Press Room
Press Responses

February 22, 2001

Letters to the Editor
Forbes, Inc.
60 Fifth Avenue
New York, New York 10011

To the Editor:

We are writing in response to the article entitled "Annuity Gratuity" by Carrie Coolidge, which was published in the February 19, 2001 issue of Forbes. To say that the article paints only half the picture would be overly generous. The article provides an incomplete analysis based on what is apparently a fundamental lack of understanding of variable annuities-an important financial product that millions of Americans have included in their portfolios to provide for a secure retirement.

Annuity Tax Issues

The article asserts that the tax deferral advantage offered by variable annuities is "often an illusion, since the annuity converts low-taxed capital gains into higher-taxed ordinary income." The author apparently does not understand the impact that deferring taxes can have on an investment's earnings.

The Value of Tax Deferral. In October 2000, PricewaterhouseCoopers (PwC) conducted a study comparing the after-tax returns of variable annuities and mutual funds and concluded that variable annuities "are frequently a more attractive investment relative to mutual funds for long-term savers." The study examined a variety of fund types and accumulation periods, and calculated the after-tax return to an investor in a mutual fund and a variable annuity that is invested identically to the mutual fund under various distribution options. Using historical income and expense data, the study found that for the average investor and the average variable annuity and mutual fund, the after-tax payouts funded by variable annuity investments are substantially larger than for mutual fund investments for holding periods as short as 10 years.

For example, the study looked at an investor in the 36% income tax bracket during the accumulation phase and the 28% bracket during the distribution phase. After-tax payouts funded by variable annuities, per $1,000 of investment, exceed mutual fund payouts by $57 to $3,071 after a 10-year accumulation period. The attached chart, reprinted from the study, illustrates these findings and shows that the tax deferral advantage of variable annuities is no illusion.

Tax Rate Comparison. In addition to tax deferral, the results of the study reflect the fact that not all gains on mutual funds are taxed at capital gains rates. Mutual funds generally distribute all dividends, short-term gains and long-term capital gains realized by the fund through its investment activities. Mutual funds investors are taxed annually on their share of distributed income. A mutual fund investor includes all dividends and short-term capital gains distributions in ordinary income. Across all mutual funds, the PwC study found that over 40% of the total return was taxable at ordinary income rates.

Variable annuities offer another tax savings feature in that money can be moved between funds within the annuity tax-free as markets and individual circumstances change. In contrast, every sale of shares or transfer of funds from one mutual fund to another triggers a taxable event which, depending on whether the requisite 12 month holding period has been met, can be either a short-term or long-term capital gain.

Insurance Guarantees

The article also claims that variable annuities provide only a "patina" of an insurance policy. On the contrary, variable annuities provide a number of insurance protections that are potentially very valuable. For example, variable annuities provide beneficiary protection in the form of a death benefit that many investors regard as vitally important. The standard benefit provided by variable annuities guarantees that if the policyholder dies while still saving for retirement, his or her beneficiaries will receive the greater of the amount of money that was invested or the policy's value at the time of death. Many variable annuities go even further and offer "stepped up" benefits that lock in investment gains every few years or even every year. This benefit gives policyholders the confidence to invest in the stock market, which is important in order to keep pace with inflation, since they know that their family will be protected against financial loss in the event of an untimely death.

Variable annuities also provide payout options that can protect individuals from outliving their assets by guaranteeing them payments that will continue for the rest of their life, no matter how long that is. And, since variable annuities allow policy holders to base the amount of their annuity payments on the investment experience of an underlying equity fund, they are an ideal choice as a hedge against inflation. Even with modest investment returns, variable annuity payments can increase over the years, for as long as one lives.

Bonus Contracts

The article is critical of variable annuities that offer purchase payment credits, or "bonuses." However, the article does not provide a balanced perspective of these products, which is unfortunate because investors need to have all of the facts to be able to evaluate any financial product and determine if it is right for them.

The purchase payment credits, or bonuses, offered by some variable annuity contracts are similar to other innovative variable annuity features in that they benefit some, but not all, investors. Financial professionals who sell variable annuities work with their individual clients to evaluate bonuses and other features to determine the most suitable annuity product given the specific financial needs and objectives of each individual.

Bonus annuities can be appropriate for individuals in a number of situations. For example, they may be appropriate for individuals invested in certificates of deposit or mutual funds with back-end sales loads, who face a withdrawal charge or penalty if they move to a variable annuity that may be more suitable for them based on any number of factors. Or they may be appropriate for individuals in products with remaining withdrawal charges and where services in the products, or investment performance, have been poor.

The article provides a comparison between a bonus annuity with an annual charge of 1.65% and a non-bonus annuity with an annual charge of 1.3%. While the comparison demonstrates that higher fees affect the performance of an annuity, the conclusion that the fee differential is necessarily due to the bonus reflects a complete lack of understanding of the product. Any cost differential that exists between bonus and non-bonus products can be due to a number of product features unrelated to the bonus. For example, the bonus product may have a more generous death benefit than the non-bonus product. Moreover, the non-bonus contract used in the article's example is no longer available for new sales. In other words, the article provides your readers with a comparison between a recently introduced bonus contract and a non-bonus contract introduced in 1981 that your readers cannot even buy.

In short, bonus products can be appropriate investments, depending on the individual purchaser's circumstances. Unfortunately, the article provides incomplete information about bonus annuities and, as a result, does not provide your readers with a good basis for evaluating these products.

Market Conduct

The article suggests that bonus products are by and large being sold improperly. As we have noted, bonus contracts are appropriate for their intended market. And we would certainly agree that broker/agents have a responsibility to be knowledgeable about the contracts they are offering, and are recommending them based upon full disclosure and proper suitability guidelines. Bonus products are not right for everyone, and NAVA supports the efforts of regulators and industry participants to ensure that the products are being sold correctly. However, the article's assertions that "most variable annuities are very bad investments," and bonus annuities are nothing but a "new variation" on an "old game," are clearly unwarranted and unsubstantiated.

No product or investment is perfect for everyone, and investors need to fully understand their alternatives so that they can make choices based on their individual needs and circumstances. We share a common goal of educating the public about variable annuities and trust our response will assist you in this effort.

Sincerely,

Mark J. Mackey
President and CEO
NAVA

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