Retirement Expert Rants: Made-Up FIA Indexes

Hi, Stan The Annuity Man, America's annuity agent, licensed in all 50 states, including yours. What we’re going to talk about today are what I call made-up indexes out of midair in the Fixed Indexed Annuity world.

Let’s start with a bit of a disclaimer here: I sell Indexed Annuities. They are CD products, first introduced in 1995 to produce CD returns, not market returns. I like them for future income needs when you attach an Income Rider, and you know contractually what that Income Rider will produce.

For people out there who say, “Stan The Annuity Man hates all Indexed Annuities,” that is not true. In fact, I bet you I sell more Indexed Annuities than 98% of all agents on the planet. But I don’t like how some people sell them, and I don’t like what’s happening in the industry. The issue is that the carriers are making up indexes and index names out of midair.

What Is Happening with Indexed Annuities?

What do I mean by that? Most of us are familiar with the S&P index, NASDAQ, and the Russell 2000. The S&P 500 is typically the go-to index for index option call options. But what the annuity companies have done—and I completely disagree with it—is that they’re running back-tested numbers, algorithmic numbers, to look for a return based on a basket of investments. Once they find that return, they package it, place a name on it, and then add it to an Indexed Annuity. The sales pitch then goes like this: “Well, if you’d owned this index for the last 10 years, your return would’ve been this.”

In my opinion, you can’t say that because the index didn’t even exist for the last 10 years. In fact, it hasn’t even existed for a month. I understand the drive to sell indexed annuities, but there are some states now trying to outlaw this type of back-testing and algorithmic picking out of midair. I agree with them.

We don’t have to be that creative and create indices out of thin air. We don’t need the sizzle. You buy the steak, not the sizzle. There can’t be that kind of sizzle all the time. In my perfect world, I don’t think there should be any back-tested, projected, hopeful agent return scenarios. All back-testing should be illegal. Looking back and saying, “Well, if you’d have owned it back then, you would’ve gotten this,” is just wrong. Ten years ago, the economy, interest rates, and pricing of annuities were different. You can’t back-test like that.

The Reality of Back-Tested Returns

That goes for everything, whether it’s mutual funds (which I don’t sell because I sell fixed annuities) or indexed annuities. We should not be pre-packaging these things, and some of the most popular annuities being sold right now have indexes that we’ve never heard of. People call me up and say, “Hey, Stan. What do you think of this index?” And I reply, “I don’t know because it wasn’t even in existence until about six months ago.” Then they say, “Well, this guy told me that if you’d have owned it 10 years ago, you’d have made a 9% return.” What? That’s annuity 20/20 hindsight! We shouldn’t have to do that as an industry.

We shouldn’t have to create an algorithm to find a basket of investments to generate a return scenario that, if you’d owned it 10 years ago, would’ve reproduced that return. The public, unfortunately, isn’t always smart enough to realize how crazy and ridiculous that is. Now, I know some of the indexed annuity companies will say, “Well, it worked in this and that.” Okay, that’s fine. But that doesn’t mean we should do it. We shouldn’t sell the public on indexed annuities based on returns that never happened.

Why We Shouldn’t Sell the Hype

Why do we keep doing this? Why do we have to sell the three-card money? Why do we keep pushing the envelope and fitting square pegs into round holes? We shouldn’t be doing that. Why can’t we just say, “Indexed annuities are a great product”? They were created in 1995 to compete with CD returns. Since then, the average return has been just a little bit better than CD returns. So

, when you buy an indexed annuity, you’re getting CD-type returns, or slightly better, on average. What's wrong with that? Why do we always push the envelope for market returns and try to make the product sound sexier?

We all know that if it sounds too good to be true, it is. Every single time. And with a lot of these contracts, with these made-up indexes out of midair, the rules can be changed at the carrier’s discretion. If you’re going to buy one of these based on this pie-in-the-sky, unicorn-chasing-the-butterfly return scenario of an index that didn’t exist six months ago, then do your homework. Read the specimen policy. See if they can change the rules.

The Bottom Line on Indexed Annuities

Here’s the bottom line: Annuities aren’t market growth products. Fixed Indexed Annuities aren’t market growth products. I like them and sell them more than most people on the planet because I use them as an efficient delivery system for the Income Rider and as a CD-return product. But they are not market products.

If we continue down this road, talking about indexed annuities with market returns, then we are essentially selling securities. Now, I know the purists out there will say, “Stan, it’s a life insurance policy issued at the state level. It’s a fixed annuity.” Bingo. You’re right—it’s not a security. So why do we continually sell it as a security? Why do we sell it with market return scenarios? Why do we keep selling these non-guaranteed, pie-in-the-sky numbers? Why do we keep saying “market upside with no downside”? Why do we brand ourselves as an industry this way? We shouldn’t. We have a monopoly on lifetime income streams. No other product type can provide lifetime income, period.

When Indexed Annuities Are Sold the Right Way

If you’re buying an indexed annuity with an attached income rider for future income needs, and you’re only focused on the contractual guarantees of the Income Rider, fantastic. In my opinion, that’s the way they should be sold. Or, if you’re selling it without the income rider, you should say, “Mr. and Mrs. Client, this is a CD product. You’ll get CD-type returns. If we get a little bit better than that, great, but the average return will be CD-type.” But do not, do not buy into the hype about returns that would’ve happened 10 years ago if the index didn’t even exist.

Do Your Homework and Be Smarter Than That

Here’s the bottom line: I’m not saying don’t buy these made-up indexes. Just don’t look at the back-tested numbers. If you like the sound of it, the basket of investments, or stocks, or whatever it has inside, and you like the story, then buy it. But do not look at back-tested numbers. Do not allow an agent to show you back-tested, “If you’d have owned it back here when it didn’t exist, you’d have gotten this return.” Be smarter than that as a consumer.

For the industry, we need to revisit the fact that we might not want to do back-tested numbers. We might not want to mislead the public. In my opinion, we are misleading the public. I know the industry will argue with me and say, “We’re not misleading the public,” but when you show back-tested numbers and pie-in-the-sky return scenarios for indexes that didn’t exist back in the day, you’re misleading people.

The people looking at annuities want to believe it’s true. They want to believe they can get those pie-in-the-sky returns. Maybe some years they will, but as an industry, we need to clean it up. As a consumer, you need to be very aware of what’s being sold. So, if someone shows you back-tested numbers, no matter the index, you should say, “I don’t care about that. I like the sound of it going forward.”

Do not make a decision based on past performance. Annuities aren’t investments—they’re contracts—but especially with annuities, do not buy the back-tested numbers. Do not buy the dream. You will own the contractual reality.