Safety First:

Grow Your Money without Market Risk

For many retirees today, the alternatives for their long term savings can feel less than appealing. They know that they need to keep up with inflation on the one hand, but they are afraid of market risk on the other. Banks can be a safe place for their money (and a place where seniors should absolutely have some of their money) but the interest rates are not terribly attractive. The market can be a great place to enjoy upside potential but can also be a place where losses can be incurred.

It is sort of like when Goldilocks wandered into the home of the three bears and tasted their porridge. Much like the stock market, the first bowl was too hot. Much like the interest rates paid by banks, the second bowl was too cold. The third bowl struck a balance by being not too hot or too cold, but just right. For your long term savings, let’s now look at an option that could possibly be for you that “third bowl,” a way to have downside protection against loss (as long as you abide by the terms of the contract) but still have some attractive upside interest potential.

 Grow Your Money … Safely

Fixed Index Annuities were introduced into the market place in 1995. The first Fixed Index Annuity was purchased by a gentleman who placed an initial amount of $21,000 into a product from Sun Life.   Five years later (according to the Index Compendium), the annuity had grown to $51,779. Since then, they have become enormously popular for conservative, safe money people who want to enjoy competitive interest without the risks of the stock market. Business Week magazine wrote in an article on Fixed Index Annuities that “in a dicey market, their no-downside feature and the potential upside make for an attractive combination.” Best Selling financial author Suze Orman in her book “The Road to Wealth” says, “I have to admit I like the concept for the right investor … In fact, for those who do not want to take any downside risk, the index annuity can be a good option … If you are willing to give up some upside potential, an index annuity can help you protect yourself against downside risk, both in the short term and the long term … If you do not want to take any risks but still want to play the stock market, a good index annuity may be right for you.” So what is a Fixed Index Annuity and how does it work?

How Does A Fixed Index Annuity Work?

A Fixed Index Annuity is not an investment in the stock market. Rather, it links your interest to a percentage of the growth of a major market index (not including dividends), typically the Standard and Poor 500 Index. The S&P 500 is an index that measures the growth and losses of 500 major companies across multiple industries. Companies such as Pepsi, Wal-Mart, Walt Disney, General Electric, IBM and Microsoft are all part of the S&P 500. At the end of the year, a Fixed Index Annuity will credit you with all of the growth of the index up to a predetermined limit. That ceiling might be an annual or a monthly cap, or a percentage of the growth of the index. In other words, if the annual cap were 9% and the index grew 12%, you would be credited with 9% interest for the year and that interest would be added to your annuity and would “lock in.” What do you get in return for your willingness to give up some of your upside? The elimination of downside market risk. Your principal is guaranteed against market risk from day one and your interest gains lock in each year on your contract anniversary and cannot be taken away in a future market downturn. In other words, you can participate in a percentage of the upside of a major market index, but you are never exposed to any of the downside market risk! At the end of the year, you will never have lost money in the market because a Fixed Index Annuity is not a stock market investment, but rather is a fixed financial product backed up by an insurance company with interest gains linked to a percentage of a market index. They are not designed to “beat the market” but to give you a better than average opportunity for a better than average rate of credited interest on your money.

There is no such thing as a “free lunch.” You give up some of your upside potential in return for the safety that the annuity provides. Let’s look now at that issue of safety.

Four Pillars of Safety in A Fixed Index Annuity

There are four “pillars of safety” in Fixed Index Annuities to support your retirement, helping you to feel very comfortable that your nest egg is secure. Let’s look at each of these “pillars”:

 Pillar of Safety #1:  Strength of the Insurance Company

The number one consideration in purchasing an Annuity is the strength of the insurance company that stands behind it. Issues such as the size of the company, the length of time they have been in business and how conservative their investments are all considerations that you should carefully discuss and research with the financial advisor who you are working with. I only recommend large and established companies. One company I work with has a history that dates back to 1697 … not exactly what you would call a fly-by-night company! There are a number of independent ratings agencies that rate the financial strength of insurance companies. The most well known of these companies is A.M. Best. They rate insurers much like a teacher would grade students, from an A++ down to an F. I only recommend Annuities from companies with “A” ratings or higher from A.M. Best. A.M. Best can be found on the internet at www.ambest.com and by phone at (908) 439-2200.

 Pillar of Safety #2:  Strength of the Parent Company

In this age of corporate consolidation, many companies in multiple industries are owned by parent companies that often are very large and diversified corporations. The insurance industry is no different, and the presence of a large, stable parent company is another reason for peace of mind with a Fixed Index Annuity. Some of the companies that I work with who issue Fixed Index Annuity products are owned by insurance parent companies with assets in some cases exceeding $1 Trillion.

 Pillar of Safety #3:  Strength of the Legal Reserve System

The insurance industry is required by the Legal Reserve System to keep one dollar in reserve for every one dollar on deposit. Those reserve requirements give the insurance industry a very high degree of stability and gives safety-first seniors a very high level of peace of mind. Because of the massive reserves of insurance companies, best selling author Gordon K. Williamson points out that “during the Great Depression, it was not the U.S. Government that bailed out the banking industry – it was U.S. insurance companies. If there were ever a financial collapse in the United States , the insurance industry would be the second to the last entity to fold (second only to the government). This ‘second billing’ is because the government has taxing power and, of course, the ability to print money.”

 Fourth Pillar of Safety:  Contract Guarantees

In a Fixed Index Annuity product a promise is put into writing by the insurance company that you are protected against loss as long as you abide by the terms of the contract. Your principal is protected from day one, and your credited interest locks in every year. You are giving up some of your upside potential in order to protect yourself against downside risk. Remember, there is no such thing as a free lunch.

Summary of Fixed Index Annuities:  Babe Ruth

Everyone remembers Babe Ruth for one thing:  he was a great homerun hitter. In fact, when he retired, he was the all time leader in home runs with 714. Did you know that he was also the all time leader in baseball in another category? That category would be strikeouts, for the Babe struck out almost twice as many times as he hit a homerun. Many seniors feel that way about their retirement savings – in the stock market they have a chance for a homerun but there is always a fear of striking out and losing money. What if there was a way to “split the difference,” to give up the potential of the homerun of the stock market in return for the guarantee that you couldn’t strike out and lose money in the market. That is what a Fixed Index Annuity is designed to do. You agree in advance to limits on what you can earn on the upside (giving up the potential homerun), while the insurance company in advance agrees to guarantee that you will never lose money in a negative market year (giving up the risk of the potential strikeout). Please note:  These are long term financial products and should only be considered with the long term in mind. (See the article on this web site, entitled, “When Annuities Might Be a Good Idea … And When They Would Be A Really Dumb Idea.”)

Notice:  Not intended as tax, legal or investment advice. Annuities are not for everyone. Carefully consider your circumstances to determine their suitability for you. Read all product disclosures carefully and consult with your tax, legal and financial advisors before purchasing. Also, consult the NIAC “Buyer’s Guide to Fixed Annuities” as a tool to help you determine suitability. Westport Insurance Group, LLC provides a copy to everyone with whom we discuss annuities. Contact us and we will gladly send you a copy free of charge.