Dec. 16, 2005 - Mirage in the Desert |
Several years ago, I received a call from an elderly couple I had been working with for only about 6 months. An insurance salesperson had been over to visit them and was touting a new-fangled insurance product that appeared to be fool-proof -- equity-indexed annuities (EIAs). The couple wondered if I thought an EIA might be a good idea for them.
I'm glad they called me before signing any papers because they were about to walk blindly into an investment that would have been disastrous for them but lucrative for the insurance salesperson.
How equity-indexed annuities work.
EIAs allow a person to invest in a stock market index (like the S&P 500) but without any downside risk (supposedly). That is, the EIA guarantees an investor will at least break even or receive a modest return on the principal investment. In exchange, the investor accepts a cap on the gains of the stock market index (and hence on the investment principal) and usually forgoes any dividends from the index. So, in a bad year there are no losses, but in a really good year the returns are artificially restricted to a maximum percentage (say 8% or so).
In short, EIAs promise no losses while providing some upside potential.
This is a powerful and appealing investment alternative to seniors who are cautious of losing any money. That was certainly the case with my client who called. Before signing on with me, they had suffered horrendous losses during the bear market of 2000 to 2002 (mostly due to a lack of diversification and inappropriate investment choices, but that's another story altogether). Who could blame them for being skittish?
Insurance companies understand older investors are skittish and play up those fears. That's why EIA investments have grown so much in the last 5 years. (Of course, it helps that the insurance salesperson earns a 9% to 10% commission. That might also explain why EIAs are suddenly so popular). But I digress.
It's a mirage in the desert.
While tantalizing on the surface, EIAs are really just piles of sand in the desert -- dry and bitter tasting. In the specific case of my client, I was able to show this couple how much further behind they would have been over the last 5, 10, 15, 20, and 25 years by using the particular EIA presented to them versus just simply investing in an S&P 500 Index mutual fund directly. The investment returns of the EIA were paltry by comparison. They happily followed my counsel and avoided this bad investment.
Other studies now confirm how bad EIAs really are.
I was reminded of this episode with my elderly client when I saw a column in the Wall Street Journal last Wednesday (12-14-2005). This column tackled the realities of equity-indexed annuities by highlighting recent research on this subject.
One study cited in the article was done by MassMutual Financial Group, a large insurance provider that does not sell equity-indexed annuities. The MassMutual study came up with the following annualized returns over the 30 years ending in December 2003:
By comparison, the columnist notes, an investment in perfectly safe, plain vanilla U.S. Treasury bills yielded 6.4% per year over that same time period. That doesn't say much for the equity-indexed annuity.
Another study by MCP Premium Software showed how an investment of $100,000 would have grown from 1964 to 2003 in 8 different equity-indexed annuities. The results are staggering:
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S&P 500 Index with dividends reinvested: $4,847,000
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Best of the 8 equity-indexed annuities studied: $1,312,000
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Worst of the 8 equity-indexed annuities studied: $366,000
The numbers speak for themselves.
Don't let yourself be lured by the mirage in the desert called equity-indexed annuities. More importantly, don't let your elderly parents, grandparents, friends, or neighbors be conned into this inappropriate investment -- unless, of course, they like to drink dry, bitter sand instead of real water.
Final note. There are individuals and specific situations where EIAs make sense. And, there are a few good EIA products available out of thousands on the market. The point I am making is that there are many poor EIA products being sold to individuals in situations that are not appropriate. You've got to be very careful.
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Feb. 20, 2006 - The EIA is a fixed annuity |
| Posted by MCP Premium |
Your comparisons of EIA performance to mutual funds and the stock market are innapropriate and improper.
The EIA is a fixed annuity, with no direct investment of principal into the the stock market or mutual funds. It is not designed to beat the market: it is a safety of principal vehicle with a guaranteed minimum interest rate and the potential to outpace other fixed-rate vehicles like CDs.
Furthermore, the EIA is entirely appropriate for retirees and others who cannot afford any loss of principal, yet wish to position themselves to potentially earn more interest than other fixed-rate vehicles. An a fixed annuity, it allows principal to grow tax deferred and affords income-taking options.
You should be instead comparing the EIA to CDs, traditional fixed annuities, etc. That is the proper arena of evaluation.
Finally, our MCP Premium Suite software (and online Rating Service) is used by agents & advisors to evaluate the various EIA credit methods over a variety of market environments and choose the "best of show" for their clients. We do not condone or encourage presentation of the EIA as a stock market alternative. This representation or charaterization is entirely improper.
Sincerely,
Dorice A Maynard,
VP Sales & Marketing
MCP Premium Software
http://mcppremium.com |
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Feb. 20, 2006 - Reply to Dorice |
| Posted by stevebraun |
Thanks for stopping by, reading the article, and leaving a comment. I do appreciate your feedback. From what I have read about your firm, I think you are doing a great job in providing tools to evaluate EIAs. Hopefully that will lead to better matches of EIA products to clients.
You are correct that an EIA is a fixed annuity but that doesn't mean the comparison with a stock index fund is "inappropriate and improper." I am merely pointing out that there is a difference in the returns you can expect from these products over time -- just as I did in my post titled "Inflation, Taxes, & Investment Expenses." It is no different than pointing out that equities outperform bonds over time.
It is not a direct investment, as you say, yet its "potential to outpace other fixed-rate vehicles" is tied directly to the performance of a stock market index. Also, in my experience, this product is marketed as an alternative to investing directly in a stock market index or as a way to have the upside of an index without the risk of any downside (though I note you do not approve of that either). In the client's mind, however, EIAs are perceived as "safe" investments in the stock market. Besides, the E in EIA does stand for EQUITY. What do you think people are going to perceive it to be? For that reason, it is appropriate and proper to compare the two.
I also stated that there are "individuals and specific situations where EIAs make sense" and noted that there are good EIA products out there but that people have to be careful. Unfortunately, my experience has taught me that the industry views this product as a panacea for everyone. For example, one insurance agent commented to me that the bulk of his clientele is age 50+ and that that means he's sitting on a "gold mine" for EIA sales. In continuing our discussion it became very clear to me that he reached this conclusion on the basis of the commissions he will make rather than the appropriateness of EIAs to his clients. I'm sure you would not agree with that approach either.
We may differ, however, in our financial theory as it pertains to retirement. I do not believe EIAs are necessarily appropriate for retirees carte blanche. Depending on a retired client's situation, not all the portfolio should even be in fixed-rate instruments -- EIAs or otherwise. There are other risks besides the risk of loss in a portfolio. Many retirees face the risk of outliving their assets or being cleaned out by inflation, taxes, and investment expenses. Fixed-rate instruments are only part of the total picture. In many cases there is still a substantial need for the growth provided by real equities (properly diversified of course). Here again, I have found EIAs to be pitched as a total solution for the entire portfolio or as a replacement for the equity investments. I do not agree with that.
In summary, people need to be careful and watch what they are being told (and sold) and who is the one doing the telling (and selling). That goes for EIAs or any other investment.
Thanks Dorice and best wishes to MCP Premium!
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Apr. 4, 2006 - Great Website |
| Posted by Anonymous |
Steve-
I wanted to drop you a brief note to thank you for such a good website. A client of mine recently heard an ad on a local Christian radio network touting the "benefits" of EIAs and severely criticizing IRAs, 401(k)s etc as "bad" investments.
When I hear ads like this, I have to stop and wonder how anyone can market these funds using a religious (and presumably ethical) affiliation and live with their conscience. While I am not a Christian myself, I don't think you need to be in order to recognize that anyone promoting such a biased sales pitch clearly isn't walking in the footsteps of Christ, as so many of my Christian friends strive to do every day.
Again, thank you for such a good and unbiased look at this topic.
- D.W.
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Aug. 13, 2006 - A New Problem is now unfolding for the Safe Index Annuity....... |
| Posted by Anonymous |
Please review the following "news release" from the NASD etc. What the NASD does to control it's own membership is it's own business, but I want the public to see what they are doing to control the Index Annuity as a safe product and it's effects for seniors and the retired. Once again they look at the Index Annuity as very serious competition and are very fearful of this product and it's position in the market place and have issued the following guide line and rules for it's membership. Index Annuity design and safety standards that are built in to protect principal loss are now a real issue.
The NASD does not control all of the Annuity Industry nor the products that are non-registered with them etc. but they do control it's membership that fall under the NASD rules as well the Insurance Industry rules/regulations.
Risk vs Non-Risk and who approves this suitability issue......for any client?
Are there more problems in the wings? Let's not forget "Suitability" Issues have long been the cause of the problems with the Variable Annuity product and industry and not the Index Annuity product Industry. So who is going to be reviewing these issues on the clients behalf ? Based on what suitability criteria? Is it really going to be risk against non risk? Safety of principal vs product that by design that does not have any?
Since the NASD still has not taken a formal position with the senior market and any effect the Variable Annuities have played with their problems as a public position as the SEC has done, it should be very interesting as to how they think they can resolve the many issues of suitabilty that occur between the Variable Annuity and the Index Annuity.
The question remains by whose authority does the NASD plan to oversee the non registered Index Annuity a safe product and how they are supplied and by whom to the Senior Market? A market that's suppose to be overseen by the Insurance Industry and the many great organizatios already in place to do just that.
Suitabilty complaints/fines have been many with the Variable Annuity Industry not the Index Annuity Industry, so once again we ask the NASD if you can not keep your own backyard clean why are you concerned about jumping the fence into somone elses back yard?
News Release
FOR RELEASE:
CONTACTS: Monday, August 8, 2005 Nancy Condon (202) 728-8379Herb Perone (202) 728-8464
NASD Issues Guidance Regarding Equity Indexed Annuity Sales
Concerns About Marketing, Supervision and Investor Protection Cited
Washington, D.C. Expressing concerns about marketing, supervision, disclosure and investor protection issues, NASD today issued formal guidance to registered firms selling equity indexed annuities (EIAs).
EIAs are complex financial instruments in which the issuer, usually an insurance company, guarantees a stated interest rate and some protection from loss of principal, and provides an opportunity to earn additional interest based on the performance of a securities market index. Some EIAs are registered with the Securities and Exchange Commission (SEC) as securities. Many are not, based on a determination that they are insurance products that qualify for exemption under the Securities Act of 1933. The question of whether a particular EIA is an insurance product or a security is complicated, depends upon the particular facts and circumstances concerning the instrument offered or sold, and is determined on a case-by-case basis.
Notice to Members 05-50 does not take a position on whether a particular EIA is a security. Nevertheless, this uncertainty over whether a particular unregistered EIA may be a security complicates a broker-dealer's supervisory responsibilities. If an EIA is an insurance product, then a firm would have to treat sales of the EIA by its brokers as an outside business activity. If the EIA is a security, the firm would have to supervise the sale as a private security transaction. Because of this uncertainty, some firms require their brokers to obtain specific approval to sell unregistered EIAs. Still other firms maintain a list of approved EIAs and prohibit the sale of all others.
NASD's Notice says that firms should:
Consider maintaining a list of acceptable unregistered EIAs and prohibiting their brokers from selling any other unregistered EIA without the firm's written confirmation that the sale is acceptable.
Consider whether additional supervisory procedures would help protect the firm's customers. For example, a firm could require that all sales of unregistered EIAs are processed through the firm, meaning the firm must supervise the marketing material, suitability analysis and other sales practices in the same way it supervises the sale of securities through the firm.
Provide brokers selling any unregistered EIA through the firm with the proper training to ensure they understand the EIA's features and the extent to which the EIA meets the needs of a particular customer.
The Notice also reminds firms that under any circumstances, NASD suitability rules apply to any recommendation that a customer liquidate or surrender a registered security for the purpose of purchasing an unregistered EIA.
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Oct. 10, 2006 - Understand/don't care for annuities yet what about... |
| Posted by Steven Roth |
Oct. 10, 2006 - Hate/Understand annuities yet what about...
Steve, I begin by stating that I have researched annuities (private and commercial) in great lengths. I am generally of the opinion that Annuities are poor investment choices due to tax, crediting rate scheme and other issues I won't go into at this time. That said, what about the use of EIAs for those nearing or in retirement who seek a better than CD, bond, or fixed instrument return? Are there situations where the EIA could produce better after-tax dollars to the client? I haven't taken the time to do a short-term market analysis and compare against EIA crediting rates. Presumably, someone has already done this. I am interested in the findings. I imagine there are market scenarios that would bode in favor of the EIA, such as a gain that get's locked in at say a 10% return -- followed by a subsequent market decline.
Lastly, I agree that salespeople routinely mislead consumers. However, they often don t understand themselves and are simply repeating what they have read in brochures and were told in sales training meetings. So theres often innocence to the misguidance.
Steven Roth - WMi
Please forgive/delete previous post. If anyone needed a spell checker its me.
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Oct. 12, 2006 - Reply to Steven Roth |
| Posted by stevebraun |
I think your main question is whether or not there are scenarios under which the EIA would be the better investment (say vs. bonds, CDs, or even stocks). The answer is yes. We can imagine scenarios in which that would be true, though I don't know of any academic studies to back that up. The problem is that this is a theoretical exercise and is only good IF we know what the future holds. That is, IF we knew that the favorable scenario(s) would be unfolding down the road, then it would make sense to go with the EIA. In real life we don't know that. Therefore, I wouldn't generally recommend the EIA because I believe it is favorable in a minority of the scenarios that could possibly unfold in the future.
As an example, we know historically that there have been time periods (greater than 3 or 4 years) when cash was a better investment than stocks. Under some scenarios, that may be true again in the future. But I'm not going to base the foundation of any client's portfolio on this fact because it is a rare event.
Another problem for the masses is that not all EIAs are alike. Most of them are terrible, as in the case I cited with my client. So not only must the right circumstances be present, but one must also be in the right EIA to take advantage of the scenario. You or I might know how to spot the best EIAs, but most folks just simply don't have the knowledge or evaluation tools to make that decision.
As for salespeople, you're right that many of them don't really understand the product. There is, as you say, "innocence to the misguidance" in some but not all cases. That is sad. That is the fault of the insurance company. What they do understand, however, is that selling the EIA (no matter how good or bad it is) will put food on their tables. So they sell away and don't worry too much about the fallout in the years to come. Too bad that's not the case for the client.
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