The annuity industry has had its ups and downs lately, and though the road ahead may split in different directions, advisers who know how to decipher the signposts can help clients stay on course.

In the second quarter, fixed index annuity sales jumped 30% from a year earlier, according to the LIMRA Secure Retirement Institute.

Meanwhile, variable annuity sales dropped 25%.

These disparate paths might seem surprising, as both types of annuities have links to the stock market.

VA money might be invested largely in stocks. Index annuities are a type of fixed annuity, so they may be known as fixed index annuities or equity index annuities, because returns often depend on the performance of stock indexes such as the S&P 500.

So why have FIAs soared while VAs have sagged?

“There has been market volatility, challenging the VA business,” says Joe Montminy, assistant vice president of annuities at LIMRA. “In addition, some insurers have pulled back on their VA benefits, making them less attractive.”

Stock market volatility may not be as great of an issue for FIAs, which have an indirect connection to equities.

“I recommend fixed index annuities for some conservative clients,” says Joe Heider, president and adviser at Cirrus Wealth Management in Cleveland.

“For them, the alternative would be to put their money in bank [certificates of deposit] or high-grade bonds, which have very low yields now,” he says. “An FIA can be part of a fixed-income allocation, with the chance for higher returns.”

However, putting money into an FIA is much different than investing in CDs or bonds and receiving agreed-upon amounts of interest.

“FIAs are complex instruments,” Heider says.

“Clients may not understand all the nuances, but it’s incumbent on advisers to go through them and explain the details,” he says. “You can provide a worst-case scenario, and keep expectations reasonable.”


Adam Leone, a CFP and principal and wealth manager at Modera Wealth Management in Westwood, N.J., can attest to this complexity.

“I have not seen new products that I would recommend, but I have recommended that several clients retain older FIAs,” he says.

“Most of them were bought between 2008 and 2010, when market fear was high and policy features were more generous,” Leone says. “From the contracts I have seen, most have a traditional contract value as well as a secondary income base value.”

To illustrate, Leone tells of a client who had purchased an FIA in 2008.

“We were hired in 2010, so we have data on the contract since then. There are several indexes to choose from, including the ‘point to point’ S&P 500,” Leone says.

“Here, the crediting calculation is a measurement of the index value between an annual date, excluding dividends. There is a hurdle rate and a cap, both of which the issuer can change annually,” Leone says.

“In order to produce any earnings, the S&P 500, net of dividends, has to increase by at least the hurdle amount,” he says. “From there, the credited interest is then capped.”

For this FIA, the hurdle rate has changed each year, bouncing between 1.70% and 4.90%, while the cap stayed at 7.75% until dropping to 6.75% last year.

“Assuming that the S&P 500’s total return was 6% between the 2015 and 2016 annual dates and that 2% was from dividends, the client would have no interest credited to the account. The 6% total return minus 2% in dividends equals 4%, less than the 4.9% hurdle rate for that period,” Leone says.

“If the S&P 500 returned 15%, then, with 2% from dividends, the credited interest would be capped at 6.75%,” he says.

A 6.75% return may not seem impressive in a bullish year for equities, but a conservative client might be pleased with that result from a CD proxy.

“I have recommended that clients keep such FIAs only because the annuity payment is more attractive than what they could receive by surrendering the contract and buying another annuity with the lower contract value,” Leone says. “This contract initially had an 18% surrender charge that did not expire for 13 years.”


Just as the FIA described above has a cap on the potential upside, these products often limit the downside as well.

“The FIAs I use have underlying guarantees, which might be 3% a year, no matter how their index performs,” Heider says. “They also give some participation in the market to clients who don’t want to go into stocks.”

Therefore, FIAs may generate possible upside with limited downside, a package that appeals to some advisers and clients.

“FIAs provide premium protection, credit interest growth in the absence of market risk and safety of invested premium,” says Blake Fambrough, a CFP and an adviser with Dubots Capital Management in Temecula, Calif.

“They make sense for clients who are in or near retirement and need guaranteed income for life,” he says. “An FIA can be a client’s personal pension, delivering a monthly check he or she never outlives.”

The need for guaranteed income may increase as people reach their 50s or 60s.

“As investors get closer to retirement, an FIA can be an excellent way to replace the lost income from work, after retirement,” Fambrough says. “Therefore, clients in that age group may benefit the most from FIAs.”


Where will the guaranteed income come from? Often, from an income rider purchased with an FIA.

This rider probably will be a guaranteed lifetime withdrawal benefit based on a phantom account that grows at a specified rate, regardless of any market index performance. FIA purchasers may buy the annuity, wait for years as the income value increases and eventually take penalty-free withdrawals for life, based on the higher of the income value or the annuity’s accumulation value.

“In 2015, a GLWB was elected on 54% of all index annuity sales,” Montminy says. “These benefits were elected more often in the independent agent channel and the independent broker-dealer channel, [and] less frequently in the bank and career agent channels.”

With or without an income rider, FIAs may deliver advantages to clients.

“What seems to make them so attractive is the lack of a downside or having a floor in place,” says Tom Orecchio, a CFP, who is a principal and wealth manager at Modera Wealth Management.

“When illustrated and used in the right circumstances, they can be a good way to participate in the upside of the markets without the downside typically associated with equity investing,” he says. “However, it is important that investors understand all of the issues associated with these types of investments prior to committing any capital.”


Those issues, according to Orecchio, can be numerous.

“There is no participation in stock dividends,” he says.

“Sometimes the indexes are difficult to understand, and the same may be true of the methods for determining the change in value. There may also be an upside participation limit,” Orecchio says.

“FIAs also can have steep fees, including a contingent deferred sales charge. Investors don't always comprehend how long these back-end fees can go on,” Orecchio says.

“In addition, sales illustrations sometime use higher-than-reasonable rates of return,” he says.

For some advisers, such issues raise the FIA hurdle too high to clear.

“I don't recommend FIAs,” says Alan Katz, a CFP and president of Comprehensive Wealth Management Group in Staten Island, N.Y.

“I have heard that the sales pitch is that they offer stock market returns without the downside risk. Clearly, this can't be true, and typically isn't,” Katz says.

“Most FIAs are tied to various indexes, but the returns are limited on a monthly basis,” he says. “I have seen years where the market was up 30% or more, but one of these investments was up only 5%.”

Indeed, Katz prefers VAs to FIAs.

“Variable annuities do carry more risk, but they also offer a wide array of investment choices, which allows us to manage that risk. This is what people are paying us for,” Katz says.

“The key to any recommendation is finding the right tool for the job,” he says. “I haven't seen a case where an FIA was a better tool than a VA."


Both of these tools may look duller under the new fiduciary rules from the Department of Labor.

“We’re forecasting down years in 2016 and 2017 for VAs. FIAs may be up for the full year in 2016, but we think next year will bring a decline as the new rules take effect,” Montminy says.

“By 2018, we expect the industry to have the necessary solutions in place,” he says. “VAs and FIAs may rebound then.”

This forecast could be revised, pending future developments. In early June, several lawsuits were filed against the DoL by annuity associations and other parties, protesting the treatment of FIAs under the new rules.

Regardless of how these lawsuits play out, for FIAs, the reasons for the recent hot streak remain.

“On the consumer side, the desire for guarantees is increasing,” says Eric Thomes, senior vice president of sales at Allianz Life Insurance of North America.

“In volatile markets, downside protection is very appealing,” he says. “With many baby boomers going from asset accumulation to asset distribution, some retirees and pre-retirees may want to devote more dollars to receiving a lifetime income stream.”

Increased interest on the distribution side has brought more advisers to FIAs, increasing sales, Thomes says.

“It’s way too early to say how the industry will react to the new rules and how sales will be affected,” he says.

“We’re working with our distribution partners to find ways to comply,” Thomes says. “There will still be a strong desire for guaranteed income, which will be a driver in the future.”

This story is part of a 30-30 series on tools and strategies for retirement. It was originally published on June 22.

Donald Jay Korn

Donald Jay Korn is a New York-based financial writer who contributes to Financial Planning and On Wall Street.