Index annuities (IAs) are not designed to beat the stock indexes but are designed to create higher performance than fixed-rate savings vehicles. This fact must be demonstrated when presenting an IA to a client. Financial advisors who compare only hypothetical IA credit method performance against stock indexes during periods of stock-index losses can be considered misleading -- not because the results are fictitious, but because the results can create a false expectation that the IA credit method will always outperform the market.
Using Monte Carlo simulations
Financial markets don't move in straight lines. They're unpredictable and random. A Monte Carlo simulation is a mathematical way of evaluating or measuring possible outcomes of a future event. Without Monte Carlo simulations, a spreadsheet will show only a single outcome, generally the most likely or average scenario. Using Monte Carlo in your IA comparison software, you can illustrate various outcomes that reflect the random nature of stock market returns.
Monte Carlo simulates the real world in the financial markets in a way clients can understand. These simulations show them that you're not promising them the moon. They'll see a range of possible outcomes for bull, bear, and choppy markets. With each, you can clearly point out the upside potential plus the minimum return guarantees the IA offers should the markets do poorly over the life of the contract.
Monte Carlo simulations allow for a more realistic picture of future growth and provide an effective way to show how the reset properties of an IA protect the growth of principal.
Mitchell M. Maynard is CEO of MCP Premium Software in Fullerton, CA, which offers a complete series of software tools for analyzing equity indexed annuities. Contact him at mitchm@mcppremium.com or 714-255-0707. For more information, visit www.mcppremium.com.
