

  Traditional universal life (UL) is a type of fixed life insurance that is regulated by state insurance divisions.  It credits a minimum guaranteed interest rate, as well as a stated fixed interest rate on an annual basis.  It is generally known for its high guarantees, and steady, lower credited rates.

  Indexed universal life (IUL) is also a type of fixed life insurance and is also regulated by the insurance divisions.  It credits a minimum guarantee usually less than annually, although there is an annual 0% floor on all IUL plans.  The credited interest rate on IUL is based on the performance of an outside index, such as the Standard and Poor’s 500 (S&P 500).  Potential index interest is limited through the use of participation rates or caps, as we previously discussed in this text.

  IUL offers lower guarantees, but has the ability to earn interest that is higher than that found in traditional UL (although it may be on an inconsistent basis).

  Variable universal life (VUL) is a type of securities product that is regulated by the Securities and Exchange Commission.  VUL typically has no minimum guarantee, except on any fixed bucket strategies.  The credited interest rate on a VUL is based on the performance of stocks, bonds, or mutual funds that the consumer selects.  Consumers cannot lose any of the money they have in a fixed UL or IUL as a result of market performance, but they could lose funds in a VUL as a result of market performance.

The Illustration Problem

  The problems with Indexed Universal Life (IUL) typically come down to one single issue: illustrated rates.

  What is an illustrated rate?  An illustration is a projection of future policy values; it attempts to answer the question consumers often ask: “what will my policy cash values and death benefit be when I retire?”  The National Association of Insurance Commissioners mandates that all permanent life insurance policies must have an illustration that is signed by the purchaser at point-of-sale.

  The “illustrated rate” on the illustration is the interest rate at which the policy values are projected.  For traditional universal life (UL), the illustrated rate is the current credited interest rate on the policy.  This rate represents what the insurance company is currently crediting on the UL for new business.  In-force ULs may receive higher or lower renewal rates.  Most ULs are illustrated at a rate that is constant throughout the policy.

  For variable universal life (VUL) policies, the illustrated rate is a hypothetical gross rate.  This rate is supposed to be a reasonable expectation of what the VUL may be credited as a result of market, fund, or bond performance (based on the policyholder’s premium allocation).  VULs may receive a higher or lower rate in future policy years, but most VULs are illustrated at a consistent rate throughout the policy.

  For IULs, the illustrated rate is a hypothetical rate selected by the insurance company.  This rate is supposed to be a reasonable expectation of what the IUL may be credited as a result of the outside index’s performance.  Although IUL illustrations may assume a varying rate in the early years, this rate usually levels out to a constant illustrated rate in later policy durations.  IULs are priced to return about 1% to 2% greater interest potential than traditional fixed UL.

  The concept of illustrated rates is important because interest-sensitive life insurance products, such as UL, IUL, and VUL, can have dramatically different policy performance compared to what is illustrated at point-of-sale.  Changing renewal rates, premium payments, policy loans and withdrawals all have an effect on future policy values.  Consumers may not realize how dramatically their future policy values can change from what was illustrated to them at policy purchase.

  While most VUL policies are compared on specific rates, the fixed and indexed UL markets have become a numbers game of figures that are not always realistic or even possible in some cases.  The fixed and indexed products are nearly impossible to compare on an apples-to-apples basis, making judgment of the insurance charges nearly unattainable for purchaser and agent.

  The IUL market in particular has become a “race” to illustrate the highest policy values, with some agents (and even companies) illustrating impossibly high rates.  Some insurance agents are looking for products that can illustrate the highest cash values and death benefits, while losing sight of the fact that actual policy results may be different than illustrated.  In fact, from the day any interest-sensitive policy is sold, what is illustrated will never become reality.  The likelihood that interest rates, premium payments, and loan rates will never vary is simply not logical.

  It is unfortunately that misleading life insurance illustrations are back and buyers are again being subjected to policy performance promises that are quite unlikely to be realized.  During the late 1980s and 1990s many companies used illustration gimmicks to make their policies appear to have fewer premiums or create higher values than their current pricing could provide.  Among the common techniques used: bonus interest in 5 or 10 years, lapse-supported pricing, and return of mortality costs after 10 or 20 years. Companies that don’t use such tricks produce far superior values for their policies.

  The illustration wars of the 1980s and 1990s were such a problem that the life insurance industry finally moved to curtail such abuses by promulgating model regulations for life insurance illustrations in 2001. Under the regulations, interest rates embedded in the illustrations are not supposed to be “…greater than the earned interest rate underlying the disciplined current scale.”  The disciplined current scale requires insurers to use non-guaranteed elements that are “reasonably based on actual recent historical experience.”

  We are seeing some of the old tactics coming back for index universal life.  The sellers of index universal life claim they are able to provide such high returns by using various hedging techniques to cover the larger returns.  There is some concern regarding whether or not the illustrations meet required regulations in some cases.

Annual Statements

  The insurer must annually provide a report to senior management, including to the senior manager responsible for audit functions, which details a review, with appropriate testing, reasonably designed to determine the effectiveness of the supervision system, the exceptions found, and corrective action taken or recommended, if any.

  The period or “term” of the interest credit establishes the point at which interest will be credited to the contract.  Generally this happens each year, but not in all products so it is important to be informed on the specific product purchased.  Some products have multi-year terms for interest crediting ranging from two years to the end of the surrender period.  These products have no provision for any interim interest credit.

  The interest “compounds” since earnings are based on account values, not just on principal.  Since earning may be added at the end of the year versus throughout the year, the annual statement typically arrives just following the interest crediting.

  Agents are wise to keep in touch with their clients and an excellent way to do this is by scheduling an annual visit.  If the visit immediately follows receipt of the annual statement the policyholder has the opportunity to ask questions arising from the yearly statement and the agent has the opportunity to determine if the product still meets the buyer’s needs.

Full Content Disclosure

  The topic of insurance is complicated but it is important that agents fully understand it to prevent serious errors; one or two small terms found in a footnote can drastically change the coverage.  Agents are considered contract specialists; consumers are not.

The Doctrine of Utmost Good Faith

  The doctrine of utmost good faith is a key principle in insurance contracts.  This doctrine emphasizes the presence of mutual faith between the insured and the insurer.  The doctrine includes:

Duty of disclosure: Applicants for insurance are legally obliged to reveal all information that would influence the insurer's decision to cover the risk and enter into the insurance contract.

  Some factors increase insurer risk.  These would include, but are not necessarily limited to, previous losses and claims under other policies, insurance coverage that has been declined in the past, the existence of other insurance contracts, full facts and descriptions regarding the property or the event to be insured.  These facts are called material facts.

  Depending on these material facts, the insurer will decide whether to insure the applicant and what premium to charge.  For instance, in critical illness insurance, smoking habits are an important consideration or material fact for the insurer.  Therefore, the insurer may decide to charge a significantly higher premium if the applicant uses tobacco products in any form.

Representations and Warranty: In most kinds of insurances, the applicant must sign a declaration at the end of the application form stating that the given answers to the questions in the application form and other personal statements and questionnaires are true and complete.  Therefore, when applying for any type of insurance the applicant should make sure the information he or she provided was correctly recorded if the agent fills out the application.  Even if the applicant physically records the answers he or she should review them for accuracy.

Depending on their nature, these statements may either be representations or warranties.

Representations

  Representations are the written statements made by the applicant on their application form, which represent the proposed risk to the insurance company.  For example, on a life insurance application form, information about age, details of family history, occupation, and so forth are representations and should be true in every respect.

  Breach of representations occurs only when the applicant gives false information (age for example) in important statements.  If breach of representation occurs the contract may or may not be voided depending on the type of the misrepresentation

Warranty

  Warranties in insurance contracts are different from those of ordinary commercial contracts.  They are imposed by the insurer to ensure that the risk remains the same throughout the policy and does not increase.  For example, in auto insurance, if the applicant lends his or her car to a friend who doesn't hold a license and that friend is involved in an accident, the insurer may consider it a breach of warranty because the insurer was not informed about this alteration.  As a result, the claim could be rejected.

Breach of Utmost Good Faith

  Insurance, as we said, works on the principle of mutual trust.  It is the responsibility of all parties to disclose all relevant facts to your insurer.  This responsibility rests not only on the applicant, but also on the agent.

  Normally, a breach of the principle of utmost good faith arises when the applicant, whether deliberately or accidentally, fails to disclose important facts.  There are two kinds of non-disclosure:

• An innocent non-disclosure relates to failing to supply the information the applicant or agent did not know about.
• Deliberate non-disclosure means someone purposely and intentionally disclosed or stated incorrect material information.

  For example, suppose the applicant is unaware that his grandfather died from cancer and, therefore, did not disclose this material fact in the family history questionnaire when applying for life insurance.  This would be an innocent non-disclosure.  On the other hand, if he knew about this material fact and purposely held it back from the insurer, then he is guilty of fraudulent non-disclosure.

Action Taken by Insurer Against a Breach

  When an applicant supplies inaccurate information with the intention to deceive the insurance contract typically becomes void.

• If this deliberate breach is discovered at the time of a claim, the insurance company will probably not pay the claim.

• If the insurer considers the breach as innocent but significant to the risk, it may choose to collect additional premiums to cover their actual risk.

• In case of an innocent breach that is irrelevant to the risk, the insurer may decide to ignore the breach as if it had never occurred.

  A breach is never worth a denied claim so it is in the best interests of everyone, certainly the agent, to disclose all information.

Principle of Waiver and Estoppel

  A waiver is voluntary surrender of a known right.  Estoppel prevents a person from asserting those rights because he or she has acted in such a way as to deny interest in preserving those rights.

  For example, suppose an applicant fails to disclose some fact or information in the insurance proposal form.  The insurer does not request that information and issues the insurance policy.  This is waiver.  In the future, when a claim arises, the insurer cannot question the contract on the basis of non-disclosure because they did not request the information.  This is estoppel.  For this reason, the insurer will have to pay the claim.

  Insurance companies try very hard to request all necessary information but if they fail to do so the applicant cannot be punished for their error.

Endorsements

  Endorsements are normally used when the terms of insurance contracts are to be altered. They could also be issued to add specific conditions to the policy.

Deductible

  A deductible is the amount the insured pays in out-of-pocket expenses before the insurer covers the remaining expense.  Therefore, if the deductible is $5,000 and the total insured loss comes to $15,000, the insurance company will only pay $10,000; the higher the deductible, the lower the premium and vice versa.  This would apply to some types of riders such as long-term care nursing home riders that often have deductibles.

Coinsurance

  Health care riders, such as long-term care riders, may have coinsurance provisions.  Coinsurance, in this case, exists between the insured and the issuing insurance company. Although it might vary, typically the insurer pays 80% of the covered loss while the insured covers the remaining 20%.

Is the Product Suitable?

  Many states have mandated suitability standards for indexed life insurance and annuities because there have been errors made in the past.  Most agents intend to do a good job for their clients but unfortunately some agents did not understand whether or not the annuity was suitable for their client’s financial situation.  By mandating suitability standards (and in some cases special suitability education) the state insurance departments hope to avoid errors that may cause financial harm to its citizens.  Suitability standards provide guidelines for agents who may not otherwise understand how to determine product suitability.

  Insurance product suitability may be a matter of opinion, in the absence of state mandated criteria.  Advocates of equity indexed annuities may feel that there are no bad EIAs while critics may feel there are no good EIAs.  Aside from extreme opinions, while there are no “good” or “bad” products there are certainly situations that are suitable and unsuitable, based on a particular person’s circumstances.  The goal of the agent is to determine if his or her particular client’s situation would benefit from an equity indexed annuity.  If it would not, then the product may not be suitable.

  There are several elements that determine whether or not a product is suitable, including the individual’s risk tolerance, financial needs, cash reserves, and personal or financial goals.  In some cases, it is obvious that the equity indexed annuity is not suitable.  As we know (or should know by now), there is no product that is always right for every investor.  It is misleading to compare one annuity product to another if the features each offers widely vary.  We often hear this stated as “comparing apples to oranges.”  Each is a fruit, but the differences are so great that they cannot be adequately compared.  The same is true for some types of annuities.

  Iowa has specific suitability requirements:

  The purpose of the IA suitability rules is to establish an insurer system to supervise recommendations and set standards and procedures for recommendations to consumers that.  The goal is to have recommendations that are appropriate for the consumer’s needs and financial objectives at the time of the transaction.  This applied to all annuities not specifically exempted that were issued on or after January 1, 2007.

  The updated rules below apply to any consumer recommendations to purchase, exchange, or replace an annuity on or after January 1, 2011, by an insurance producer, or by an insurer where no producer is involved, that results in an annuity purchase, exchange, or replacement.

15.69(2) Unless otherwise specifically included, this rule would not apply to recommendation transactions involving direct-response solicitations where there is no recommendation based on information collected from the consumer pursuant to these rules.  It would also not apply when no change occurs in the current annuities held.

ITEM 3. Amend rule 191—15.70(507B), definitions of “Annuity” and “Recommendation,” as follows:

“Annuity” means a fixed or variable annuity that is an insurance product under state law, individually solicited, whether the product is classified as an individual or group annuity.

“Recommendation” means advice provided by an insurance producer (or an insurer where no producer is involved) to an individual consumer that results in a purchase, exchange or replacement of an annuity in accordance with that advice.

ITEM 4. Adopt the following new definitions in rule 191—15.70(507B):

“Continuing education credit” or “CE credit” means one credit as defined in rule 191—11.2(505,522B).

“Continuing education provider” or “CE provider” means a CE provider as defined in rule 191—11.2(505,522B).

“FINRA” means the Financial Industry Regulatory Authority or a succeeding agency.

“Replacement” means a transaction in which a new policy or contract is to be purchased, and it is known or should be known to the proposing producer, or to the proposing insurer if there is no producer, that, by reason of the transaction, an existing policy or contract has been or is to be:

1. Lapsed, forfeited, surrendered or partially surrendered, assigned to the replacing insurer or otherwise terminated;

2. Converted to reduced paid-up insurance, continued as extended term insurance, or otherwise reduced in value by the use of nonforfeiture benefits or other policy values;

3. Amended so as to effect either a reduction in benefits or in the term for which coverage would otherwise remain in force or for which benefits would be paid;

4. Reissued with any reduction in cash value; or

5. Used in a financed purchase.

“Suitability information” means information that is reasonably appropriate to determine the suitability of a recommendation, including the following:

1. Age;
2. Annual income;
3. Financial situation and needs, including the financial resources used for the funding of the annuity;
4. Financial experience;
5. Financial objectives;
6. Intended use of the annuity;
7. Financial time horizon;
8. Existing assets, including investment and life insurance holdings;
9. Liquidity needs;
10. Liquid net worth;
11. Risk tolerance; and
12. Tax status.

ITEM 5. Amend sub-rules 15.71(1) and 15.71(2) as follows:

  In recommending the purchase or exchange of an annuity to a consumer that results in another insurance transaction or series of insurance transactions, the insurance producer (or the insurer where no producer is involved) must have reasonable grounds for believing that the recommendation is suitable for the consumer on the basis of the facts disclosed by the consumer as to the consumer’s investments and other insurance products and as to the consumer’s financial situation and needs, including the consumer’s suitability information, and that there is a reasonable basis to believe all of the following:

1. The consumer has been reasonably informed of various features of the recommended annuity, such as the potential surrender period and surrender charge; potential tax penalty if the consumer sells, exchanges, surrenders or annuitizes the annuity; mortality and expense fees; investment advisory fees; potential charges for and features of riders; limitations on interest returns; insurance and investment components; and market risk;

2. The consumer would benefit from certain features of the annuity, such as tax-deferred growth, annuitization, death benefit, or living benefit;

3. The particular annuity as a whole, the underlying sub-accounts to which funds are allocated at the time of purchase or exchange of the annuity, and riders and similar product enhancements, if any, are suitable (and in the case of an exchange or replacement, the transaction as a whole is suitable) for the particular consumer based on the consumer’s suitability information; and

4. In the case of an exchange or replacement of an annuity, the exchange or replacement is suitable, including taking into consideration whether:

1. The consumer will incur a surrender charge, be subject to the commencement of a new surrender period, lose existing benefits (such as death benefit, living benefit, or other contractual benefits), or be subject to increased fees, investment advisory fees or charges for riders and similar product enhancements;

2. The consumer would benefit from product enhancements and improvements; and

3. The consumer has had another annuity exchange or replacement and, in particular, an exchange or replacement within the preceding 36 months.

  Prior to the execution of a purchase, or exchange or replacement of an annuity resulting from a recommendation, an insurance producer, or an insurer where no producer is involved, must make reasonable efforts to obtain the consumer’s suitability information concerning:

1. The consumer’s financial status;
2. The consumer’s tax status;
3. The consumer’s investment objectives; and
4. Such other information used or considered to be reasonable by the insurance producer, or the insurer where no producer is involved, in making recommendations to the consumer.

ITEM 6. Rescinded sub-rules 15.71(3) to 15.71(5).

ITEM 7. Adopt the following new sub-rules 15.71(3) to 15.71(8):

  Except as permitted under sub-rule 15.71(4), an insurer shall not issue an annuity recommended to a consumer unless there is a reasonable basis to believe the annuity is suitable based on the consumer’s suitability information.

Exceptions.

1. a. Except as provided neither an insurance producer nor an insurer has any obligation to a consumer under sub-rule 15.71(1) or 15.71(3) related to any annuity transaction if:

1. No recommendation is made;
2. A recommendation was made and was later found to have been prepared based on inaccurate material information provided by the consumer;
3. A consumer refuses to providerelevant suitability information and the annuity transaction is not recommended; or
4. A consumer decides to enter into an annuity transaction that is not based on a recommendation of the insurer or the insurance producer.

2. An insurer’s issuance of an annuity must be reasonable under all the circumstances actually known to the insurer at the time the annuity is issued.

  An insurance producer or, where no insurance producer is involved, the responsible insurer representative, shall at the time of sale:

1. Make a record of any recommendation;

2. Obtain a customer-signed statement documenting a customer’s refusal to provide suitability information, if any; and

3. Obtain a customer-signed statement acknowledging that an annuity transaction is not recommended if a customer decides to enter into an annuity transaction that is not based on the insurance producer’s or insurer’s recommendation.

Insurers’ duties to supervise

  An insurer must establish a supervision system that is reasonably designed to achieve the insurer’s and its insurance producers’ compliance with all rules including, but not limited to, the following:

1. The insurer must maintain reasonable procedures to inform its insurance producers of the requirements of these rules and must incorporate the requirements of these rules into relevant insurance producer training manuals;

2. The insurer must establish standards for insurance producer product training and must maintain reasonable procedures to require its insurance producers to comply with the requirements;

3. The insurer will provide product-specific training and training materials explaining all material features of its annuity products to its insurance producers;

4. The insurer must maintain procedures for review of each recommendation prior to issuance of an annuity that are designed to ensure that there is a reasonable basis to believe a recommendation is suitable.  Such review procedures may apply a screening system for the purpose of identifying selected transactions for additional review and may be accomplished electronically or through other means including, but not limited to, physical review.  The electronic or other system may be designed to require additional review only of those transactions identified for additional review by the selection criteria;

5. The insurer must maintain reasonable procedures to detect recommendations that are not suitable. These procedures may include, but are not limited to, confirmation of consumer suitability information, systematic customer surveys, interviews, confirmation letters and programs of internal monitoring.  Nothing prevents an insurer from complying by applying sampling procedures or by confirming suitability information after issuance or delivery of the annuity; and

6. The insurer must annually provide a report to senior management, including to the senior manager responsible for audit functions that details a review, with appropriate testing, reasonably designed to determine the effectiveness of the supervision system, the exceptions found, and corrective action taken or recommended, if any.

Third-party supervisor.

  Nothing in this sub-rule restricts an insurer from contracting for performance of a function (including maintenance of procedures) required.  An insurer is responsible for taking appropriate corrective action and may be subject to sanctions and penalties regardless of whether the insurer contracts for performance of a function and regardless of the insurer’s compliance.

  An insurer’s supervision system must include supervision of contractual performance including, but not limited to, the following:

1. Monitoring and, as appropriate, conducting audits to assure that the contracted function is properly performed; and

2. Annually obtaining a certification from a senior manager who has responsibility for the contracted function that the manager has a reasonable basis to represent, and does represent, that the function is properly performed.

  An insurer is not required to include in its supervisory system the insurance producer’s recommendations to consumers of products other than the annuities offered by the insurer.

  An insurance producer may not dissuade, or attempt to dissuade, a consumer from:

1. Truthfully responding to an insurer’s request for confirmation of suitability information;
2. Filing a complaint; or
3. Cooperating with the investigation of a complaint.

Compliance with FINRA.

  Sales made in compliance with FINRA requirements pertaining to suitability and supervision of annuity transactions must satisfy the requirements under these rules.  This sub-rule applies to FINRA member broker-dealer sales of variable annuities and fixed annuities if the suitability and supervision IAB 5/19/10 NOTICES 2567 are similar to those applied to variable annuity sales. However, nothing in this sub-rule limits the insurance commissioner’s ability to enforce (including investigate) the provisions of this regulation.

  As it relates to the previous paragraph an insurer shall:

1. Monitor the FINRA member broker-dealer using information collected in the normal course of an insurer’s business; and

2. Provide to the FINRA member broker-dealer information and reports that are reasonably appropriate to assist the FINRA member broker-dealer to maintain its supervision system.

ITEM 8. Renumber rules 191—15.72(507B) and 191—15.73(507B) as 191—15.73(507B) and

191—15.74(507B).

ITEM 9. Adopt the following new agent training requirements.

Insurance producer training

  An insurance producer may not solicit the sale of an annuity product unless he or she has adequate knowledge of the product to make the recommendation.  The insurance producer must also be in compliance with the insurer’s standards for product training.  An insurance producer may rely on insurer-provided product-specific training standards and materials to comply with this sub-rule.

Training required

  One-time course:

1. An insurance producer who engages in the sale of annuity products must complete a one-time four-hour-credit training course approved by the Iowa insurance division and provided by an education provider approved by the insurance division.

2. Insurance producers may not engage in the sale of annuities until the annuity training course required under this rule has been completed.

  The minimum length of the training required under this rule shall be sufficient to qualify for at least four CE credits, but may be longer.

  The training required under this rule shall include information on the following topics:

• The types of annuities and various classifications of annuities;
• Identification of the parties to an annuity;
• How fixed, variable and indexed annuity contract provisions affect consumers;
• The application of income taxation of qualified and nonqualified annuities;
• The primary uses of annuities;
• Appropriate sales practices; and
• Replacement and disclosure requirements.

  Providers of courses intended to comply with this rule must cover all topics listed in the prescribed outline and may not present any marketing information or provide training on sales techniques or provide specific information about a particular insurer’s products.  Additional topics may be offered in conjunction with and in addition to the required outline.

  A provider of an annuity training course intended to comply with this rule must register as a CE provider in Iowa and comply with the rules and guidelines applicable to insurance producer continuing education courses as set forth in 191—Chapter 11.

  Annuity training courses may be conducted and completed by classroom or self-study methods in accordance with 191—Chapter 11.

  Providers of annuity training shall comply with the reporting requirements and shall issue certificates of completion in accordance with 191—Chapter 11.

  Satisfaction of the training requirements of another state that are substantially similar to the provisions of this sub-rule will be deemed to satisfy the training requirements of this sub-rule in Iowa.

  An insurer must verify that an insurance producer has completed the annuity training course required under this sub-rule before allowing him or her to sell an annuity product for that insurer.  An insurer may satisfy its responsibility under this sub-rule by obtaining certificates of completion of the training course or obtaining reports provided by Iowa insurance commissioner-sponsored database systems or vendors or from a reasonably reliable commercial database vendor that has a reporting arrangement with approved continuing education providers.

ITEM 10. Amend renumbered rule 191—15.73(507B) as follows:

Mitigation of responsibility Compliance; mitigation; penalties

  Insurers are responsible for compliance with this regulation.  If a violation occurs, either because of the action or inaction of the insurer or its insurance producers, the commissioner may order:

1. An insurer to take reasonably appropriate corrective action for any consumer harmed by the insurers, or by its insurance producer’s, violation of the rules of this division;

2. An A general agency, independent agency or the insurance producer to take reasonably appropriate corrective action for any consumer harmed by the insurance producer’s violation of the rules of this division; and

3. A general agency or independent agency that employs or contracts with an insurance producer to sell or solicit the sale of annuities to consumers, to take reasonably appropriate corrective action for any consumer harmed by the insurance producer’s violation of the rules of this division. Appropriate penalties and sanctions.

  Any applicable penalty under Iowa Code chapter 507B for a violation of the rules in Division V of this chapter may be reduced or eliminated if corrective action for the consumer was taken promptly after a violation was discovered or the violation was not part of a pattern or practice.

End of Iowa Law Section

Predicting Product Performance

  Agents must stress that it is not possible to predict how the markets will perform in the future.  Even looking at past performance seldom offers guidelines, as we have witnessed over the last few years.  Unfortunately clients often blame their agents when investments perform poorly, so it is in the agent’s best interests to have a written statement regarding the inability to make predictions.  This statement should be signed at the time an annuity is purchased and kept by the agent in the client’s file.  Consider this signed statement future protection if the client or his or her family becomes dissatisfied with the investment’s performance.

Information Gathering Critical to Recommendations

  Agents must ask their clients to consider several questions when considering the appropriateness or suitability of an equity indexed annuity (or any annuity for that matter).  The following questions are not inclusive, but they are likely to be among the necessary questions to ask:

1. What is your current income and expected future income?  Will income go up or down in the client’s estimation?

2. What are your current liquid assets?

3. What is the soonest date the investment money will be needed?  In other words, when will the money need to be withdrawn for daily living requirements?

4. Will annuitization be an option or does the investor think he or she will want to withdraw the investment as a lump sum? 

5. Depending upon the date of withdrawal, could the surrender penalties be imposed if funds were withdrawn and the policy surrendered (not annuitized)?

6. Does it seem likely that withdrawals will be needed that are larger than any “free withdrawals” allowed under the annuity contract?  This relates to any insurer imposed surrender penalties.

7. How old does the investor expect to be when funds are withdrawn?  This relates to the IRS penalty if funds are withdrawn prior to age 59 ½.

8. What is the client’s current tax status?

9. What is the intended use of the annuity investment?

10. Is the investor more interested in the highest possible gains or in preservation of principal?  This relates to risk tolerance.

11. It is not possible to have both the highest rate of return and little or no investment risk.  Does your client understand this?

12. Will health conditions play a role in underwriting the product?

  When agents ask these and similar questions of their clients their focus should be on the most adverse possibilities.  For example, if the investor thinks he or she may need large withdrawals during the surrender phase of the contract it is likely that an annuity, of any type, may not be suitable for their personal circumstances.

  Investors and agents should never simply assume liquidity will be available somewhere, such as home equity or amazing investment growth.  Taking the optimistic view does not comply with product suitability requirements.  Any investor that does not have sufficient liquidity for the surprises in life should not invest everything in an annuity; enough cash reserves should be retained in a liquid account of some kind.  This is true for all investors of all ages.  We all need an emergency account that can be easily accessed.

  Annuities are often used to pass wealth on to heirs, such as children and grandchildren, but many financial managers feel that goal is better served with a life insurance policy.  This might be true even if the money in the annuity will not be needed at any future date.  The life insurance policy should be held outside of the estate to minimize delays in distributing funds.  These issues should be discussed with a qualified financial planner of course, so that the best avenues are utilized.

A Complex Product

  Equity indexed products are complex; if the selling agent feels the concepts are not well understood by the investor it could prove foolish to still initiate an application for the product.  Perhaps a traditional fixed annuity would be better understood than an equity indexed annuity.  If so, that would be a better product to place with the investor.  Agents should never place a product that is not adequately understood and accepted by the investor.

  Annuities are considered long-term investments, which includes equity indexed contracts.  Never should excessive funds be tied up in long-term vehicles.  Even when the investor does not expect to need the funds it is impossible to predict future circumstances.  The investor could lose their job, experience an uncovered medical emergency or simply need a new refrigerator.  All adults need an emergency cash fund that is easily accessible on short notice.

  A criticism of equity indexed annuities is their complexity.  In fact, even many agents avoid presenting them purely due to lack of understanding.  They are right to avoid marketing them if they are not understood since agents must understand the contracts they are selling.

  Even advocates of equity indexed annuities admit that they are more complex than most other types of annuities.  Since EIAs are not all the same, an understanding of one EIA product does not guarantee understanding of all EIA products.  Although the basic concept may be understandable, that does not automatically mean the agent (and investor) understands the individual products being marketed.  Even experienced financial planners often have to read the actual equity indexed annuity policy to gain an understanding of how the individual product performs.  Certainly agents must read and fully understand any product they plan to present to consumers.

Full Contract Disclosure

  Of course agents must fully disclose all product contract features, both advantageous and disadvantageous.  Investors must be able to make a fully informed investment choice and that can only be done with complete information.  While this is true of all insurance and investment products, the complexity of indexed products makes full disclosure especially important.

  Suitability issues seem to arise for some basic reasons, including (though not limited to):

1. The agent believes he or she understands the equity indexed annuity product but does not know how to convey the terms and limitations to their clients, so they adopt a “trust me” mythology when selling them.

2. The agent realizes he or she does not understand the “details” of the product but believes the details are not important enough to worry about and markets the product anyway.

3. The agent mistakenly believes he or she understands the product they are selling.  Even though it may result in an unintentional agent error, the end result can cause great financial harm to the investors.  Financial harm often results in lawsuits.

4. When investors clearly misunderstand how a product works, only a fool will sell the product anyway.  When agents know their clients have misunderstood an EIA under no circumstances should the product be placed until the investor’s error is corrected.

  Just because an investment product, such as equity indexed annuities, are complex does not necessarily mean they should not be sold.  Most agents will never understand all the small details of EIAs but if they understand the mechanics well enough to relay a full understanding to their clients that will likely be sufficient.  The point is to understand the ups and downs well enough so clients do not get nasty surprises later on.  Certainly a full and complete understanding is best, but an understanding that allows products to be sold safely is also generally acceptable.  Many agents will gain a full understanding of just one or two equity indexed annuities and sell only those particular EIA products.  This prevents any harm done to their clients as long as suitability standards are observed.

  It is likely that most equity indexed annuities are marketed by annuity specialists that primarily sell only these products; they probably do not sell nursing home insurance, major medical insurance, and perhaps do not even sell life insurance products.  Their focus is on annuities of various kinds. That allows these agents to become knowledgeable to a greater extent than agents that market various products.  Insurance is fast becoming an industry of specialists.  First we saw specialization in long-term health care products and now we are seeing the same thing happen in the annuity field.

  The states have a very difficult job.  They must attempt to eliminate use of the “trust me” technique to place annuity products regardless of client suitability.  It is doubtful that the states will ever be able to completely eliminate unethical agents but with required suitability standards the states at least have an avenue to punish those who refuse to act ethically.

Annuities are Long-Term Investments

  Every product has advantages in the right circumstances and disadvantages in the wrong situations.  The goal is to place products where they are most likely to be advantageous for the investors. 

  There will always be annuity critics, although many of them disappear during difficult financial times.  When the markets are performing well annuities are criticized for their low returns and lack of liquidity but when the markets are down those same critics often praise the safety of annuity products.

  There is no question that annuities are long-term investments and, as such, lack liquidity.  Large early withdrawals – prior to the end of the surrender penalties – will also result in loss of principal due to penalties.  Therefore, large withdrawals are not suggested during the surrender penalty years.  Many products allow smaller withdrawals during the surrender penalty years without any insurer fees however.  All annuity investors must be aware of the Internal Revenue Service penalty of 10% on withdrawals prior to age 59½, called early withdrawal penalties.

  It is due to these early withdrawal fees, both from the IRS and the insurer, that make it theoretically possible for equity indexed annuities to lose money.  According to NASD, the guaranteed minimum return for an EIA is typically 90% of the premium paid at a 3% annual interest rate.  If, however, the investor surrendered his or her EIA early, he or she could end up paying a significant surrender charge and a 10% tax penalty that would reduce or even eliminate any returns.

  Since many EIA products only guarantee a return of 90% it is possible to lose money on equity indexed annuities, whereas traditional fixed rate annuities guarantee 100 percent of the amount deposited into the annuity product.  Obviously one way to avoid this is to look for equity indexed annuities that guarantee 100% of the premiums paid.

  Some equity indexed annuities do not pay earnings until maturity, which is usually the point at which the surrender penalties end.  In other words, some contracts will not credit the annuity with the index-linked interest if it is surrendered early.

  As we have repeatedly said, equity indexed annuities are intended to be long-term investments.  They are typically not suitable for short-term use.  In most cases, investors may take all or part of the money at any time but there is likely to be a cost for doing so.  The cost may be stated as a dollar amount, a percentage, or as interest earnings.  The greatest disadvantage of an equity indexed annuity is their significant surrender charges, especially during the first few years of the contract.  It is these surrender charges that allow the insurance companies to make long term investments so they may pay investors the earnings the annuities guarantee.  If too many EIA investors pulled their money early the insurers could not earn the returns they need.  Surrender penalties, therefore, are used to discourage early withdrawals.  Regardless why insurers do this however, the important thing for investors to fully understand is that they must be willing to leave their deposits in the annuity for the number of years stated as surrender penalties in their contracts.  Investors must always be aware that the money they deposit in an equity indexed annuity is not for short term use or goals.  At all times the investors must have other cash on hand for emergencies that arise.  If agents learn nothing else from this course, they must learn to stress the long-term nature of equity indexed annuities with their clients.

It is Not a Liquidity Issue but Rather a Suitability Issue

  Annuities of all kinds are typically long-term investments so the issue is never about liquidity (there is none) but rather it is about suitability.  When the topic seems to snag on liquidity it is usually a sure sign that the agent should not place an annuity with the investor.  Equity indexed annuities are only suitable for those who will not need to withdraw significant sums during the contract term.  Even small withdrawals should not be an issue when addressing product suitability.  Withdrawals prior to the equity index annuity term should never be a goal – period.  Therefore product liquidity requirements simply tell the agent that the EIA is not suitable for the buyer.

  Although some EIAs may have provisions for withdrawals under specified conditions, such as medical need, if the investor has set aside sufficient liquid reserves (outside of any annuities purchased) even that should not be a topic.  Agents and financial planners should assess liquid reserves prior to determining EIA suitability – prior to suggesting buyers consider an equity indexed annuity.

  Some investors tend to be spenders and will spend funds if they are available, even if set aside for other purposes.  Such people have difficulty maintaining emergency cash funds because they are constantly removing the funds for other purposes.  For such individuals an EIA might seem attractive because they are long-term, illiquid financial vehicles.  The lack of liquidity may seem beneficial as a result.  When consumers look for financial vehicles that prevent them from removing funds this is known as lock-boxing, but many are skeptical of using EIAs in this way.  If the investor cannot maintain an emergency fund he or she may access their equity indexed annuity anyway so the illiquidity is not ultimately a successful deterrent.

  There are circumstances where lack of liquidity is an advantage.  This might be true for an individual that needs money kept out of reach, and will not access the EIA on a whim.  For example, an inheritance that is not needed for daily living costs or emergencies might do well in an equity indexed annuity.  This might especially be true for investors who are behind on saving for retirement security.

  Generally speaking, creditors cannot access funds in an equity indexed annuity so, for some people who are having credit issues, the inaccessibility of EIAs might prove to be an advantage.  Creditors can usually access such things as bonds, stocks or mutual fund shares, which would have to be sold at current market value even if that means a loss.  Not all states offer creditor protection for annuities so investors should seek legal council.  It might even be prudent to establish residency in a state that does offer protection for funds placed in annuities.  In such states creditors would never be able to get access to annuity funds (sometimes even annuity payments may receive protection from creditors).  Seldom would an annuity be protected from Internal Revenue Service claims however.  If this is a threat we would recommend that legal council be sought.

Suitability in Annuity Transactions Model Regulations

  The NAIC periodically looks at insurance topics and develops recommendations.  This Model Regulation was adopted to set standards and procedures for suitable annuity recommendations and to require insurers to establish an adequate system to supervise those recommendations.  The goal is always to meet the insurance needs and financial objectives of the consumers.  Product suitability will always play an important role.

  An insurer and its producers are required under these model regulations to make a “reasonable effort” to obtain the consumer’s suitability information.  Luckily for agents, insurance companies generally provide guidelines (questionnaires usually) to help agents make this determination.  Based on the suitability information gathered, the producer (or the insurer if no producer is involved) must have reasonable grounds to believe the transaction is suitable based on the investor’s financial situation, needs and goals.  Agents are prohibited from trying to dissuade a consumer from providing any responses to questions that are not completely truthful.

Sometimes No Agent/Insurer Obligation Exists

  Neither an insurance producer nor the insurer has any suitability obligations if:

• No recommendation is made;
• The consumer provided inaccurate information which led to an unsuitable recommendation;
• The consumer failed to provide relevant suitability information and the transaction is not recommended; or
• A consumer enters into an annuity transaction that is not based on the recommendations the agent provided him or her.

  Of course, an insurer’s issuance of an annuity must be reasonable under all circumstances actually known to the insurer, even if the four elements listed above apply.

Recordkeeping

  The Suitability in Annuity Transactions Model Regulation requires agents and insurance companies to record recommendations so there is a record of them.  If the investor refuses to provide required information, then the agent or insurer should obtain a form signed by the investor that he or she refuses to provide requested information and is making a buying decision without a recommendation.  Agents are wise to always document any situation where there may be liability involved; it protects them in case a lawsuit is filed by either the investor or their family members.

  Prior to issuance of an annuity contract, a recommendation must be reviewed to ensure there is a reasonable basis to believe the transaction is suitable.  This may be done by the insurer or by a third party contracted with the insurer.  The insurer must annually obtain a certificate from a senior manager with responsibility for the contracted function that states the manager has a reasonable basis to represent the function is being properly performed.

  Producers are required to have adequate training on the products, including training in compliance requirements.  Those selling annuity products must acquire a one-time minimum four-credit hour general annuity training course offered by an approved education provider (such as United Insurance Educators, Inc.).  The course must be approved by the insurance department as meeting this requirement.  The course may not contain sales or marketing techniques.  Insurers must verify that their agents have met this training requirement.

  If a policyowner is harmed by the actions of an agent or the issuing insurer either party may be required to take reasonably appropriate corrective action, even if the harm was not intentional.  Appropriate corrective action will be required whether it is due to the action or inaction of the insurer or the producer, regardless of whether the insurer contracted with a third party to prevent inappropriate placement of products.  The state’s insurance commissioner may take additional appropriate sanctions or penalties as he or she sees fit within their power to do so.

  The so called “safe harbor” is intended to prevent duplicative suitability standards being applied to sales of annuities through FINRA broker-dealers.  Sales of insurance products that are securities under federal law (variable annuities in other words) are required to meet FINRA suitability rules.  These rules would not apply to fixed rate annuities including equity indexed fixed rate annuities.

  While insurers may seek additional information from investors considering the purchase of an annuity product, there is basic information that is typically requested, including:

• Age;
• Annual income;
• Financial situation and needs, including financial resources used for funding;
• Financial experience;
• Financial objectives;
• Intended use of the annuity;
• Financial time horizon (when will the funds be needed?);
• Existing assets, including investments and life insurance contracts;
• Liquidity needs;
• Liquid net worth (the money they can easily access);
• Risk tolerance; and
• Tax status.

  There are specific duties that must be met by the agent and issuing insurer.  When recommending the purchase of an annuity product, including an exchange of one product for another (replacement), the agent must have reasonable grounds for believing the recommendation he or she is making is suitable for the buyer’s financial situation, needs and goals.  There are no short-cuts.  This can only be determined by the following:

1. The consumer has been reasonably informed of various features of the annuity, including surrender charges and tax liabilities.  Any attached riders must be thoroughly understood as well.

2. The consumer will benefit from the annuity features, such as the tax-deferred growth and future payout options.

3. The particular annuity sold, and all aspects of it, are suitable for the buyer.  In other words, the product selected meets the needs and is suitable for the buyer.

4. In the case of an annuity exchange (replacement) the buyer understands any surrender penalties that might apply and understands that a new surrender penalty period in the new product will apply.  The buyer must be appraised of all aspects of the exchange, such as death, living or other contractual benefits lost or replaced and any fees or riders that will apply or be lost.

  In the case of replacement, it is always important that there be a point in doing so; the consumer must benefit in some way from replacing one product with another.

Supervisory System

  The issuing insurer must establish a supervision system that is reasonably expected to achieve compliance with the state’s regulations.  The supervision must help agents to do as the state intends and would include:

1. Maintaining reasonable procedures to inform agents of the requirements so they can conform to them.  The requirements should be in any training manuals used.

2. The insurer must establish standards for agent product training (so unintended errors are not made) must maintain reasonable procedures to require its agents to comply with the requirements.

3. The insurer must provide product-specific training and training materials that explain all features adequately.  In other words, the agents must be able to read the training materials and understand what they say.

4. The insurer must maintain procedures for review of each recommendation prior to issuance of the annuity.  The insurer is looking to see if the product is suitable for the buyer.

5. The insurer must maintain reasonable procedures to detect recommendations that are not suitable for the buyer.  It might include such things as confirmation of consumer suitability information, systematic customer surveys (maybe calling new annuity buyers for example), or other means of monitoring.

6. The insurer must annually provide a report to senior management, including to the senior manager responsible for audit functions that details a review with appropriate testing, reasonably designed to determine the effectiveness of the supervision system, the exceptions found, and corrective action taken or recommended.

Needs-Based Life Insurance Selling

  Life insurance is typically considered financial protection against premature death, although many life insurance products are used for other reasons.  When determining the amount of life insurance needed, there are multiple formulas that an agent can utilize.  In the end it must be tailored to the individual needs of the buyer’s situation.  Does the buyer need only replace lost income?  Are there special needs, such as a disabled child that will need life-long financial help?  Are college funds a concern?  All questions of this type will need to be asked and answered.

Underwriting the Application

  There will probably be underwriting issues in life insurance policies.  Underwriting can refer to health underwriting but also financial underwriting.  For example, the insurer would not want to encourage over-insuring since that has the potential of creating a situation that might end with an illegal act (killing the insured person to gain their life insurance death benefit for example).  Murder has been committed for small amounts of money but when a person is insured far beyond a reasonable amount, it could create a climate of danger.

  Insurance underwriting is the process of classification, rating, and selection of risks.  In simpler terms, it is a risk selection process.  This selection process consists of evaluating information and resources to determine how an individual will be classified (whether a standard or substandard risk).  After this classification procedure is completed, the policy is rated in terms of the premium that the applicant will be charged.  The policy is then issued and subsequently delivered to the buyer by the agent or producer.

  The underwriter's job is to use all the information gathered from numerous sources to determine whether or not to accept a particular applicant.  Individuals applying for individually-owned life and health insurance typically receive more underwriting scrutiny than members holding a group policy.  The underwriter must employ sound judgment based on his or her years of experience to read beyond the basic facts and get a true picture of the applicant's lifestyle.  For example, the underwriter will consider any factors that could make the applicant more likely to die before his or her natural life expectancy, or reasons to anticipate that the individual may become ill or involved in an accident that will create high medical expenses or a premature death (what the underwriter considers depends upon the type of policy being issued).  In a life insurance application, the underwriter is concerned with premature death; only if there are riders being applied for will he or she consider other aspects of underwriting, such as potential illness.  A life insurance underwriter will not be concerned, for example, about the possibility of a long-term illness the same way a disability underwriter would be.

  No one expects the underwriter to foresee all possible circumstances.  The underwriter's primary function is to protect the insurance company insofar as is possible against adverse selection (very poor risks) and those parties who may have fraudulent intent.

  Adverse selection can be said to exist when a risk (an individual) or group of risks that are insured is more likely than the average corresponding group to experience a loss.  As a basic example, let's say that in a randomly-selected group of 1,000 25-year-old individuals, only two might be expected to die in any given year.  However, human nature is generally such that many healthy 25 year old young adults do not typically regard the need to buy life insurance, and therefore prefer to spend their money on other things.  It is usually only those 25 year olds who are ill or perhaps employed in dangerous occupations that are likely to purchase insurance.  The underwriter's job is to ensure that an inordinate number of these poorer-than-average risks aren't accepted since the insurance company could lose money as a result.

  The underwriter has a number of resources that can be called upon to provide the necessary information for the risk selection process.  These sources include:

• The policy application;
• Medical history and examinations;
• Inspection reports;
• The Medical Information Bureau (MIB); and
• The producer or insurance agent.

The Application

  The application is an absolutely crucial document and is usually attached to and incorporated as an integral part of the insurance contract.  The agent has a responsibility to be accurate on the form in the interests of both the insurance company and the insured.  The application is divided into sections, with each designed to obtain specific types of information.  Although the form of the application may differ from one company to another, most provide for submission of the following data: Part 1 (General Information), Part 2 (Medical Information), the Agent's Statement or Report, and the proper signatures of all contractual parties.

  Part 1 of the application requests the insured's general or personal data, such as name and address, date of birth, business address and occupation, Social Security number, marital status, and other insurance that may be owned.  Additionally, if the policy applicant and the insured are not the same person, the applicant's name and address would also be required in this section.

  Part 2 of the application is designed to provide information regarding the insured's past medical history, current physical condition, and personal morals.  If the proposed insured is required to take a medical examination, Part 2 is usually completed as part of the physical exam.  After reviewing the medical information contained in the application and the medical exam, the underwriter may also request an Attending Physician's Statement, or APS, from the proposed insured's doctor.  The APS is typically used to obtain more specific information about a particular medical problem or issue.

  The Agent's Statement, which is part of the application, requires that the insurance agent provide certain information regarding the proposed insured.  This generally includes information regarding the agent's relationship to the insured, data about the proposed insured's financial status, habits, general character, and any other information that may be pertinent to the risk being considered by the insurance company.

  The signature of the insured (and the policyowner if not the same person) must be obtained in the appropriate places on the application.  The producer usually also signs the document as a witness to the applicants' signatures.  Additionally, the application will contain information regarding the policyowner's choices for the mode of the premium (monthly, quarterly, semiannually, or annually), the use of any dividends, and the designation of beneficiaries.

  Medical exams and tests, when required by the insurance company, are conducted by physicians or paramedics at the expense of the insurer.  These exams usually aren't required for health insurance (which only emphasizes the importance of the agent accurately recording medical information on the application).  The medical exam requirement is much more common for life insurance and some types of annuities underwriting than for health insurance.  Simplified issue life insurance requires no medical examination and the application asks only very basic health-related questions. This type of coverage is usually only available in low face amounts to reduce the insurance company's subjection to the hazard of adverse selection.

  To supplement the information on the application, the underwriter may order an inspection report on the applicant from an independent investigating firm or credit agency that provides financial and moral (or lifestyle choices) information.  This data is used only to help determine the insurability of the applicant.  If the amount of insurance being applied for is average, the inspector will typically write a general description about the applicant's finances, health, character, occupation, hobbies, and other habits. When larger amounts of coverage are requested, the inspector will provide a more detailed report.  This information is based on interviews with the applicant's associates at home (including neighbors and friends), at work, and elsewhere.  Such “investigative consumer reports” may not be made unless the applicant is clearly and accurately told beforehand about the report in writing.  This consumer report notification is usually part of the application.  At the time that the application is completed, the producer will separate the notification and present it to the applicant.

Insurable Interest

  If an indivdiual wishes to buy a life insurance policy on someone else's life, he or she must have an interest in that person remaining alive, or expect emotional or financial loss from that person's death.  This is called an insurable interest.  Without this requirement, it would be very easy to make a living by purchasing life insurance policies on elderly strangers, and then collecting the proceeds when they died.  The insurable interest requirement also prevents people from buying life insurance contracts on someone and then causing or hastening that person's death.  Obviously causing or hastening a death is illegal, but it is this illegal possibility that insurers wish to avoid.

  When a person buys insurance on their own life, he or she is assumed to have an insurable interest.  If a person is buying a policy on someone else's life, an insurable interest can typically be established if he or she has a sufficiently strong relationship with the intended insured person based on blood, marriage, or monetary interest.  In other words, he or she must be worth more to the policy buyer alive than dead.

  Husband-wife relationships and parent-child relationships are almost always sufficient to create an insurable interest.  In addition, grandparent-grandchild relationships and sibling relationships are frequently considered sufficient for establishing an insurable interest.  The ties between cousins, aunts/uncles and nieces/nephews, and other more distant relatives don't automatically give rise to insurable interests because their emotional and financial bonds may be less strong.

  Certain relationships founded on monetary interests can also create insurable interests. For example, a creditor is considered to have an insurable interest in a debtor's life.  Even though death doesn't extinguish the debtor's obligation to repay the loan, the creditor faces potential harm if the debtor's estate cannot repay it.  Other examples include the relationship between a business and a key employee, or the relationships among partners in a partnership or stockholders in a closely held corporation.  The death of a CEO, general partner, or active stockholder can cause financial disruption to the business and harm the other business owners.  Therefore, there is an insurable interest in the relationship.

  The insurable interest must exist at the time the life insurance contract is purchased.  The insurable interest generally doesn't have to remain and be present at the time of that person's death however.  If conditions change after purchase of the policy it will not void the contract; the policy will still pay the death proceeds.

Special Issues for Senior Investors

  The Gallup Organization surveyed over 1,000 nonqualified annuity owners in 2004 for the Committee of Annuity Insurers, an organization of life insurance companies that issue annuities.  They found the following nonqualified annuity owner characteristics of:

• The average age was 65 for annuity ownership;
• 52% were male; 48% were female;
• 63% of annuity owners were married; 20% were widowed;
• 56% of the contract owners were retired; 38% were still working;
• 55% had income between $20,000 and $74,999, with 62% having total household incomes under %75,000.
• 85% bought their first annuity prior to age 65.  The average purchase age was 50.

  Although any person of any age may buy an annuity, it is clear that the majority are purchased by individuals who are older.  Since, according to the 2004 Gallup survey, the average annuity purchase age is 50 years old, it is likely that most annuities are bought for use during retirement.

  As a person ages, safety of investment becomes very important since there is no longer time on the investor’s side to make up investment loss.  Conservation of principal becomes more important than the amount of interest earnings.  Certainly, the investor does not want to become stagnant since inflation will erode the principal but neither does the investor want to take unnecessary risks.

Product Complexity

  Indexed products are complex; while they may be difficult for a person of any age to understand this might especially be true for older Americans who do not have any past experience with the products.  If the applicant does not understand the product, he or she should not buy it and the agent should not sell it.

Buyer Competence

  It may not be politically correct to suggest that older Americans are less competent than younger investors but politically correct or not, it is often true.  We are not saying that older buyers are less educated, less wise, or lack common sense.  Rather older Americans may have medical issues that affect their ability to make completely sound judgments.

  As individuals age, we are more likely to take medications that affect our abilities, more likely to have memory loss, and more likely to have difficulty grasping new concepts.  That does not mean that older Americans should not purchase a product that is right for them and their goals but it does mean he or she must be sure they understand what is being purchased.  Agents are supposed to follow suitability standards in their recommendations but if the older investor fails to provide full or accurate information, whether by design or due to memory loss, the agent may make a faulty recommendation.  Although no one may be at fault that will not lessen the impact of an incorrect financial move.

Ethical Compliance Issues for Senior Investors

  There is a unique ethical and compliance issue relating to senior investors.  This arises from the assumption that the older the investor the more likely it is that a disability exists.  In other words, he or she is likely to have some medical condition that limits their ability to make sound financial decisions.

  Many agents suggest that a trusted family member be present; after all, two heads may be better than one when it comes to making investment choices.  It also lessens the agent’s liability concerns if he or she has suggested the older investor ask someone additional sit in on the equity indexed presentation and help make the investment decision.

  If there is no trusted friend or family member to help the older investor (or maybe the older investor wants no help and has stated so) agents must be very sure the individual understands the product.  Of course, agents want everyone to understand what is being purchased, but they must be especially sure that older clients understand since there might be health factors that limit their ability to either understand or to remember.  In either case, it could be detrimental to the investor and the agent.

  If the selling agent has concerns that the older American does not understand or concerns that the older American will not remember the conversation, what should he or she do?  Even if it means a lost sale, the agent could insist upon having a child or other person review the person’s buying decision prior to submitting an application.  It is better to forgo a sale than risk a dangerous financial error.

  Agents and insurance companies owe the identical ethical considerations to an investor who is 65 years old and one who is 45 years old.  Even so, if the agent or insurer finds themselves being sued the 65 year old will gain more legal sympathy than a 45 year old investor might.  Liability is the major reason agents are sued.

New Developments in Indexed Products

  Insurance companies are constantly developing new products.  Sometimes they may be revisiting past products with new twists; other times the product seems completely unique.

  For example, climate has always presented a challenge to farmers, herders, fishermen and others whose livelihoods are closely linked to their environment, particularly those in poor areas of the world.  Index insurance now offers significant opportunities as a climate-risk management tool in developing countries, according to a publication issued in Geneva.  The report, called Index Insurance and Climate Risk: Prospects for development and disaster management is part of the Climate and Society series produced by the International Research Institute for Climate and Society.  It was published in partnership with the United Nations Development Program, the International Fund for Agricultural Development, Oxfam America, Swiss Re, the US National Oceanic and Atmospheric Administration and the World Food Program.

  For poor people, a variable and unpredictable climate can critically restrict livelihood options and limit development.  Banks are unlikely to lend to farmers if they think a drought will cause widespread defaults, even if the farmers could pay back loans in most years.  The farmers' lack of access to credit limits their ability to buy improved seeds, fertilizers and other inputs.

  Index insurance products represent an attractive alternative for managing weather and climate risk because it uses a weather index, such as rainfall, to determine payouts.  This resolves a number of problems that make traditional insurance unworkable in rural parts of developing countries.  With index insurance contracts, an insurance company doesn't need to visit the policy holder to determine premiums or assess damages.  Instead, if the rainfall recorded by gauges is below an earlier, agreed-upon threshold, the insurance pays out.  Such a system significantly lowers transaction costs.  Having insurance allows these policy holders to apply for bank loans and other types of credit previously unavailable to them.

  However, if index insurance is to contribute to development at meaningful scales, a number of challenges must be overcome.  For example, some efforts to implement index insurance failed due to lack of capacity, institutional, legal and/or regulatory issues, lack of data, and other constraints.  The new publication looks at the technical and operational challenges that currently limit the growth and spread of index insurance.  It highlights a number of case studies of the various applications of index insurance across the world thus far. Among them are:

• A public-private partnership program in Brazil to support farmers
• A multinational scheme in the Caribbean for earthquake and hurricane risk
• A national program in Ethiopia to complement a drought early warning system
• A program to enable access to credit for smallholder farming communities in Malawi
• Public and private programs in India that offer contracts across many states, for many crops, covering a range of risks, from excessive rainfall to extreme temperatures

  There are sure to be other ways indexed products develop and change over time.  We often think the insurance field is stationary but simply is not true.  Without insurance change and development many of the business that exists today would disappear.

United Insurance Educators, Inc.

PO Box 1030

Eatonville, WA 98328-8638

Email: mail@uiece.com

Website: www.uiece.com