September 10, 2008
I will state my actual opinion on whether Index Annuities should be regulated as securities toward the end of my comments but first I want to address a few points I feel are very important to clearly supporting my position on this issue.
First, all investment and insurance products have "risk" in the form of inherent strengths and weaknesses however, when referring to traditional "market risk", for the consumer, there is none in an Index Annuity. All market risk is borne by the Insurance Carrier who may win or loose on the underlying options positions purchased on the corresponding indices. The consumer does not bear market risk - any of it.
One might argue that the limits to potential returns on Index Annuities - such as imposed by Caps, Spreads, Participation Rates, etc. - might pose Risk in the form of potential opportunity costs. It is important to note that the insurance company maintains complete control (within certain limits determined and spelled out in the annuity contract) to adjust these variables at will (possibly suppressing caps to recover losses from mispriced or overly aggressive caps early on) thereby potentially significantly reducing the investors return. This more subjective "risk" is in my opinion real "risk" but is by no means the exclusive domain of Index Annuities or a reason to regulate them as securities.
Furthermore, most deferred Index Annuities carry surrender charges, Market Value Adjustments and other restrictions and limitations. All of which are spelled out in the contract (albeit in hieroglyphic legalese undecipherable to many if not most). These elements and provisions are neither good or bad in themselves, in fact without them it would be impossible for the insurance company to bear the "market risk" and design the product in the first place. However, failure by some insurance agents to clearly and accurately understand a potential clients needs and disclose these important considerations, restrictions and limitations certainly presents "risk". I do not feel however that these types of issues in themselves necessarily warrant regulating these products as securities. While Index Annuities are in most cases extremely complex products (for the layperson) to clearly grasp all of the potentially positive and negative aspects of should they be regulated as securities due to their complexity?
However, one thing is for certain: we must assume that any consumer that purchases an Index Annuity is clearly doing so for the potential excess interest that may be earned by the relationship of the annuity to an underlying MARKET INDEX - otherwise they would purchase a more traditional annuity. It is important to note that Many Index Annuities now have multiple indices (both domestic AND global) that the investor can potentially earn excess interest from. Since this is a fact, it must also be assumed that the insurance agent selling the Index Annuity is therefore having at least some macroeconomic discussion of global and domestic markets to determine whether the client feels that he is likely to earn any excess interest (otherwise the traditional fixed annuity might be a better option). Furthermore, since many Index Annuities allow for the investor to build an allocation of multiple domestic and global indices this would be expected to potentially lead the insurance agent into a discussion of asset allocation regarding these domestic and global index choices. It is important to note that many insurance carriers have themselves constructed "blended" index choices within the contracts so that the Insurance Agent does not have to build an asset allocation necessarily - nevertheless, the agent must be able to explain these "blended" index choices clearly and accurately. I question whether it is appropriate for someone who has not demonstrated competency in capital markets issues to be selling products who's primary opportunity to earn returns is indelibly linked to the performance of varying capital market indices. I therefore believe it in the best interest of consumers to ensure that those selling Index Annuities have evidenced proficiency in these areas by passing the appropriate FINRA exams - being duly securities licensed as a Registered Representative, Registered Investment Advisor or Investment Advisor Representative.
I feel that for many of the afore mentioned reasons Index Annuities should therefore be regulated a securities products and that this would be in the best interest of consumers.
Thank you.