Response to Last Week’s FIA Article

FIA issuers face the "discipline of the market" when resetting their crediting formulas each year, writes David Babbel of the Wharton School.

David Babbel writes to comment on RIJ’s article in the August 25 issue on fixed income annuities, which reviewed a paper that he co-authored with Jack Marrion and Geoffrey VanDerPal:

I appreciated your thoughtful review of our recent article on "Real World Index 
Annuity Returns" in your August 25th, 2010 edition of the Retirement Income Journal.

It was accurate and expressed a healthy skepticism in your final paragraph, that
referenced the final paragraph in our article about the levers included in index
annuities, which can be changed by the insurer at its discretion.

[We] should have added to that sentence that although the insurer does have discretion
to change certain contract parameters, such as the
cap levels or participation rates, it does not have unfettered discretion to alter
them, because the contracts themselves have minimum guaranteed levels for both, as
well as state minimum nonforfeiture value schedules, that will always ensure a
return of zero or greater.

Moreover, and more importantly, the insurers face the
discipline of the market. If they try and credit less than a competitive and fair
rate for FIA writers, they will face the dissatisfaction of their consumers, the
rancor of the agents, the cost of lapsation, and the hesitancy of agents to ever put
future clients in such products. This would essentially be the death knell of their
future business.

Therefore, consumers have at least three layers of protection—
contractual minimums, state minimum nonforfeiture values, and competition enforced
by both consumers and, more importantly, agents (because they are more aware of what
other companies are offering)—which should assuage the risk aversion of many.