Competing Against Bonds W/Fixed Annuities

[insurehound]

From a guy who does not have an extensive financial services background, I am trying to understand how one positions fixed annuities against bonds in a sales situation. Anyone care to give me some pointers? I know some of the basics but I need to learn more. Thanks!

 

[insuranceexec]

From a guy who does not have an extensive financial services background, I am trying to understand how one positions fixed annuities against bonds in a sales situation. Anyone care to give me some pointers? I know some of the basics but I need to learn more. Thanks!

Are you a series 7 licensed?

 

[Freddie]

From a guy who does not have an extensive financial services background, I am trying to understand how one positions fixed annuities against bonds in a sales situation. Anyone care to give me some pointers? I know some of the basics but I need to learn more. Thanks!

There are probably more experienced people here but here are a few ideas. It depends on the bonds. T Bonds, corporates, muni or high yield.

Fixed Annuities
Positives
1. Seniors annuity gains does not count toward income calc to boost taxes on social security.
2. Usually protected from lawsuits.
3. Deferred income taxes.
4. Default risk low if A or A+ firm.
Negatives
1. Less liquid.
2. Probably lower returns.

Bonds
Positives
1. Higher returns.
2. Capital gain possibilities.
3. Some tax advantages on munis.
4. liquidity is generally good.

Negatives
1. Default risk.
2. Transaction costs.
3. Management costs.
4. Lack of diversifications. Bond funds are not so good - problems.
5. Need a lot of $$ to diversify.

Right now bonds may be pretty good with good corporates yielding 8%. The problem is the portfolio has to be managed by someone who knows what they are doing. Treasuries have lower returns than FA. Munis are possibly one of the best places to be now.

 

[SportsNut]

There are probably more experienced people here but here are a few ideas. It depends on the bonds. T Bonds, corporates, muni or high yield.

Fixed Annuities
Positives
1. Seniors annuity gains does not count toward income calc to boost taxes on social security.
2. Usually protected from lawsuits.
3. Deferred income taxes.
4. Default risk low if A or A+ firm.
Negatives
1. Less liquid.
2. Probably lower returns.

Bonds
Positives
1. Higher returns.
2. Capital gain possibilities.
3. Some tax advantages on munis.
4. liquidity is generally good.

Negatives
1. Default risk.
2. Transaction costs.
3. Management costs.
4. Lack of diversifications. Bond funds are not so good - problems.
5. Need a lot of $$ to diversify.

Right now bonds may be pretty good with good corporates yielding 8%. The problem is the portfolio has to be managed by someone who knows what they are doing. Treasuries have lower returns than FA. Munis are possibly one of the best places to be now.

No comparison betwen the risk of a corp or muni bond and an annuity. Much greater risk, especially in todays climate, with both corp and muni bonds. You will see, over the next couple of years, some munis that are not general obligation bonds, (meaning backed by the full faith and credit of the municipality), actually default; (unless the fedl gov't bails those out too). Almost a certainty that you will see some munis default, IMO. Just think about the number of states that are saying they are broke. It doesn't get any easier as you go DOWN teh food chain to smaller entities; (cities, utilities, munis for corp growth, etc.)

Here is a link about some fundamentals on muni bond investment and their risks. You and your clients might be well served to print some of these pages out... for educational purposes. Many folks who invest in direct munis have no real idea that there is a potential for default. They simply bought them because of the tax advantages and because someone suggested them and certainly depicted them as safe... duh.

MUNICIPAL BONDS AND DEFAULTS

In todays very low interest rate environment, the only way for rates to go is UP....>. When rates rise, the value of the underlying bond falls. Of course that is only if you wished to sell the bond without holding it to maturity. If the bond does not default, and regardless of what rates do, and the bond is held to maturity, then int pymts will be received and at maturity the principal will be returned. If there would be a default and the owner attempted to sell the bond, the principal value could be seriously devalued both by rising int rates and credit risk to the underlying issuer of the bond; either corp or muni.

Most of the elderly folks that do invest in munis likely hold them until maturity. Investing in either corp or muni bonds is no different in one sense than investing in stocks. you can easily buy the right or wrong one, and if the wrong issue is purchased then you could suffer loss of capital. So what works best for the indiv investor, if they are going to invest in either corp or munis is to do so through a fund, just like folks do with stock fund investing, in lieu of picking indiv stocks.

Often times folks are investing into bonds for the income, not the tax bennies.. and an annuity isn't necessarily the best trade off for them unless they are looking for accumulation with the tax deferral. So you need to make certain the application of the annuity is correct; apples to apples. But assuming that growth and safety are criteria and annuity is far better than a random selection of a muni bond, especially in liight of increased risk of default over the next 10 yrs as opposed to the last 10.... many challenging financial times lay ahead, IMO.

With all that said, I am not really an annuity guy, but less of a muni guy, and certainly think that many muni investors are misplaced or misguided. Hope some of the above is helpful.

 

[JMO Fan]

Part of the SEC "Safe Harbor" rule (old Rule 151) focuses on why & how insurance is sold. If it is sold largely for its investment potential, rather than its insurance value, it falls outside the Safe Harbor. The sales focus for any insurance product can make it a security under the law.

My state securities office says they actively prosecute insurance agents who sell insurance as a replacement for other investments, including CDs, bonds, and mutual funds. When they learned that an EIA had been sold as "a safer investment than treasuries," they got the agent's insurance license revoked as well as penalizing him under state securities law. The implications of Rule 151a stretch beyond what some folks believe is a security, but that doesn't mean the SEC won't/can't regulate it.

 

[insuranceexec]

We put a great deal of TRUST in the grade or rating of a bond. I remember recently the rating companies, for bonds, being fined for not grading appropriately. Who would have thought that corporate rating companies would be receiving a kickback for giving a higher grade on MBS to pass off as high grade, when in fact they were "high" risk.

A bond is a good fit inside a portfolio providing that it is allocated correctly. I personally have a client who has almost 4 mil in bonds and an overall net worth of 5 mil; needless to say that she is over allocated. But for the life of her will not liquidate a portion of her current position, who is to blame for this?

Annuities are more safe in my ever so humble opinion, but with that being said you, insurance professional, have to watch giving advice on said such subject if you are not properly licensed.

 

[insurehound]

Are you a series 7 licensed?

I knew exactly where you were going with this insuranceexec when I read your response. I just read an article discussing how dangerous it can be for an insurance agent to give investment advice...and no, I'm not series 7 licensed

Soon, insurance agents will only be able to say that fixed annuities are terrible and that if you must buy one, you should only buy one directly from a carrier or from a FP (that's a joke).

So then what CAN you say if a client says, "I love bonds so tell me why a fixed annuity is a better option?". What's considered "investment advice"?

 

[cloisbarton]

I knew exactly where you were going with this insuranceexec when I read your response. I just read an article discussing how dangerous it can be for an insurance agent to give investment advice...and no, I'm not series 7 licensed

Soon, insurance agents will only be able to say that fixed annuities are terrible and that if you must buy one, you should only buy one directly from a carrier or from a FP (that's a joke).

So then what CAN you say if a client says, "I love bonds so tell me why a fixed annuity is a better option?". What's considered "investment advice"?

As noted above we in the insurance industry have a real gray line when it comes to this topic of placing an annuity up against any type of investment vehicle.

Our license does not give us the ability to say bonds are good or bonds. I would say that we could provide the basic definition of a bond.

A bond is a loan given by an investor to the company. The investor is the lender and the company is the borrower. The price paid for the bond is called its face value. The money is returned by the company with interest on the maturity date.

So, what I inform my agents to do is ask more questions of the client when it comes to the initial appointment where where an investment vehicle is involved.

Ask probing questions so that you can take this information back to your consultant to put together a proposal that will position an annuity to meet the needs or concerns that the bond is taking care of for the client.

For instance:

Mr. and Mrs. Bond Lover
I notice here that you have several bonds in your portfolio, let me ask you......
What type of interest have you been earning on these accounts?
Have you been using these bonds to provide income for your family?
What type of bonds are these?
Are you paying taxes on interest earned on these bonds?
Why did you decide to place your monies into these bond accounts?

There are other questions that can be used, but these are a good start.

Then let's assume the your client answered the following way:

I am getting about 4.25% interest on my bonds and pulling that interest off for additional income and preserving my principal. I do pay taxes on the interest that I am using for income. So, the main reason for these bonds is really just for income.

Well, now you know what annuity to pick and how to position that annuity for a sale.

Hope this helps.......

 

[Franz Kafka]

Part of the SEC "Safe Harbor" rule (old Rule 151) focuses on why & how insurance is sold. If it is sold largely for its investment potential, rather than its insurance value, it falls outside the Safe Harbor. The sales focus for any insurance product can make it a security under the law.

My state securities office says they actively prosecute insurance agents who sell insurance as a replacement for other investments, including CDs, bonds, and mutual funds. When they learned that an EIA had been sold as "a safer investment than treasuries," they got the agent's insurance license revoked as well as penalizing him under state securities law. The implications of Rule 151a stretch beyond what some folks believe is a security, but that doesn't mean the SEC won't/can't regulate it.

Do you work for SEC?
- - - - - - - - - - - - - - - - - -

Part of the SEC "Safe Harbor" rule (old Rule 151) focuses on why & how insurance is sold. If it is sold largely for its investment potential, rather than its insurance value, it falls outside the Safe Harbor. The sales focus for any insurance product can make it a security under the law.

Please show me where.

Securities Act of 1933

Section 3 - Classes of Securities

Article a - Exempted Securities

Paragraph 8 -

Any insurance or endowment policy or annuity contract or optional annuity contract, issued by a corporation subject to the supervision of the insurance commissioner, bank commissioner, or any agency or officer performing like functions, of any State or Territory of the United States or the District of Columbia;

Rule 151 - Safe Harbor Definition of Certain "Annuity Contracts or Optional Annuity Contracts" Within the Meaning of Section 3(a)(8)

a. Any annuity contract or optional annuity contract (a "contract") shall be deemed to be within the provisions of section 3(a)(8) of the Securities Act of 1933, Provided, That


1. The annuity or optional annuity contract is issued by a corporation (the "insurer") subject to the supervision of the insurance commissioner, bank commissioner, or any agency or officer performing like functions, of any State or Territory of the United States or the District of Columbia;


2. The insurer assumes the investment risk under the contract as prescribed in paragraph (b) of this rule; and


3. The contract is not marketed primarily as an investment.


b. The insurer shall be deemed to assume the investment risk under the contract if:


1. The value of the contract does not vary according to the investment experience of a separate account;


2. The insurer for the life of the contract


i. Guarantees the principal amount of purchase payments and interest credited thereto, less any deduction (without regard to its timing) for sales, administrative or other expenses or charges; and


ii. Credits a specified rate of interest (as defined in paragraph (c) of this rule) to net purchase payments and interest credited thereto; and


3. The insurer guarantees that the rate of any interest to be credited in excess of that described in paragraph (b)(2)(ii) will not be modified more frequently than once per year.


c. The term "specified rate of interest," as used in paragraph (b)(2)(ii) of this rule, means a rate of interest under the contract that is at least equal to the minimum rate required to be credited by the relevant nonforfeiture law in the jurisdiction in which the contract is issued. If that jurisdiction does not have an applicable nonforfeiture law at the time the contract is issued (or if the minimum rate applicable to an existing contract is no longer mandated in that jurisdiction), the specified rate under the contract must at least be equal to the minimum rate then required for individual annuity contracts by the NAIC Standard Nonforfeiture Law.

 

[Freddie]

Part of the SEC "Safe Harbor" rule (old Rule 151) focuses on why & how insurance is sold. If it is sold largely for its investment potential, rather than its insurance value, it falls outside the Safe Harbor. The sales focus for any insurance product can make it a security under the law.

My state securities office says they actively prosecute insurance agents who sell insurance as a replacement for other investments, including CDs, bonds, and mutual funds. When they learned that an EIA had been sold as "a safer investment than treasuries," they got the agent's insurance license revoked as well as penalizing him under state securities law. The implications of Rule 151a stretch beyond what some folks believe is a security, but that doesn't mean the SEC won't/can't regulate it.

Any agent saying annuties are safer than Treasuries is asking for trouble. On the flip side, a few experts have said it would not be impossible for the U.S. to default on our debt (see Argentina). The new president has said we will have to spend our way back to prosperity - sound slike something the Peronists said in Argentina. Argentina by the way is taking over the pensions of workers. A very solid insurance company might fare better than Treasuries in the future.

The SEC has such a great track record lately - Madoff, no uptick rule, naked shorting, Soros/Flowers/Paulson hedge funds wiping out Indy Mac with Schumer's help by shorting then buying Indy this week with govt help. Amazing. There is essentially no SEC regulation of hedge funds thanks to Congress.

I hear what you are saying. The EIA/insurance industry is not perfect. Some jerks selling 15 year Allianz products to 80 years olds etc. However when they showed the Frontline "expose" on TV, they should have asked if any of the elderly lost any money in an EIA.

Any of those old folks who had their money in the market lost a ton in 2008. You also do not see bankers getting fined for offering 2.5% CDs when the real inflation rate is 6%. Very frustrating.