Do Insurance Companies Use Options for Indexed Annuities?

I received a somewhat tense call a couple of weeks ago.  Actually it was three calls with the first one being a voicemail and the other two coming a few hours apart.  I stay very busy so catching me on the phone is not that easy, especially when it’s a number I don’t recognize.  The last call came just as I was finishing my day and was mentally drained from everything I had done.  I answered because this guy wasn’t going to give up so I might as well answer his questions and turn it into a scheduled appointment if that ended up being necessary.

Ted did not call to ask any questions but rather to level some accusations at me.  He said I was spreading misinformation in regards to fixed indexed annuities and that my efforts amounted to either naivete because I’m so young or that I might likely be a con artist.  He mentioned that he had been a CPA for several years and thought it was probable that I just didn’t have much experience.  Financial products and services have changed dramatically over the last several decades and CPAs don’t deal with financial products anyway. One who has been around for 40 years or more isn’t required to do continuing education related to financial products even if he is still licensed to complete tax returns for individuals or businesses.

Let’s get to the meat of this and I’ll finish with more about the phone call.  Ted accused me of lying about insurance companies using market options to produce returns in fixed indexed annuities.  I’m not quite clear on how he suggested it was done according to him, but he didn’t let me get in a lot of words and trying to communicate a simple example resulted in us being even less able to communicate.  He was not looking to have a conversation, rather he called to tell me something.  This was a direct contradiction to everything I’ve learned about the products in the past 20 or more years.

Now, being a somewhat public figure in this space doesn’t come without making certain connections and having opportunities to learn from some pretty high-profile guys.  This is where I learned much of the information shared on this website.  It also opens me up to criticism of which I’ve received very little.  Surely if my information were found to be inaccurate I would have known about it by now.  If this CPA had something to teach me it would be news for sure.

I have heard from insiders within the company, namely actuaries and investment officers, who speak generally about pricing options to keep indexed annuities competitive and sustainable.  Using this information has enabled me to provide some of the most transparency you will find in the business.  No equivalent exists online to my knowledge.  This didn’t prevent Ted from questioning me even more and doubting the source of my information.  Nothing would satisfy him as he talked over me time and again while I tried to provide an example.

The call was cut short when I decided to raise my voice only to get the point across.  He was upset by that and hung up on me.  Remember, it had been a long day and I reserve the right to be short with anyone who questions my integrity after hours of honestly answering questions.  I’d be happy to get on the same page and have the call with him again so that we can settle things.

Either way, I immediately reached out to one of the most responsive and respected contacts I have to clear it up and see if I had indeed been misleading people.  Kerry Pechter, of the Retirement Income Journal, does not have a dog in the fight and has been a friend of mine for several years.  He reports on how the industry works and has been an invaluable resource for consumers and professionals alike.  I relayed the basics of the conversation to him and this is how he replied:

“As I understand it, indexed annuity returns are based on the appreciation of options on a selected index. The options [on a one-year contract are purchased with an options budget based more or less on the expected one-year yield of the issuer’s general account. The FIA owner does lose money if the index goes down–he loses the yield he would have gotten on a MYGA. In other words, there’s an opportunity cost.” 

Kerry has been reporting factual information on all types of financial products and inside industry information for a damn long time.  If I can trust anyone to give me something solid, it’s him.  He also offered to introduce me to a professor of finance at a major university who has done deep research on the topic.  Bingo!  That’s just the type of third-party verification I needed to increase my confidence in sharing this information.  He set up a really good contact with someone who had done deep research and written research reports on the subject.  I emailed the guy and he scheduled a call with me right away.

I delayed this podcast for a couple weeks so I could talk to the professor.  The last thing I wanted is to just double down on something that anyone could call into question.  We spoke yesterday so I am writing this today.  When I asked him whether insurance companies use market options to create yield on indexed annuities he responded, “How else would they do it? I mean, they have a bond yield on the portfolio and a spread to create profits.  What’s left is the interest paid on a fixed annuity.  If they are trying to beat the bond or the fixed rate, there’s no other way to create a 10% yield when bonds are only paying 5%.”  I was surprised by his nonchalance but it wasn’t unexpected.  It was the answer that I knew to be true.

So we just answered the question, yes, insurance companies use options to create returns on fixed indexed annuities.  The only thing you lose as a contract owner is the opportunity cost of the interest you could have earned on a MYGA, CD or bond.  Your principal is never at risk.  Sure, there is pooling of assets because there’s no way an insurance company will make a transaction based on your annuity alone.  The interest earnings from your contract are only part of what they use along with the interest earnings from every other person.  Options are purchased with the earnings of the insurance company so the principal of the contract is never at risk.  How is that different from what I’ve said before?

Fixed indexed annuities are comparable to MYGAs, CDs, and bonds.  If you are wanting to protect some money with no fees but want to try to beat bond yields then a fixed indexed annuity is worth considering.  Some really nice yield potential exists right now so get on my calendar if you’d like to look at some options.

Have a great weekend!

Bryan

Podcast Episode155: Do Insurance Companies Use Options for Indexed Annuities?

Last Updated on October 11, 2024 by Bryan Anderson