When I had clients, I often discussed with them how it was that Indexed annuities and Indexed life or Long-term Care insurance could guarantee no principal loss while offering a part of the return from some equities or bond index. We would discuss this complex invention and how it could be used to hedge the risk of market fluctuations on their most crucial portions of their savings. The level of depth of these discussions varied with the client, but they always knew that delivery of the promised minimum returns and principal protection was dependent upon the carrier’s strength. They almost always went for the guaranteed income at the other end of the guarantee period because being confident in matching guaranteed income to guaranteed-to-incur living expenses was prudent.
Once in a while, however, the light would shine brightly in a client’s or prospect’s mind and the person would say, “Well, if the insurance carrier can get these underlying contracts enabling such protections, why can’t I directly?”
The answer was always, “You can. These are called ‘structured notes or certificates.’ But only a carrier has a reserve that protects policy owners in event that these structured notes lose money or fail to gain. Carriers also assemble enough money to buy in bulk and to stagger the maturities closely so that they can honor withdrawal demands. Only life and long-term Care insurance enables payout of gain that is immune to income tax. If you own the structured securities without the insurance ’wrapper,’ then your earnings are not tax-deferred, favored payouts are not tax-free, you have no lifelong income guarantee and your principal guarantee is generally not backed by any reserve. I must say, as I do in The Secrets of Successful Financial Planning for one’s ‘Tier 3 cash reserves:’ These structured notes work well for known expenses at maturities generally ten years & fewer away (e.g., college expenses coming up starting in five years, and you want a shot at good returns but relatively low risk for funds allocated for college). So, for long-term or retirement investing, do you still want to be your own insurer and buy structured securities?”
More on the stand-alone (i.e., non-insurance) structured products at http://www.finra.org/investors/alerts/structured-notes-principal-protection-note-terms-your-investment and other tips and “fun stuff” at AuthorDan.com. Best to you from AuthorDan!