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The ABCs of doing due diligence on fixed income annuities

State regulators are stepping up as the SEC, reigned in by Dodd Frank, retreats on regulation of fixed income annuities

Author Ron Rhoades, Columnist March 18, 2011 at 1:44 PM
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Ron Rhoades: In essence, the “theory” of FIAs often fails in its execution, due to poor product design and abusive sales practices.

Ron Rhoades

Patricia Potts

Patricia Potts

March 21, 2011 — 5:35 PM

A very pithy article! If a fiduciary responsibility entails “The first requirement for any RIA is to understand all of the features and characteristics of any annuity contract to be recommended to a client. This enables the RIA to not only contrast one product against another (i.e., a step involved in appropriate investment product due diligence), but also to discern whether the investment strategy offered by any FIA is itself appropriate.” that would assume that the ficuciary is licensed to provide insurance advice.

Is Mr Think Tank licensed to provice insurance advice and does his organizations that he is a board member of require that its members be licensed?

Ron Rhoades

Ron Rhoades

March 22, 2011 — 4:42 PM

Thank you, Ms. Potts, for reminding RIAs that, at times, insurance licensure would be required if undertaking the sale of life insurance or an annuity product, or for a recommendation of a specific life insurance (including fixed income annuity) product, if done for a commission or for for a specific fee. However, there are various exemptions to insurance agent licensure, however. For example, attorneys in many states have historically performed due diligence on life insurance and annuity products, and many states provide exemptions from insurance licensure for attorneys provided they do not promote themselves as insurance agents and do not receive commissions from the sale of insurance or annuity products. Additionally, some states provide CPAs with exemptions from certain insurance licensure requirements.

The issue of whether insurance agent licensure is required for an RIA to opine on the investment, as opposed to the insurance, characteristics of a fixed indexed annuity is unresolved in most states. There are contrasting arguments, which vary from state to state depending upon the precise language of the insurance licensing statutes and the investment adviser representative licensing statutes. In a few states, those providing “financial planning” or “financial planners” are required to be licensed as IARs / RIAs; in such states the breadth of the licensure as an RIA may be sufficient to claim an exemption from insurance agent licensing, as long as the compensation received is for general analysis of insurance needs, contrasting the features of different types of insurance / annuity products, and advising the client accordingly. However, if the IAR/RIA is specifically compensated for assisting the client in the purchase of a specific annuity product, insurance / annuity licensure may be required, even in such states. Unfortunately, in many states insurance and securities regulators engage in turf wars, and each is likely to claim jurisdiction in some instances. Nor has the regulation of financial planning kept up with its rapid expansion as a professional service, bound by fiduciary obligations.

The thrust of the article was to opine on the due diligence requirements for those RIAs undertaking a review of fixed income annuities as a form of investment. When acting as the representative of the customer (i.e., a fiduciary), as opposed to a sales agent of the product manufacturer (i.e., an insurance agent), the fiduciary duty of due care requires the fiduciary advisor to undertake due diligence as to investment strategies and specific investment products. (Due diligence is also required as to client-specific suitability.) The goal of the article was to provide insights into some of the factors which should be considered in conjunction with that due diligence. Also, if the advisor is a fiduciary (however such fiduciayr status results – whether due to RIA licensure, or state common law imposition upon relationships based on trust and confidence, or otherwise), various disclosures would likely be required.

I would also note that there is a move toward the utilization by RIAs of fee-only insurance consultants. A recent article in the Wall Street Journal, appearing on March 14, 2011 – “A Smarter Way to Buy Insurance? – Fee-only advisers argue they have only one client: the consumer” provides consumers and RIAs a brief overview of this trend. See http://online.wsj.com/article/SB10001424052748703584804576144093956139406.html. An RIA may desire to utilize a fee-only insurance consultant as a resource. Although full delegation of the RIA’s fiduciary duty of due care is unlikely to be accomplished by such means, fee-only insurance consultants can serve as an important source of information and can aide in the due diligence process.

Lastly, the world of financial services is changing. In many countries all providers of financial products are required to act with fiduciary obligations. In a few countries commission-based sales of insurance and investment products are outlawed. In many respects, the United States is behind the curve. One would hope that the SEC will extend fiduciary obligations upon all providers of investment advice, and that the NAIC will likewise extend fiduciary obligations upon insurance policy providers, as the GAO recently recommended that the NAIC examine. It may take months, or years, for these changes to be effected, and there is substantial opposition to these changes driven by economic forces. In the interim, I would suggest that consumers continued to be equipped to tell the difference between a fiduciary advisor (acting in a relationship of trust and confidence with the client) and a non-fiduciary advisor (acting in arms-length, commerical relationship with the customer), and then make their choice accordingly.

Brooke Southall

Brooke Southall

March 22, 2011 — 7:09 PM

How many people are there who are licensed to give insurance advice who don’t use those licenses to sell it? Perhaps there are many. I honestly don’t know.

If I were doing due diligence on chicken coops, I might consult a licensed fox. But I might be more comfortable hearing from a smart unlicensed chicken.

Ryan Wheless

Ryan Wheless

March 22, 2011 — 7:36 PM

Before entering into this discussion, I would like to state my stance on FIA’s. They are Fixed Index Annuities and NOT Fixed Income Annuities. I 100% agree with the fact that no advisor should EVER put all of a clients assets into any one Financial Product. An advisor that does this clearly has put his or her compensation or commission ahead of the clients interest and that is a travesty. Furthermore, as with any financial product the Advisor has an obligation to disclose all material facts regarding fees and surrender charges associated with the annuity. Liquidity and crediting methods and exit strategies should also be discussed in GREAT detail.

First and foremost we can easily examine the history of the Securities Industry versus the 15 Year history of Fixed Indexed/Fixed Index/Equity Index Annuities and see there has been an ample amount of issues with not disclosing material important facts about a multitude of securities products that include VARIABLE Annuities, CDO’s, CDS’s and CMO’s, Mutual Funds and Structured Products (which by the way are the securities industries version of a Fixed Index Annuity). To infer that the securities industry has less issues with disclosure is a matter of opinion and not a matter of fact. One could argue that all of the money going to index annuities has been taken from the securities industry and some feathers have been ruffled in the process as that money is no longer available to generate fees on for and by the securities industry.

Second, Joseph Borg, The securities regulator from Alabama had NOT ONE CLUE about how to explain the attributes pros or cons of index annuities. The only thing he could do is attach sales practices. Just like the Securities industry a few bad apples with bad sales practices can and will spoil the whole bunch and thus make the whole bunch look bad. Take a look at the mass scrutiny of variable annuities in 2000-2004 that has continued today. To procure sales, advisors told clients they could not lose money in a product whose underlying investments were sub accounts which are basically mutual funds. They used the guarantees associated with the multitude of high cost riders offered to sale the clients on the safety of investing in Variable Annuities while clients watched their principal values evaporate because of high fees compounded by market losses.

The point about dividends is invalid. The index annuity returns are compared directly to the S&P 500 Index as a measurement of growth performance. The S&P 500 Index is just that. A measure of performance and that measure does not and never has included Dividends (most consumers are not aware of this). In order to get dividends from the index reinvested one must by an S&P 500 Index Mutual Fund which includes reinvested dividends. How does this impact the returns? Measuring the returns of FIA’s from 1997-2010 using five year periods and Participation Rates as low as 20-30% FIA’s won 67% of the time. When you factored in a 1.95% increase in the S&P 500 Index’s return because of the reinvested dividends, FIA’s STILL won 67% of the time. The impact of dividends is outweighed by avoiding market losses in the first place.

The next issue of how different crediting methods can impact returns is 100% true. For instance, a strategy offering a 50% participation rate would be more beneficial to a policy holder in years of double digit returns than a point to point cap strategy with a 7% cap. Why? Suppose the S&P 500 Index boasts a 20% return for the year. Half of the 20% return would be 10%. Compare that to the annual point to point cap strategy with a 7% cap and the return would be 7%. However, in years of single digit returns the annual point to point strategy would perform better. Why? Suppose the S&P 500 Index boasts a 10% return for the year. In the annual point to point strategy the return would be 7% versus 5% in the 50% participation strategy. 85% of Index Annuities allow an annual reallocation of strategies that is done on a a yearly basis. This means that a policy holder is not locked into one strategy for the entire term of the annuity. The whole concept is to give up some of the market gains on a portion of the portfolio for the safety and protection of not losing the principal or gains in a down market.

If an advisor is selling an annuity that contains a market value adjustment and telling the buyer there is no market risk they have another thing coming. Fixed Index Annuities are backed by Treasuries amongst other Fixed Income Investments. For example, suppose someone buys an index annuity while interest rates are at 5%. If rates rise the underlying bonds will decrease in market value and create a market value adjustment equal to the decrease in value of the underlying bonds. This can have a severe impact on the surrender value or maturity value of the annuity. This Market Value Adjustment could also be positive and INCREASE the surrender value and maturity value of the annuity. There are many Fixed Index Annuities that DO NOT have Market Value Adjustments.

In most (90%) cases there are no administrative fees in FIAs. That is a fee that is charged in Variable Annuities. However, there may be an asset fee charged to a crediting method. This is done in some crediting methods but not all. Therefore there may or may not be an asset fee charged depending on the selected crediting method.

In conclusion, do bad sales practices by a few make Fixed Index Annuities bad for the masses. NO! As long as full disclosure about the Liquidity, Surrender Charges for Getting Liquid, Crediting Methods, Riders, Terms, and Commissions are discussed in detail with and understood by the purchasing client.

Patricia Potts

Patricia Potts

March 22, 2011 — 8:23 PM

In your article you state that the FIA’s are regulated as insurance products and not investment product. You do not need a FINRA license to offer the FIA so that seems to preclude any variable investment product and so when you finally sit down to the table, you are discussing an insurance product.

We are not discussing the actions of attorneys here, nor CPA’s, so you should restrict your answers solely to RIA’s and fiancial planners. I cannot think of one state that requires a license to provide insurance advice for a fee, that does would not consider breaking down the contents of the FIA into all its little parts and making a recommendation either for or against it, as not providing advice. Clearly, in your due diligence sections you are breaking down not only the aspects of the product but also, if I read correctly, the financial structure of the insurance company who is making payment.

At no point in your article did you mention or allude to the fact that the index needs to be evaluated, other than when you correctly brought to the reader’s attention that the index returns do not include dividends.

What steps are you taking to ensure that members of your organization are indeed appropriately licensed to render advice on insurance? The link to an article saying that there are fee only insurance consultants is not germane to this issue. Are you and your members following the law or skirting it?

I sense that it is the latter.

Ron Rhoades

Ron Rhoades

March 22, 2011 — 8:53 PM

Ryan, thank you for your thoughtful comment, and for the additional information on FIAs which you shared with the readers. Permit me to reply to a few of your observations.

(1) DISCLOSURE OF INDEX RETURNS, WITH DIVIDENDS REINVESTED. I stand by my comment that an appropriate disclosure would include reinvested dividends. There is because of the perception among consumers that the “S&P 500 Index” has returns that would match those in an S&P 500 Index funds. Consumers do not understand the effect of reinvested dividends (or lack thereof), nor the effect of management fees and other expenses charges, nor of taxes, nor of the potential positive effect on returns derived from securities lending revenues. When a fiduciary is reviewing an FIA with a client, correcting these misconceptions, or lack of information, is an important part of the process of providing fiduciary investment advice – whether the product being analyzed is an FIA or an S&P 500 Index stock fund.

(2) CAUTION: POTENTIAL DATA MINING. Relating to the returns of FIAs from 1997 through 2010, the use of such a short period of time for testing the performance of FIAs relative to the returns of any asset class could easily be perceived to be data mining. Of course, FIAs don’t have a history going back decades and decades. Additionally, while the S&P 500 Index is often used as a proxy for the broader stock market, plenty of investment advisers have, throughout this time period, employed asset classes which possess superior returns to that of the S&P 500 Index (with reinvested dividends). The following index data illustrates same (average annualized returns shown, for January 1997-Dec. 2010) (1) 5.69% – S&P 500 Index (U.S. large cap stocks) (2) 6.68% – Russell 1000 Value Index (U.S. large cap value stocks) (3) 7.04% – Russell 2000 Index (U.S. small cap stocks) (4) 9.01% – Russell 2000 Value Index (U.S. small cap value stocks) (5) 6.09% – U.S. 5-Year Treasury Notes (6) 7.41% – Long-Term U.S. Corporate Bonds (using Ibbottson data)
Also, over this time frame international stock markets generally outperformed the S&P 500 Index.

Please note that I don’t personally recommend my clients invest in funds which track any of the foregoing indices. However, I do recommend other investments in the stock asset classes shown above which have generated, generally, even higher returns than the indices shown, even net of investment advisory fees paid. Moreover, a disciplined approach to portfolio rebalancing can also add to the long-term returns of a portfolio, relative to the returns assumed from a combined percentage allocation of the returns of the parts of the portfolio.

I provide the foregoing data to illustrate that the S&P 500 index is not representative of the returns occassioned by many RIAs who invest passively on behalf of their clients. Yet, I again stress that a time frame of 14 years is insufficient to back-test any investment strategy. And there will be periods of time, whether they be 1-year periods, 3-year periods, 5-year periods, or even 10-year periods, where an compelling investment strategy might be outperformed by a less-than-compelling strategy. In any event, a fiduciary advisor must never present cherry-picked data. Appropriate due diligence on FIAs as an investment strategy will require an examination of returns relative to benchmark indices (with reinvested dividends, as that is what consumers would reasonably understand) back-tested over longer time periods, and as suggested over multiple rolling interim time periods.

Is any reader aware of any research which has been published, which makes appropriate assumptions (index caps, crediting methods, etc.) and back tests FIA returns using several decades of data?

(3) THE LIMITATIONS OF DISCLOSURE. As previously discussed in several articles I have written, disclosure – while important – does not ensure client understanding. Nor does disclosure suffice to fulfill the fiduciary advisor’s duty of loyalty.

The reality is that clients don’t understand, in most instances, the highly complicated structure of most investment products, including FIAs. Due to various behavioral biases consumers possess, clients look to their professional advisors for trusted guidance, to help navigate through the complex maze of investment strategies and products available today.

This article hopes to provide RIAs with a base amount of information, from which they can then go forward to do further research to undertake due diligence on FIAs. For insurance agents who provide investment advice (such as advising to sell a security in order to invest in an FIA), I hope that the article provides them with information that Series 65 licensure may be required in their state to engage in such activities, and that merely obtaining licensure is but a first step on the road to meeting one’s fiduciary obligations as an investment adviser.

There is a substantive difference between product sales, in which disclosure obligations are limited and no fiduciary duties typically exist, and acting as a trusted professional advisor, where broad fiduciary duties come into play. There has been a lot of attempts in the insurance and securities industries to suggest that sales practices can be adopted into a fiduciary environment, primarily through disclosure. To me, this ignores the obvious – even with disclosure of a conflict of interest and all material facts, the investment adviser still possesses broad fiduciary duties of due care, loyalty, and utmost good faith, and cannot and should not engage in a self-serving recommendation to a client where a better alternative for the client (discerned after extensive due diligence) is available. Mixing arms-length commercial product sales relationships and fiduciary relationships seems altogether like trying to put a square peg in a round hole.

Thank you again for your insightful comments. Ron

Ron Rhoades

Ron Rhoades

March 22, 2011 — 9:07 PM

Ms. Potts,

Thank you again for your comment.

I am reminded by the old adage that when the message cannot be attacked, the politician frequently attacks the messenger. Or launches an attack via a related issue, but one not the point of the original discussion.

In reply to your question, I have in the past cautioned members of one of the several financial planning organizations to check with the insurance licensure requrements of their state before providing advice on various forms of insurance products and fixed annuities. And I am aware of several educational presentations, sponsored by various financial planning organizations, in which the subject of insurance licensure has been brought up. I believe that these educational presentations are entirely appropriate for such voluntary membership organizations.

Having said that, I do not believe, as I read the plain language of many insurance licensing statutes, that an investment adviser who is not engaged in the sale of a FIA may not evaluate its investment characteristics and discuss same with a client, in contrast to other investment strategies, and be appropriately covered by Series 65 licensure. This is especially true in states where “financial planning” is regulated (by the express terms of the state statute) as an investment advisory activity.

However, the issue you raise is not one the two of us will be able to resolve in this forum. It is an issue that has had differing views expressed for many years, by many persons (including differing opinions among various regulators to whom I have spoken in recent years). I would suggest that we simply agree to disagree.

Also, the issue you raise is an ancillary issue to the thrust of my article – that FIAs, while they possess potential benefits to consumers – also possess many features which may result them in failing an appropriate, thorough due diligence analysis when performend in a fiduciary context.

I do appreciate your effort to point out to readers, most of whom are RIAs, the potential necessity of insurance licensure. And I would encourage all readers who advise on insurance products to check with their specific state to ascertain if insurance licensure is required for the limited activities in which they may be engaged. In my view, in some states the answer will be “yes” – get licensed; in other states, given the limited scope of the services being provided (and not being compensated for any sale of an FIA), the answer will be a robust “no licensure required).

Thank you again. Ron

Patricia Potts

Patricia Potts

March 22, 2011 — 9:39 PM

Mr Southall,

Many states have requirements that those who provide insurance advice for a fee must be licensed. This is different from a producers license. Please know the differences before you make silly remarks. Basically what you are saying is that you would prefer to deal with someone that is willfully breaking a licensing law – speaks loads to your intelligence and ethics.

Advocate that the laws be changed, not that they be broken.

Ron Rhoades

Ron Rhoades

March 23, 2011 — 12:48 AM



Money Magazine’s Lisa Gibbs wrote on January 17, 2011 an article entitled, “Index annuities are a safety trap.” While the article is not itself a scholarly treatment of the subject, the article does quote a professor, stating: “As if that weren’t enough, index annuities don’t even deliver attractive returns. According to William Reichenstein, an investment management professor at Baylor University, over the long term a very conservative portfolio easily beats an index annuity. ‘These are very seductive products, marketed very effectively,’ he says, ‘but they almost always underperform’ ... A typical index annuity would have lagged an investment portfolio with equivalent risk — 85% one-month Treasury bills, 15% U.S. large-cap stocks — by nearly two percentage points annually, on average, over the past 44 years. That’s according to recent analysis by Baylor’s Reichenstein, who has been an expert plaintiff’s witness in a lawsuit involving these products.”

Professor Reichenstein’s conclusions are similar to mine. If the investor has a long-term investment horizon (necessarily the case if surrender fees exist for long periods of time), it is highly probable that a conservative portfolio consisting of low-cost stock funds and short-term, high-quality bond funds will outperform an FIA. This is not to say that the comparison is easily made. FIAs do not experience the volatility of even a conservative portfolio. Then again, a conservative stock fund / bond fund portfolio need not possess surrender fees from the onset.

This is not to say that FIAs are not a good concept, at least in theory. It is just that the high commissions associated with the current products I’ve reviewed, as well as other fees and costs embedded within these investment products, drag down the potential returns so greatly that no FIA has yet survived my own due diligence efforts. If any readers out there know of any low-cost, or even no-load, FIAs, please let me know.


One of the most vexing intellectual problems I have faced, as to the application of the fiduciary standard of conduct to sales activities, involves the situation where proprietary products are sold by a fiduciary advisor. This is particularly difficult when proprietary products are the only products which can be offered to the client, as is the case with the representative of a mutual fund complex (such as Fidelity) or as is the case with some captive insurance agents.

An article appearing in August 2010, by Fran Lysiak, BestWire, entitled “Captive Life Agents May Face Selling Conflicts After Financial Reform” (reproduced at http://www.consumerwatchdog.org/story/captive-life-agents-may-face-selling-conflicts-after-financial-reform), indicates the severity of the issue, at least as to insurance agents: “A uniform fiduciary standard could possibly destroy the captive agency business, said Steven Schwartz, an equity analyst with Raymond James. ‘The issue is whether a career agent, if he or she is restricted to selling the products of a single company, can actually be acting in the best interest of the client,’ he said. If a captive agent can only sell variable annuities from one company, ‘the conflicts may be so great that acting in the best interests of a client becomes problematic at best,’ he said.”

Of course, insurance agents who sell variable products, such as variable annuities and variable life insurance, must be registered representatives of a broker-dealer. Hence, the potential extension by the SEC of the fiduciary standard of conduct upon broker-dealers is of keen interest to insurance companies.

However, imposition of the fiduciary standard upon broker-dealers and their registered representatives is far from certain. Insurance companies are lobbying intensively against the possible SEC rule-making. See Helen Kearney’s article, “Insurers fight against strict fiduciary standard” (Dec. 2010), found at https://news.fidelity.com/news/news.jhtml?articleid=201012171354RTRSNEWSCOMBINED_N1796927_1&IMG.

I continue to seek to reconcile the requirements of the fiduciary standard of conduct with proprietary product sales, but I find difficulty in reconciling the wearing of two such different hats. Fundamentally the fiduciary standard acts as a restraint on conduct, and severe or multiple conflicts of interest can prevent any attempt to fulfill one’s fiduciary obligation. (Recent academic research, by Daylian Cain and others, suggest that even modest conflicts of interest, even when disclosed, are likely to create bias in even well-intentioned advisors and therefore lead to harm to the client.) Any input from readers who are themselves students of fiduciary law would be appreciated

Unknown to many insurance agents (who are not registered representatives of a broker-dealer firm), it is quite possible to “cross the line” and provide investment advice, to which the licensure requirements (as an investment adviser representative or RIA) of state securities regulators apply. A good explanation of this issue can be found at RIA Compliance Consultant’s article, “Frequently Asked Questions about Whether an Insurance-Only Licensed Agent Offering Equity-Indexed Annuities (EIAs) is Acting as an Unregistered Investment Adviser,” posted on their web site at http://www.ria-compliance-consultants.com/faq_eia_equity_indexed_linked_annuities_insurance_agent_unregistered_investment_advisor.html.

The Dodd Frank Act, pursuant to what is known as the Harkin Amendment (Senator Harkin from Iowa, which state contains five large providers of fixed indexed annuities), restricts the SEC to regulate fixed indexed annuities as a “security” (provided the product meets certain requirements). However, the Dodd Frank Act did not affect the attack by state securities regulators on sales practices involving equity indexed annuities, such as when the insurance agent recommends to the customer that a security be sold in order to purchase the FIA.

Perhaps the most aggressive state securities administrator in attacking sales of equity indexed annuities has been Missouri Secretary of State Robin Carnahan. A December 2010 report issued by her Missouri Securities Division states: “Secretary Carnahan has long identified unsuitable recommendations and sales practices concerning variable and equity-indexed annuities as a top threat to investors, especially seniors. Equity-indexed annuities, the primary product pitched at free lunch investment seminars, which target seniors across Missouri, are often unsuitable for senior investors because of long lock-up periods, high surrender fees, high commissions, and a high level of complexity.”

Enforcement actions involving failure to register as an investment adviser when providing advice regarding the sale of a security to purchase an equity indexed annuity continue. One recent case illustrates well an insurance agent “crossing the line” with regard to FIA sales. In re: Arthur S. Miller and Asset Protection Associates, Illinois, the Notice of Hearing filed on Feb. 16, 2011 alleges that “Respondent Miller engage in providing investment advice by recommending the sale of specific securities in order to purchase what was purported to be a safe product.”

Are state securities administrators still going after insurance agents (who are not licensed as either registered representatives or IARs/RIAs), post-Dodd Frank, when they advise a customer to sell securities to purchase a FIA? Probably, but I have not yet confirmed this.

4. RIAS PROVIDING INSURANCE ADVICE. Is it unlawful for an RIA to opine about the investment characteristics of a fixed annuity, including fixed indexed annuities? It’s an interesting question, and the answer rests largely on how various state laws are interpreted.

In some respects, RIA licensure would seem to cover the provision of investment advice, even if the product involves a fixed annuity (provided that the RIA is not selling the annuity in return for a fee).

One might ask the question, “Can an RIA opine on the safety and investment return of a certificate of deposit, even though the RIA does not work for a bank?”

Yet, state laws on insurance licensure are not as clear. For example, North Carolina statutes provide “A person shall not sell, solicit, or negotiate insurance in this State unless the person is licensed for that kind of insurance in accordance with this Article.” North Carolina law then defines “negotiate” as “the act of conferring directly with, or offering advice directly to, a purchaser or prospective purchaser of a particular contract of insurance concerning any of the substantive benefits, terms, or conditions of the contract, only if the person engaged in that act either sells insurance or obtains insurance from insurers for purchasers. ‘Negotiate’ does not mean a referral to a licensed insurance agent or broker that does not include a discussion of specific insurance policy terms and conditions.”

Hence, at least under North Carolina insurance regulation, it could be argued that an RIA, providing advice on FIAs (especially when contrasting other investment products thereto), is not “selling” nor “soliciting” insurance. And “negotiation” does not take place unless the RIA “sells insurance” or “obtains insurance from insurers.” Since only licensed insurance agents can obtain insurance, the RIA is not obtaining same. Rather, if a determination is made by an RIA that a fixed indexed annuity is a good investment for the client, then the RIA would refer the client to an insurance agent for its purchase. This is very similar to the way investment counsel used to work with regard to securities … structure the overall investment portfolio in the context of holistic financial advice, and then refer the client to a stockbroker for actual implementation.

Moreover, some states impose the requirement that those who hold themselves out as financial planners, or who engage in financial planning, register as IARs / RIAs. Financial planning has long been known to address matters involving insurance, and presumably this was known at the time these statutes were adopted. Hence, does regulation of financial planners under RIAs this trump insurance regulation, as long as the financial planner does not engage in the sale of life insurance (or other forms of insurance) or annuities on a commission basis?

We can only hope someday that investment and financial advice will be regulated functionally, and not spread among BD, RIA, bank, and insurance regulation.

It is clear that market conduct regulation for insurance agents, who operate under a suitability standard (under recently adopted NAIC model legislation), currently falls far short of the fiduciary requirements of an investment adviser. While the NAIC’s Annuity Disclosure (A) Working Group will be reviewing the NAIC Annuity Disclosure Model Regulation to improve the disclosure of information provided for annuity products, including indexed annuities, it does not appear that the NAIC is yet ready to embrace fiduciary obligations for those providing advice on FIAs or other insurance products when consumers are sold these products as forms of investment. However, the GAO in its Jan. 2011 report on financial planners recommended that the NAIC explore the application of fiduciary standards upon insurance product intermediaries.

Interesting questions abound … If you’ve read this far, and have more information on these issues, or about due diligence on FIAs, I hope you share them by posting a comment. Thank you. Ron

P.S. – Ms. Potts, in your first post you inquired if I was licensed to provide insurance advice. In a latter post I pointed out the exemption existing for attorneys, which exists in several states. In addition to being a <a rel="nofollow" title="r">CFP</acronym> and an IAR of an RIA, I am also an attorney, for the record. Hence, the relevance of my first reply to your first post. Thank you. </a>

Patricai Potts

Patricai Potts

March 23, 2011 — 8:26 PM

Thank you for pointing out that you are an attorney. In your response, you spoke in the third person and not the first, and I took your comments to be generalized and not specific to your practice.

I think that if you canvass those states that require people who are providing advice on insurance for a fee to be licensed that it is possible that an attorney who is a member of that states bar may indeed be exempt, but the exemption does not apply to someone just because they are an RIA.

Furthermore, as I have been told by compliance personnel at several insurance commissions, once you get past the declaration page, you are giving advice.

As long as insurance is a state matter, subject to state law, it is incumbent upon all ethical advisors to be licensed, or refer the matter out.

Sadly, being brilliant and pithy does not make one above regulation.

Sheryl J. Moore

Sheryl J. Moore

April 5, 2011 — 7:02 PM

Sadly, this article was abundantly full of inaccurate information on indexed annuities. For a correction to this article, and the FACTS in indexed annuities, please go to http://www.sheryljmoore.com/2011/04/response-the-abcs-of-doing-due-diligence-on-fixed/.

I do not sell or endorse any company or financial product. i just find it deplorable that the general public is being intentionally misled on these insurance products which compete against securities products for their retirement dollars.

Thank you.

Sheryl J. Moore
President and CEO
(515) 262-2623 office
(515) 313-5799 cell

Ron Rhoades

Ron Rhoades

April 7, 2011 — 5:12 PM

Dear Ms. Moore,

I realize that when an article is submitted that may well challenge a firm’s economic livelihood, such as the fortunes of your firm in its offer to assist those who sell fixed indexed annuities (FIAs), that a substantial and emotional response might well ensue. Yet, I was saddened to find that you failed to understand the focus of my article – the scope of due diligence likely to be required by life insurance agents who are also engaged as investment adviser representatives (IARs) of registered investment advisers (RIAs), and the types of disclosures which would be required by such an RIA/IAR.

Please permit me to use this opportunity to provide those readers of RIABiz, many of whom are registered investment advisers, with additional information regarding the scope of their fiduciary obligations, and due diligence with regard to FIAs.

However, I would first note your comment assumes that I am a securities salesperson – a registered representative of a stock brokerage firm. I am not. I am the IAR (and principal) of an RIA firm. Neither I, nor my firm, sell any investment or insurance products. Instead, we provide objective advice as trusted advisors to our clients. Hence, your commentary appears to approach my article as if the article were only an explanation of a type of product – FIAs. Your commentary also attacks my article for its lack of comprehensive analysis of all of the benefits and features, as well as risks and negative attributes, of FIAs. But my article was not designed to be an all-inclusive overview of FIAs; while the editors at RIABiz have been most gracious in permitting the somewhat lengthy articles which I tend to write to be published, I doubt they would approve of an article ten times the length, as would be required to provide such a comprehensive analysis. The limited purpose of my article was to point out to RIAs/IARs the types of risks of FIAs which exist, and other material facts, which RIAs/IARs may be required to disclose in accordance with SEC rules and the adviser’s general fiduciary obligation under state common law.

You commented that: “While you mislead your readers into believing that indexed annuity contracts are long and/or difficult to understand, you need to not lose sight of the fact that every client needs to bear responsibility in understanding the paperwork that they sign and ask questions if they do not understand.” First off, you sorely miss the point – the client of a fiduciary possesses only a limited “duty to read” under the law. The SEC’s relatively new rule regarding Form ADV Part 2A explicitly requires “that advisers explain the material risks involved for each significant investment strategy or method of analysis they use and particular type of security they recommend, with more detail if those risks are unusual.” Not only would failure to undertake required disclosures of the material facts and risks of an FIA, by an RIA, be a violation of SEC rules, but also failure of a fiduciary to disclose material facts is actionable fraud. Hendry v. Wells, 650 S.E.2d 338 (Ga. App., 2007). Moreover, when a fiduciary relationship is imposed, the duty that the party signing a contract to read it first and know what it contains becomes the fiduciary’s duty to fully disclose the facts. Thigpen v. Locke, 363 S.W.2d 247, 251-52 (Tex. 1962). I am not suggesting that the client’s entire duty to read is abrogated; rather, only that when an adviser is already in a fiduciary relationship with the client, the client’s duty to read and understand is somewhat circumscribed. A fiduciary adviser in such circumstances possesses a far higher obligation to ensure (affirmatively) not only disclosure of material facts, but also client understanding of same, and such obligations would not be satisfied by merely furnishing the annuity contract to the client.

Second, you imply that indexed annuity contracts are not “long and/or difficult to understand” despite reciting as well that such contracts average a “mere 26.7 pages long.” Also, the length of your reply to my article suggests that annuity contracts possess many features that are, indeed, highly complex and difficult to understand. Additionally, in all my years as an attorney and investment adviser, I have never met a single client who reasonably understood an FIA which had already been sold to him or her. Most were unaware of surrender fees (even though they are set forth in, as you put it, the “minimum-NAIC-required font size on the third page of the contract.”) Fewer clients still were aware that the values of their contract (and its internal rate of return) for purposes of withdrawals could be (for many FIAs) much less than the values achieved (and rates of return) achieved for purposes of subsequent annuitization of the FIA.

This complexity of FIAs did not go unnoticed at the SEC, whose attempt to protect investors by regulating annuities as a security was overturned by Congress, following intensive lobbying (and huge campaign contributions) by insurance companies. The SEC noted: “The growth in sales of indexed annuities has, unfortunately, been accompanied by complaints of abusive sales practices. These include claims that the often-complex features of these annuities have not been adequately disclosed to purchasers, as well as claims that rapid sales growth has been fueled by the payment of outsize commissions that are funded by high surrender charges imposed over long periods, which can make these annuities unsuitable for seniors and others who may need ready access to their assets.” (The SEC cited the Letter of Susan E. Voss, Commissioner, Iowa Insurance Division, dated Nov. 18, 2008, “acknowledging sales practice issues and ‘great deal’ of concern about suitability and disclosures in indexed annuity market.”). See also FINRA, Equity Indexed Annuities – A Complex Choice (updated Apr. 22, 2008), available at: http://www.finra.org/InvestorInformation/InvestorAlerts/AnnuitiesandInsurance/Equity-IndexedAnnuities-AComplexChoice/P010614 (“FINRA Investor Alert”) (investor alert on indexed annuities); Office of Compliance Inspections and Examinations, Securities and Exchange Commission, et al., Protecting Senior Investors: Report of Examinations of Securities Firms Providing ‘Free Lunch’ Sales Seminars, at 4 (Sept. 2007), available at: http://www.sec.gov/spotlight/seniors/freelunchreport.pdf (joint examination conducted by Commission, North American Securities Administrators Association (“NASAA”), and FINRA identified potentially misleading sales materials and potential suitability issues relating to products discussed at sales seminars, which commonly included indexed annuities); Statement of Patricia Struck, President, NASAA, at the Senior Summit of the United States Securities and Exchange Commission, July 17, 2006, available at: http://www.nasaa.org/Issues___Answers/Legislative_Activity/Testimony/4999.cfm (identifying indexed annuities as among the most pervasive products involved in senior investment fraud); NTM 05-50 … (citing concerns about marketing of indexed annuities and the absence of adequate supervision of sales practices).” http://www.sec.gov/rules/final/2009/33-8996.pdf, at p.10. [Emphasis added.]

You question the basis for my statement that “indexed annuities have ‘lax insurance sales practices?’” See the discussion, in the paragraph above, for the well-documented and credible authority underlying my statement.

Your comments also take great pain to point out that FIAs are not “investments.” Yet you also call FIAs “safe money products.” Your attempt to draw such a fine line of distinction is unusual, but illustrative of many of the fine lines you attempt to draw in your many comments. I would note that even Merriam-Webster defines “investment” as “the outlay of money usually for income or profit.” Also, so often insurance agents refer to FIAs as investments (for example, “the answer to the question ‘Are Fixed Index Annuities A Good Investment?’ is yes, they are a good investment choice” – appearing on an insurance agent’s web site, discerned very easily in a simple web search.) Moreover, there is no doubt that consumers view FIAs as an “investment” – as that word is used in every day English.

While you sought to opine that FIAs are not an “investment” for regulatory purposes, you also misstated the law in this regard. The regulatory distinction is (or was) that nearly all FIAs are not “securities” under prior law (prior to Rule 151A and prior to Dodd Frank), in that FIAs would escape regulation as a security – as long as they were not sold as an “investment.” In United Benefit, the U.S. Supreme Court, in holding an annuity to be outside the scope of Section 3(a)(8) exemption found in the ’33 Securities Act, found significant the fact that the contract was “considered to appeal to the purchaser not on the usual insurance basis of stability and security but on the prospect of ‘growth’ through sound investment management.” Under these circumstances, the Court concluded “it is not inappropriate that promoters’ offerings be judged as being what they were represented to be.” Prior to Dodd Frank Act, many insurance companies offering FIAs offered substantial guidance to the insurance agents selling them on how to promote the sales of FIAs without calling them an “investment.”

While you list many reasons for the surrender fees for an FIA, you fail to note that a major purpose of surrender fees is to compensate the insurance company for the commission already paid to the agent, which often cannot be recovered by the insurance company after a relatively brief time period if the FIA is surrendered by the customer. You also note my observation that indexed annuities’ surrender charges “last as long as 20 years” and “can be as high as 25%.” I have personally reviewed such a policy. Such policies continue to exist – most have not yet reached their termination, and hence such existing policies may well find their way into a review undertaken by a fiduciary advisor. I was pleased to hear that, as to new policies being issued at present, your observation that “There is no indexed annuity available today with surrender charges over 16 years.” Yet, I was disappointed to learn of your observation that “the average surrender penalty is just under 11% in the first year.” There are likely many fiduciary investment advisers who would share my view that an 11% surrender fee, and the likely high commission it supports, seems unconscionable for the sale of an investment product which (generally) does not impose upon the insurance agent any duty to continue to monitor or provide advice after the sale of the product.

You state that “there has never been a product feature more miscommunicated than the concept of dividends being excluded from the crediting calculation of indexed annuities.” I concur, as to the UNDERSTANDING of investors of this exclusion of dividends and its impact upon possible returns seen. The point of my article is that, as a fiduciary, the RIA possesses the duty to understand this feature and its potential effects (i.e., an S&P 500 index fund might earn the cap of 9% over the time of a point-to-point calculation, but the FIA investor tied to such index will earn much less). Moreover, the fiduciary advisor possesses a duty to ensure client understanding of this limitation.

You emphatically state that, and I quote verbatim: “INSURANCE AGENTS DON’T NEED TO SUGGEST THAT PROSPECTIVE PURCHASERS SELL THEIR SECURITIES IN EXCHANGE FOR THESE PRODUCTS WHEN THE PURCHASER’S INVESTMENTS HAVE DECLINED IN VALUE 50% OVER A ONE-YEAR PERIOD.” Individual investors who would have followed insurance agent’s “suggestions” at the time would have done so at their folly. However, it must be recognized that, generally, an insurance agent has no present duty (except in limited cases in which a relationship of trust and confidence is formed, or the agent is subject to regulation due to his or her activities as an RIA/IAR) to evaluate risk and returns of various investment strategies. Nor does an insurance agent possess the duty to undertake due diligence upon, and then counsel clients on, the risks and potential rewards (and opportunity costs) of many different investment strategies. I would note that a fiduciary investment adviser would rarely have suggested that a client move out of the stock market, and into an FIA whose potential returns possess a relatively low cap, precisely when expected returns of stock asset classes were at the highest seen in many, many years. The high returns of stock asset classes actually seen since early March 2009 reflect those high expected returns. It would have been extremely poor judgment by anyone to provide blanket advice to customers to get out of the market at such time, as you suggest occurred by some sellers of FIAs. Fiduciaries understand that stock market investing is a long-term endeavor, and that the biggest mistake most individual investors make (apparently aided by sellers of FIAs) is to “sell low.” See, e.g., DALBAR, Inc., 2010 QAIB (“Quantative Analysis of Investor Behavior”) Adviser Edition. A major role of investment fiduciaries today is counseling investors to be patient. The duty of care of a fiduciary is just far greater than that of an insurance product salesperson.

In your numerous comments, you take my observations out of context frequently. For example, the comments about market risk relative to insurance company default risk. I never stated that variable annuity contract owners are not subject to market risk (and other risks, of which there are many types); such was not the focus nor scope of my article. However, I would further note that the risk of insurance company defaults has received a lot of recent attention. “Since the 1980s a long list of defaulted life insurance companies in Europe, Japan and the United States has been reported.” An Chen, Default Risk, Bankruptcy Procedures and the Market Value of Life Insurance Liabilities (2007) (an article written prior to the substantial decline in capital seen in many insurers). The point of my article is that insurance company financial strength is a key consideration in the evaluation of FIAs, designed by their nature to be longer-term investments; indeed, counter-party risk of every form must be evaluated by a registered investment adviser when undertaking due diligence on any form of investment.

While I could go on and readily rebut nearly all of your contentions, time does not permit me to correct each one of the mistakes you make in your comments. My rebuttal would be quite long, as I would have to frame each of your out-of-context comments back into the scope and focus of my article – an exploration of the material facts and risks of FIAs, and consequently those material facts which fiduciaries would likely do well to disclose to their clients. You ignore the framework of my article, which I suspect is because you do not appear to possess fiduciary obligations and hence may be unfamiliar with what they require.

Ms. Moore, you tout that you are an “independent market research analyst” – yet your comments admit that you focused on indexed annuity and life products exclusively. Additionally, on your own web site you acknowledge your “strong relationships with nearly every carrier in the indexed product market.”

Your comments took aim at me, FINRA, the Alabama Securities Commissioner, and a respected reporter from a national publication. I stand behind my article. I leave it to the others – highly regarded securities regulators and a highly respected national publication – to respond to you if they desire.

I am well aware of the insurance industry’s attempts at times to intimidate those who might be critical of insurance companies or their products, or (as I perceive it) the lax market conduct regulation relating to insurance product sales. I must point out that in my article, and even in my byline, I made no mention of either my current or my future employer. I write this column as a means to educate advisers, not to market my firm. Moreover, my byline expressly noted: “The foregoing article represents Ron’s personal views and are not necessarily the views of any organization or firm with which Ron is associated.” HOWEVER, despite this disclosure, you somehow felt compelled to set forth in your comments the name of my present employer – a fee-only registered investment advisory firm. You also saw fit to mention (despite no discussion of same in my RIABiz columns at any time) the name of a highly respected future educational institution at which I have accepted an appointment as an Assistant Professor commencing in August 2011. More troubling is that you also felt compelled to directly e-mail not only my firm, but also the President and Dean of the College at which I will soon be employed, with the entirety of your out-of-context criticisms, suggesting therein that “a serious lack of journalistic integrity” occurred – along with many other insinuations. My personal reaction to this attack is profound disappointment – that we cannot possess a serious discussion of the many issues involving insurance products without being subjected to such a personal attack. Additionally, if the purpose of these e-mails to my firm and to my future employer was to seek to intimidate mein some fashion, please rest assured that I will not be so intimidated.

From the tone and content of your comments, and your failure to understand that the focus of the article was on the due diligence and disclosures required of fiduciary advisors when engaging in sales of FIAs, it appears that your personal economic interests (and possibly those of the industry to which you possess such close ties) may have clouded your ability to perceive the scope and purpose of my article. I am not surprised, as there is much academic research that has demonstrated that advice which is biased due to undisclosed conflicts of interest is poor advice. Moreover, recent academic studies also conclude that advisors possessing serious material conflicts of interest (such as those who can sell one product with a higher commission, versus another with a lesser commission) provide even worse advice when disclosures of the conflict of interest are undertaken. See, e.g., Paul Thagard, The Moral Psychology of Conflicts of Interest: Insights from Affective Neuroscience (Journal of Applied Philosophy, Vol. 24, No. 4, 2007) (“Rationalization seems relevant to understanding conflicts of interest because compromised decision makers may construct self-serving explanations of why they acted as they did, insisting that they were just doing their jobs, or even that they thought they were acting in accord with their professional obligations.”). See also, e.g., Daylian M. Cain, George Loewenstein, and Don A. Moore, When Sunlight Fails to Disinfect: Understanding the Perverse Effects of Disclosing Conflicts of Interest (Aug. 27, 2010) (“[A]fter a conflict of interest has been disclosed, advisors may feel that advisees have been warned and that advisors are “morally licensed” to provide biased advice … The most effective antidote for the problems caused by conflicts of interest is not to disclose them but to eliminate them … Disclosure is much less likely to help individuals such as personal investors, purchasers of insurance … who are unlikely to possess the knowledge or experience to know how much they should discount advice or whether they should get a second opinion in a given conflict-of-interest situation ….)

A recent report suggests that the” Dodd-Frank financial services reform legislation, especially the provision mandating a uniform fiduciary standard, will require changes in organizational processes, product development and marketing practices if the companies want to remain competitive. Life & Health National Underwriter aricle, “Report Foresees Changes for Angets and Brokers in Wake of Dodd Frank.” http://www.lifeandhealthinsurancenews.com/Pages/Authors.aspx?key=NU ONLINE NEWS SERVICE> Published 4/5/2011. Until this occurs, fiduciary registered investment advisers – representatives of their clients, not the product manufacturer- will continue to serve as a bastion in protecting the best interests of their clients.

For my own part, I have and will continue to recommend no-load fixed IMMEDIATE annuities (but not fixed indexed annuities) to the clients of my firm when their overall personal financial situation and the overall market environment so dictates. However, currently there is no fixed indexed annuity which passes my firm’s due diligence testing, for the many reasons previously explained. As a fiduciary I consider, as the expert trusted advisor upon which my clients rely, all of the risk and return characteristics of dozens of potential investment strategies each year. I select only those few investment strategies, and investment products, which pass our firm’s strict due diligence requirements. My firm will continue to utilize the collective knowledge and expertise of our professional advisors to serve our clients in a truly objective fashion. We adhere to not only SEC but state common law fiduciary principles, including where appropriate an observance of the Prudent Investor Rule. [See, e.g., Erlich v. First Nat. Bank of Princeton, 505 A.2d 220 (N.J.Super.L., 1984) (“The obligation of the (professional investment adviser) to give prudent advice is the standard of care to be applied in this case. This is a higher standard of care than that found in the ‘Know Your Customer’ and ‘Suitability’ rules.”)]

I stand behind my article, and its conclusions, including but not limited to these: “In all of my research to date I have yet to come across a fixed indexed annuity which I would recommend to a client … when a fiduciary engages in the sale of FIAs, much more is required than just presenting standard sales literature, gathering basic information regarding a client’s situation, and ensuring contract forms are signed … if your own due diligence efforts leads you to recommend a fixed indexed annuity product to your clients, I suggest a multitude of disclosures occur, in writing, at the time of undertaking such a recommendation. (Most of these disclosures may also be required in the RIA’s Form ADV, Part 2A, if sales of FIAs are a “significant” investment strategy utilized by the RIA.)”

At the same time, I would encourage insurers possessing of high financial strength to explore entering this market and providing a no-load FIA with better features and higher potential returns. If this were to occur, then such an FIA may well survive our firm’s due diligence processes and be recommended to our clients in those situations in which they would best serve our clients’ needs.

The fact of the matter is that FIAs involve several forms of real risks to consumers, and that registered investment advisers possess the obligation, as fiduciaries, to uncover those risks and to affirmatively disclose them to their clients. Due diligence involves, as to investment strategies and products, the weighing of all risks, and fees and costs (whether explicit or implicit) against potential returns. The weak protection afforded by the suitability doctrine (applicable to registered representatives and insurance agents who are not also fiduciaries) results in many sales involving FIAs, which sales many fiduciaries would not have recommended. Of course, the much higher duties of due care and loyalty – and the due diligence required of a fiduciary arising therefrom – are paramount obligations of registered investment advisers. It is for fiduciaries that I wrote the article. I don’t expect that those who are engaged in product sales only, or those with” strong relationships with nearly every carrier” who in turn advise such product sellers, to either understand, or embrace, the fiduciary obligations which were the focus of my article.

Ron A. Rhoades, JD, CFP®
E-mail: ron@scholarfi.com

Sheryl J. Moore

Sheryl J. Moore

April 9, 2011 — 4:14 PM

Mr. Rhoades,

Thank you for your response.

Your article in no ways threatens my company’s ‘economic livelihood.’ I could do what I do today on any other product: fixed annuities, indexed life, whole life, etc. As the foremost authority in the indexed insurance market, I do many things beyond running an independent third-party market research firm. And although I do not endorse any company or financial product, I make no secret of the fact that I am a big fan of indexed insurance products.

That being said, I do everything I can to educate others on these products and the market, and I would say that I have been very successful in helping to build the indexed markets to their present sales levels because of my educational efforts. However, I have never claimed to be a LIMRA. If you are looking for someone that doesn’t have opinions on one product class over another, that individual is not me.

I started this company years ago because my previous employer didn’t communicate that I could lose money in a 401(k) and that changed my life dramatically. I subsequently lost ALOT of money in my retirement account after the dot.com bubble burst, despite my risk aversion. As a single mother of three children with no child support, I was devastated by the loss of more than a year’s salary in a period of less than a single year. My boss at the time asked why I hadn’t purchased an indexed annuity instead of investing in a 401(k). I didn’t even know what an annuity was at the time. He explained that it was just a different type of vehicle for retirement income; one that would guarantee that I would receive a paycheck for life, no matter how long I lived. I asked where I could buy an indexed annuity. He informed me that the company I worked for was the #1 seller of indexed annuities in the country. I am certain you can imagine how I felt after finding this out.

I have done competitive intelligence, market research and product development on fixed, indexed, and variable insurance and annuity products. I have owned numerous types of investments. However, my reason for starting this company is because I think that the indexed annuity/indexed life story is PHENOMENAL. Yet, everyone I asked about these products prior to starting this company had never heard of them. They were ignorant, but wanted more information about the products. The basis for my taking the risk of starting this company was to educate others on indexed insurance products. I find it despicable that every American knows what a 401(k) is (and they often have the product shoved down their throats by their employer’s HR rep), despite the fact that it isn’t always a suitable product choice for them. Meanwhile, millions have no idea what an indexed annuity is despite the fact that this product may possibly a more suitable vehicle for their retirement savings goals.

Since starting this company, I’ve been offered many positions paying hundreds of thousands of dollars a year with impressive benefits packages by many an insurer or marketing group. Yet, I continue to work as CEO of Advantage Group, making less than $100,000 a year. I do what I do because of my morals and ethics. This has nothing to do with money or the perpetuation of my business. I don’t work a single day in my life; I get to do something that I love, something that I am passionate about. If I can keep doing that every day until my death, I will die a happy woman. Hopefully at that time, it will be said that I spent my life educating Americans on the facts about indexed insurance products. Until that time, I will do whatever necessary to ensure that I further my cause.

I do many things in my pursuit of educating people about indexed insurance products, and running a market research firm that specializes in indexed insurance products is one of them. However, you will never hear me promoting variable annuities, mutual funds, or even whole life insurance products. I am not a big believer in these products although I do believe there is a legitimate use for them. I just will never be the one to promote them (let someone who has been personally affected by these products do that). I just don’t feel passionate about these products because my life experiences have shaped my perspective on financial services products. Consider: my grandmother rolled-over her pension into a variable annuity product that with a GLWB (which I assisted in developing). Incidentally, she lost thousands of dollars when the market collapsed in 2008. Admittedly, an indexed annuity would have been a much better choice for her, but the agent that she worked with was a career agent that only had fixed and variable annuities at his disposal. Two dramatic stories about loss of retirement income have affected me personally. These occurrences, fueled by similar stories for thousands of people that I do not even know, are what have motivated me to educate others on indexed insurance products. And while I could certainly do what I am doing on many different product lines, I’ve chosen to reserve my efforts over the past 13 years to this market that was once so small. There is just too much work for me to do in even this market, much less expand my efforts beyond indexed insurance products.

While it is true that I have had to become involved in many things in addition to pure market research because of my position in this industry, I still maintain my independence. I don’t care if anyone purchases an indexed annuity or not, as long as they understand how it works and that it is an alternative to many products that they are already aware of. Because of my knowledge, background, and independence, my market research firm has relationships with every carrier in the indexed product market as well as the distributors and agents that sell the products. However, I also have relationships with most every carrier in the fixed and variable life and annuity markets, as well as regulators, legislators, trade groups, and consumer protection agencies. I do not work on behalf of these entities; I work on behalf of MYSELF. We run several subscription websites and compile sales and market trend data. I also write prolifically and speak throughout the country. I won’t further the market at any expense; I will admit the bad while I also promote the good. Search my newsletters, articles, and blogs and you will find equal coverage of insurance companies in the negative spotlight because of their of indexed annuities sales, insurance agents losing their licenses while using indexed annuities in their pursuit of bad behavior, and more. Those who work with me know my story and it works for us. I do not make a single penny off of the sale of indexed life or indexed annuity products. In fact, I spend tens of thousands of dollars each year on my own insurance and annuities and have another insurance agent make the sale, despite the fact that I have long been a licensed insurance agent. You see- I’d rather maintain my credibility as a third-party expert, than have someone speculate that I favor Company A because I bought their product. So, another individual makes thousands in commissions off of me each year in exchange for signing the paperwork that I fill-out. I am the best client my agent has! That being said, I could do what I do today on fixed or variable annuities, whole life insurance or even bank CDs. However, I don’t have a PASSION for other financial services products the way I do for indexed life and indexed annuities. My personal experience changed my life. I have committed my life since that change to ensuring that no one else has to go through what I have.

If you don’t like it, that is fine. You don’t have to do business with me. However, I do have to ask that you reserve your public comments on indexed insurance products to the facts. Like you have done in your response to me, thousands of others use articles or statements that they find on the web as a legitimate, factual source of information on indexed annuities. This is about as credible as sourcing Wikipedia for the information in your doctoral thesis. I care not what the focus of your article was on; you made some inaccurate statements about indexed annuities in the piece. That is the extent of my concern and my reason for contacting you. And although I have a tremendous respect for the fiduciary’s obligations, I am ashamed that someone would make inaccurate statements about any product in their efforts to communicate this standard of care to the fiduciary. This is the premise for my contacting you, Mr. Rhoades. Likewise, I stand by my comments about FINRA, Joe Borg, and the reporter. Anyone who publishes inaccurate information about indexed annuities or indexed life insurance products in a public forum is likely to hear from me about the folly of their methods. Even those that are considered to be ‘highly regarded’ sometimes make mistakes. And although they may be credible on one type of financial services product, that does not make them an authority or credible resource on indexed annuities. You, and so many others, would do well to take note of it.

And like you, I haven’t the time to perpetuate a listless response to each of your points. However, I will respond to a few that caught my eye in particular. I want to provide you with factual information on these products and reduce your reliance on sources that are not credible when it comes to indexed annuities. First, I understood well your position and it does not change the fact that you are more oriented toward securities, not insurance products.

In addition, it would be silly to suggest that the insurance industry’s lobbyists are more powerful or have more financial influence that the lobbyists of the securities world. Therefore, a suggestion that 151A was overturned simply because of money is asinine. Many people worked very hard on the legislation in question and although I cannot speak for everyone, I spent endless hours in meetings, on teleconferences, and on phone calls with my legislators until Obama signed the Dodd-Frank Finance Reform Bill last July. The data that I provided to members of Congress, most notably Congressman Harkin, was the ultimate source of action on the amendment in question. I was paid nothing to provide information on how indexed insurance products work, how effective the current regulatory structure of the NAIC was, how many jobs would be lost if indexed annuities were regulated as securities, or how much money would leave the state of Iowa as a result of securities regulation on these fixed insurance products. I did this tireless work because these products are legitimate and the level of inaccurate information in the media is so expansive that outsiders cannot separate the truth from fiction. Articles like yours have contributed to this unfortunate circumstance for nearly 16 years. I am doing what I can to end such perpetuation and my work on 151A is only one example of this.

And although the SEC initially stated that the premise for Rule 151A was “complaints of abusive sales practices,” they changed their tune after I submitted my comment to them on the rule (attached), providing them with the same factual NAIC complaint data that I provided to you. You’ll notice that in the final rule 151A, the SEC comments changed in light of receiving this data, and they proposed that their rule was truly based on ‘risk’ (the risk that the purchaser would not know what about of credited interest they would receive above 0%). Furthermore, I would like to draw your attention to the fact that although I have provided you with FACTUAL data from an NAIC complaint database, you assert that insurance sales practices are ‘lax’ as evidenced by comments and hearsay from sources that are not credible on indexed annuities (FINRA, SEC, NASAA). I have provided ample evidence of these groups perpetually making inaccurate statements on indexed annuities as well. It is because of the reliance on such discredible sources as yours, that the perpetuation of inaccurate information on indexed annuities has risen to its current level. I again urge you to evaluate the material misstatements that have been made about these products by those you rely on so heavily.

Similarly, I would suggest that you not rely on information on insurance agents’ sites found on the internet. I never said that there is no such thing as an insurance agent that calls indexed annuities an ‘investment.’ I pointed-out that the NAIC does not permit the use of the word ‘investment’ in conjunction with fixed insurance products such as indexed annuities. A single agent’s lack of integrity on this matter does not provide solid evidence that it is a generally-acceptable industry practice to refer to these products as securities.

Did you truly read all of my email? As I mentioned, the average commission on the products is 6.37%; a commission that is paid a single time while the agent is intended to service the contract for life. I could hardly call this commission ‘high’ when you compare it to the generous commissions that are paid on products like stocks, bonds, and mutual funds every year. And although the average surrender penalty on these contracts is just under 11% in the first year, this penalty is providing a hedge against the risk that the policyholder will cash-surrender their annuity only to receive the generous up-front premium bonus that accompanies the average indexed annuity in the early years of the contract. It is true that surrender charges cover commissions, but you fail to acknowledge that they also cover premium bonuses.

It is not surprising to me that you are unaware of the fact that ‘insurers possessing high financial strength’ have offered ‘no-load’ indexed annuities. Again, doing a little fact-checking, prior to publishing articles, goes a long way.

In closing, I’d like to address my method of contacting you and those that you report to. I feel that anyone that is in a position to influence others in a position of authority, and particularly in a position as an educator, should be held to the strict standard of integrity. I did not intend for you to perceive my email as a personal attack on you. My apologies if you received it as such. I certainly would not attempt to intimidate you, as I hardly feel that someone in your position would find a young woman like me to be a threat. I frequently enjoy the opportunity to ‘seriously discuss the many issues involving insurance’ and securities products with many that I do not agree with. As long as they have their facts straight, I take no issue with them and enjoy these spirited debates. I may try and present data to change their perspectives, but I respect their positions. On the other hand, I do intend to make it very clear to you and others that it is inexcusable to publish inaccurate information in a public forum. Perhaps you fail to realize that consumers are more financially-savvy today than ever before and the internet is a source that they have come to rely on heavily for their research? Had I access to accurate information on indexed annuities (particularly via the internet), prior to enrolling in my previous employer’s 401(k), perhaps I would be able to retire much sooner. You must be cognizant of the fact that your articles have the power to influence not only your intended audience, but also these consumers. I have zero tolerance for those who pursue their objectives while blind to the facts and the methods used to ensure accuracy in their pursuit. It is on this basis that I copied the editors of RIABiz.com and your colleagues. RIABiz had a right to know that they had published inaccurate information. Such inaccuracies reflect poorly on them as a source of credible financial services information. Your current and future employers have the right to know that you represent them while making disparaging, inaccurate comments on financial services products in a public forum. These inaccurate statements also reflected poorly on them.

As for your profound disappointment, I now see that you understand how I felt when I read your article. Thank you for your response.

Sheryl J. Moore
President and CEO
Advantage Group Associates, Inc.
(515) 262-2623 office
(515) 313-5799 cell
(515) 266-4689 fax

John Olsen

John Olsen

April 15, 2011 — 1:25 PM

Generally a good analysis, but Mr. Rhoades misses the mark occasionally. For example, the fact that an index annuity does not entitle the buyer to the dividends paid by stocks included in the index is not a defect of the annuity. The annuity owner is not buying those stocks, merely options thereon (and that, indirectly). If you buy Call options on a stock, do you get its dividends? No. But that’s OK because you didn’t pay for them (and neither did the buyer of the index annuity).

Moreover, the fact that index annuity gains are taxed as Ordinary Income is not a defect, because the instruments to which an index annuity is properly comparable are taxed that way, too. An index annuity is a FIXED annuity. It is properly comparable to CDs, not equities.

The fact that participation rates and “caps” limit the upside performance of the index in which the annuity buyer may participate is also no defect. Those “moving parts” exist because the issuing insurer cannot give the annuity buyer interest based on the entire upside movement of the index unless that insurer bought options for that full movement. Except in periods of high bond yields and low option costs, an insurer does not have enough left from the buyer’s premium (after buying the bonds required to back contractual guarantees) to purchase enough Call options to give 100% of positive index performance to 100% of the annuity purchaser’s premium. That’s simply how it is. One may lament the fact that an insurer isn’t giving ALL of the upside of an index on EVERY dollar invested in the annuity, but that’s because the insurer GENERALLY (but not always) cannot do so. It must back the guarantees of the annuity by buying bonds. The money spent on those bonds cannot buy options. It’s really that simple.

Mr. Rhoads’ analysis suggests that he considers fixed index annuities as alternatives to equity investments (as he uses them as yardsticks); that notion is wrong when it’s expressed by an insurance agent selling those annuities, and it’s just as wrong coming from Mr. Rhoades. Buying a FIXED annuity, the non-guaranteed “excess” interest from which will be credited by reference to the performance of an equity index in which the issuing insurer has bought OPTIONS, is NOT – repeat, NOT – the same as, or even properly comparable to buying the stocks of that index or a fund seeking to mirror its performance. The risks are wholly different, as are the rewards.

- John L. Olsen, CLU, ChFC, AEP – co-author, “Index Annuities: A Suitable Approach” (Olsen & Marrion, LLC, 2010 – www.indexannuitybook.com).

David Merkel

David Merkel

June 22, 2011 — 3:51 PM

Very good article. As a former life actuary, I will tell you there is nothing new here. These are all the defects with EIAs that have been known for years. And, let me give you one quick “acid test” for buying insurance products. Ask an actuary if he would buy it for himself, his mother, etc. Odds are he will say no, except for term insurance, unless there is an advanced tax dodge going on for a wealthy person.

And yes, I have written much the same on EIAs elsewhere.



February 20, 2012 — 11:04 PM

Until I examined the use of FIA’s as a possible alternative to bonds in an investor’s allocation mix, I could not recommend them either. But, as an alternative to bonds in a rising rate world, along with the income guarantees and other liquidity features, I think they deserve further attention.

Furthermore, our job as investment advisors is not just about analysis. Whether we like it or not, we must also deal with investor behavior. Perhaps we should bring Dalbar research into the equation – and compare investOR returns, not just investMENT returns. I can design and implement the best conservative balanced investment model in the world, but if my clients can’t stomach volatility, like in 2008, then their abandonment of an otherwise solid plan will result in dismal outcomes. The use of annuities is a tool to help combat faulty investor behavior. The TOOL is not evil; just the improper sales tactics used to sell a product are. Let’s not throw the baby out with the bathwater.

Finally, let us consider the dismal failure of the RIA world to help clients achieve goals. 128 years of historical statistics does not help a client when they are the “1” in a “1 in x% chance” of failed outcomes. In other words, if that “black swan” event hits ME as an investor, should I feel okay that it should only happen once every thousand years? Can (DID?) your models and your advice keep your investors from harm in 2008? I doubt it. Mine sure didn’t to the extent they or I hoped they would. MY clients want to eliminate some of those risks. Immediate annuities and CD’s, and cash for that matter, are not providing the answers. I have a longer investment outlook than my father and mother, and many of my like-aged clients, and like my proven and profitable investment models. But I have watched too many people derail perfectly good plans, to their own financial harm, to sit by and do nothing. My DUTY is to help them find solutions that they can live with, not just what is statistically the best likelihood of the highest terminal wealth outcome.

I have incorporated annuities, and specifically FIA’s, into my practice as part of the fixed income sleeve a) as an alternative to incurring losses which will almost certainly occur when rates begin to go up again, and b) so that clients can let the rest of the investment strategies I employ actually do what they were intended to do over the long haul. They understand they are giving up some return potential, but they also sleep better at night knowing their nest egg wont evaporate when Wall Street’s next fraud dejour blows up. If they stick to a plan and receive even moderate returns instead of the returns Dalbar research suggests, then they are better off aren’t they?

Brooke Southall

Brooke Southall

February 20, 2012 — 11:42 PM

Thank you for adding these thoughts that capture your experience and still show respect for other views. I think that’s helpful.




November 2, 2013 — 4:40 PM


Your suggestion as an alternatice: the investment strategy utilized within the product could be replicated outside of a fixed annuity product (such as through a combination of fixed indexed investments and call options),

If you would spend more time on educating the regulators on how they have provide such poor oversight of the Advisor community at large then your time would be better spent.

I have recruited, trained and supervised hundreds of Registered Reps over the last 30 years and I can count on FINGER the number of Advisors that have been able to provide adequate financial advice over the last 30 years to the average investor!

FIA’s appear to me to allow for long term protection for the average investor to protect themselves from FEE BASED , Comission based or however you want to pay people, the constantly moving of their assets from one failed strategy to the next. Let’s see, we sell them 8.5% upfront growth funds in 90’s, then high annual fee B shares, then move into High Fee fund of Fund then to 1% RIA advisor accounts ( 'same side ' of the table crap ).

Spend more time finding ways to keep your clients best interest 'front and center’, not blasting a Financial Solution that for those that find it, will be protected from the ravages of another failed investment strategy from the Sanctimonious advisor community!

It’s not return on your MONEY, It’s return of your MONEY! The casinos and securities industry have a lot in common and buyer beware!

By not focussing on this one thought, the Advisor community has continuely provided POOR advice and as we will see again over the next 7-10 years of Market volatility, provide ZERO comfort to Boomers Retirement savings!

By the way, none of your responses to comments help your case of being biased!

John Olsen

John Olsen

November 2, 2013 — 7:35 PM

GPT: To whom were you addressing your reply?

Anthony Kosobud

Anthony Kosobud

June 2, 2014 — 7:37 PM

You creditability as a published writer would be more positive if you were to actually know the difference between a Fixed Income Annuity and a Fixed Indexed Annuity. Two completely different products. A Fixed Income Annuity (also known as a SPIA Single Premium Immediate Annuity or a DIA Deferred Income Annuity) has a low commission to it. It is based on mortality credits not interest rates. They can provide lifetime income and they can be tax-advantaged for clients in a high tax bracket who use non-qualified assets.

I work with many RIA’s who recommend their clients purchase one for those who do not have a pension (Defined Benefit Plans). These products can be a great compliment to a fee-based managed account (as long as the advisor uses products that actually have low internal fee’s).



February 12, 2015 — 2:34 AM

Great article. Thanks for the info, it’s easy to understand. BTW, if anyone needs to fill out a cyberdriveillinois, I found a blank form here http://goo.gl/HJKNjH

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