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A Look at an Equity-Indexed Annuity
By JLP | September 13, 2007
After writing yesterday’s post on seminars, I decided to build a spreadsheet to analyze an equity-indexed annuity similar to the one my dad told me about. Now, it is important to note that there are LOTS of varaibles involved with annuities (particularly equity-indexed annuities). My illustration assumes something called a one year point-to-point, meaning that the account value is based on the performance of the index over a one year period. Other EIAs might have a monthly point-to-point.
Here’s the assumptions I made when putting this spreadsheet together:
1. The annual EIA growth is capped at 10%, with a 100% participation rate. This means that the annuity holder gets 100% of anything up to 10% rate of return. So, if the annuity returns 7% one year, you get 7%. If it returns 12%, you get 10% due to the cap. I’m almost certain that my assumption favors the EIA.
2. I assumed that the guarantee was no loss of principal. So, if the index returned -5%, the account had a 0% rate of return for that year.
3. I used the S&P 500 Index total returns for 1950 - 2006 as my foundation for the illustration. For comparison’s sake with the EIA, I assumed an account that earned the S&P 500 Index’s return minus a 1.50% management fee. I also did not include any fees on the EIA, which again favors the annuity.
4. I left out taxes completely. We’ll assume that the non-annuity account is held in an IRA.
I have asked my dad to get a copy of the annuity’s prospectus. Once I get that, I’ll do an even more detailed analysis and post about it later.
.GIF)
Okay, here’s the results I found after running my numbers:
The hypothetical growth of a $1,000 investment in 1950 in the EIA would have grown to $42,670, for an average annual rate of return of 6.81%. The non-annuity account would have grown to $292,674 over the same period - an average annual rate of return of 10.48%. So the “stability” of the EIA cost $250,000! OUCH!
Why is the EIA’s performance so pathetic? Here’s why:
1. The EIA’s annual return is capped at 10%. Over the 57-year period in the example, 34 years (59.6% of the time) had returns greater than 10%. Each of those 34 years, the rate of return was capped at 10%.
2. Over that same period, only 13 years had negative returns. In other words, the guarantee didn’t really help out that much. Oh, and remember that there were no fees taken out of the EIA. So, you may not have lost money that particular year, but you would have still had to pay your fees.
If you are interested, you can download the spreadsheet I put together.
I would stay away from this EIA! I bet you the presenter of the seminar my dad went to did not go into this much detail!
Like I said, this is only an example to illustrate the EIA concept. There are many different kinds of EIAs (some are better than others) with many different “features.” Trying to sort through all the details is very confusing and nearly impossible to do a side-by-side comparison.
Note to any EIA salespeople: If I have misrepresented the EIA, please let me know (nicely). It is my goal to educate, not misrepresent.
UPDATE: Here’s some follow-up posts on this topic. Please read them before you leave any comments.
My Response to a Comment on My Equity-Indexed Annuity Post
Another Follow-up on Equity-Indexed Annuities
Topics: Financial Math Basics, Financial Planning |
September 13th, 2007 at 10:53 am
Here is a link to a recent study done on EIAs:
http://www.slcg.com/documents/EIA_Working_Paper.pdf
The results are not pretty!
September 13th, 2007 at 11:10 am
Wow. Thanks for putting that together! It really adds perspective….this isn’t just a slightly more conservative investment, it’s crazy. I assume that the EIA profits if the returns are above 10% (not to mention the profits they make through fees and such).
September 13th, 2007 at 12:24 pm
Thanks for the analysis, JLP. I was hoping you would put something more concrete together after your last post.
Not knowing a lot about these products, my initial reaction was that they may be good for retirees who don’t want to lose principal. After your analysis, though, I can see that I should have looked deeper.
September 13th, 2007 at 12:59 pm
You DEFINITELY gave the benefit of the doubt to the EIA as well. 1.5% ER for an SP500 index fund? You can find them for
September 13th, 2007 at 1:01 pm
Ryan,
Yes, I did that like that just to show how crappy this particular EIA really is. I know that you can find an index fund that tracks the S&P 500 for a lot less than 1.5%.
September 13th, 2007 at 2:45 pm
While your analysis is sound, it is also unfair. No one who really understands financial products can reasonably compare the S&P to an EIA. One is an investment. The other is a fixed product.
EIA’s are not right for everyone. They are definately not right for someone who is suitable for an investment in the S&P. EIA’s are fixed products and are only suitable for people with very conservative risk tolerances (who also can tolerate several other limitations EIA’s would impose).
I could not see your entire spreadsheet even when I clicked on it (my bifocals are not THAT strong) so I will just assume your numbers are correct. A much better comparison would be what was the average CD rate 1950 - 2006? I don’t know but I am guessing that it would be less than 6.81% (only in the mid to late 80’s can I think it was higher). As a reminder CD interest is currently taxable and annuities are tax deferred.
I am not getting up on a soapbox and professing EIA’s for everyone. They’re not. But your comparison would be like comparing a moped to a Harley Davidson. Both have two wheels but they have entirely different uses.
September 13th, 2007 at 2:56 pm
Art,
I have to disagree with you.
I think the comparison is fair because the presenter of this seminar used the S&P 500 Index as his basis. And, if an annuity is based on an index but without the “risk” then it is more than fair to compare it with the actual index or another investment that is based on that index.
And I’ll ignore your comment about my not understanding financial products.
September 13th, 2007 at 3:44 pm
Correct analysis, and I’ll reiterate my points that EIA’s are fairly complex (for seniors especially) and unless you fully understand them and the opportunity cost, you shouldn’t even think about touching them. This on top of the fact that the presenter was obviously fudging details (important details) like mad. It is extremely difficult to find a good annuity without a consultant that charges a lot per hour.
What is clear from the get-go that if you are young enough, annuities are completely worthless and basically give away money. Annuities are somewhat more stable for the elderly, but give away a lot of return on top of not being completely safe. I’d submit that instead of annuities when I’m old, I’d invest in bonds or bond funds for stability in my Roth IRA or traditional IRA. The annuity business like the insurance business geared towards the elderly are both devious on the whole (not to say that all annuity and insurance carriers are sleazy, but a majority are).
September 13th, 2007 at 3:52 pm
The numbers are actually worse than your spreadsheet. Equity-Indexed Annuities only return the index — the dividends are not included. Take out the 4%-6% yearly dividends for that period and it’s a total disaster.
September 13th, 2007 at 4:37 pm
I’m glad that someone mentioned seniors. You may or may not be aware that Citizens Bank (owned by Royal Bank of Scotland) was fined $3,000,000 (yes $3.0 Million!!!) for targeting elderly customers and selling them highly inappropriate annuities. They were being sold to individuals over 80 years old!!
Re: a comparison with the S&P not being valid - I thought the product was called an EQUITY based Annuity, not a fixed asset based annuity. In my language, EQUITY means the S&P.
The number of scams (sorry - inappropriate investments) being addressed to seniors is extraordinary
September 13th, 2007 at 4:50 pm
JLP, I did not mean to imply that YOU do not understand financial products. But now when I read my own comment I understand how that message was conveyed. My appologies.
While I still think the comparison is unfair, I will say that this presenter is dead wrong too. EIA’s are not investements, nor are they viable as investment alternatives. As others have said EIA’s are complex and there are some people are out there pushing them in inappropriate situations. Rather than blame the EIA, I blame the pusher.
I just ask this. Try to look at an EIA as a CD alternative. Do you still think it is so bad? Of course that also changes the perspective of who it is appropriate for.
September 13th, 2007 at 9:12 pm
Al,
The reason they called EQUITY INDEXED annuities is because the INTEREST that is paid is based on a market index such as DJIA, S&P, etc. Since they pay interest, and the crediting rate can never be negative, they are fixed products and not investments.
Again I feel the need to re-iterate. I am NOT promoting EIA’s. I am just being fair in my analysis. JLP said the goal is to educate, not to persecute. That is all I am trying to do.
September 13th, 2007 at 10:28 pm
Art said:
“The reason they called EQUITY INDEXED annuities is because the INTEREST that is paid is based on a market index such as DJIA, S&P, etc. Since they pay interest, and the crediting rate can never be negative, they are fixed products and not investments.”
I always thought “fixed” meant that it didn’t change. When I think of a fixed annuity, I think of one where the interest payment (or earnings) doesn’t change and the income is basically the same year after year.
I’ll admit that there is a lot of confusion when it comes to annuities and EIAs. A lot of the confusion is brought on by sales people who like to talk up the EIA as a way to play the market without the risk. And the risk, although there, is a WAY overplayed by the salespeople.
September 13th, 2007 at 11:29 pm
JLP, I think that we are closer than you think. I too believe that the longer your time frame, the less risk you take investing in the market. Invest for a long enough time and the risk of loss is nil.
By regulator’s definition, a fixed product is one which is not an investment. EIA’s are not investments.
A traditional fixed annuity pays interest that is “fixed” by the issuing insurance company. Usually, the interest rate is set for each year at the beginning of the contract year. The contract may have surrender charges for several years and a guaranteed minimum interest rate, but the actual interest paid still varies from period to period. As long as the rate is at least equal to the contractual minimum, the insurance company can pay whatever rate they want. It is often based on economic conditions and marketing factors.
In an EIA the interest rate is not set in advance. Instead, formula(s) based on stock index values are used to calcualte the interest earned. Other key differences are that the minimum interest paid on an EIA is 0%, and it is impossible to calculate the interest earned in any given year until that year is over. The actual mechanics of an EIA are too involved for a comment. I think I will try to post about them next week.
In the meantime, lets agree that:
1. EIA’s are NOT a way to play the market without the risk
2. EIA’s are a conservative alternative
3. If someone claims otherwise, they are either unethical or uninformed.
4. The products themselves are not necessarily bad, but they can be used improperly.
September 14th, 2007 at 4:18 am
Let’s consider the idea of EIAs being a CD alternative. I decided to pull up spreadsheet and run some numbers myself. Since 1928, I have the following real returns and volatility:
* S&P500: 6.46% real, 19.09% stdev
* Treasury Bills: 0.55% real, 4.42% stdev
* Treasury Bonds: 1.57% real, 8.88% stdev
* EIA 0% floor, 10% ceiling: 2.45% real, 6.36% stdev
So compared to just T-Bills (good proxy for CDs) or T-Bonds alone, an 0%-10% EIA looks to be a good deal. Obviously, it underperforms the S&P500 but the standard deviations are so much lower, they’re not in the same category.
But let’s say we have a portfolio of 20% Stock, 40% T-Bonds, 40% T-Bills. This would have returned:
* 2.45% real, 6.81% stdev
Pretty close. Looks like we can probably reproduce EIA performance without having to deal with commissions, extra annual fees and surrender charges. With more asset classes, we could really make a CD-like portfolio hard for an EIA to beat. An example using data going back to 1972:
0%-10% EIA: 1.56% real, 5.89% stdev
Permanent Portfolio: 4.82% real, 5.88% stdev
The Permanent Portfolio author Harry Browne’s conservative allocation designed to handle many economic cycles: 25% cash, 25% long bonds, 25% gold/commodities, 25% stocks. I dropped gold/commodities to 20% and increased bonds to 30% to get the standard deviations to match up.
September 14th, 2007 at 5:02 am
A note about the numbers I just ran. Starting the period from 1972 is a huge hit against an EIA because an EIA is absolutely pummelled by high inflation. Inflation ran 6%-12% during the 70s. So an average return of 2% above inflation for the S&P500, the nominal returns would have been high (8%-14%). EIA caps would then produce next to nothing with the inflation portion artificially causing the cap to chop off much of the real return. 1974 and 1979-1981 had inflation above 10% so a 10% cap would have guaranteed real losses no matter what the market did.
I don’t know if there are be inflation-indexed EIAs. If so, that would solve the 1970s issue. But a deflationary period like the Great Depression would be corner case for that option. A string of low returns with deflation adjusted would also produce negative real returns.
September 14th, 2007 at 7:06 am
I could be wrong on this, but as far as the “guaranteed principle”, you might be slightly off. You stated that if the index return is -5% one year, the account had 0% return, which is correct, but I think that the account balance still drops, even though it is guaranteed for the full amount. For ease, let’s say you have $100 in the account and the index return is -5%. Now the account is $95, but your guaranteed principle keeps it at $100. If the following year the index return is +5.2% (the return to get the account back to the orignal balance), I believe your account balance would only be $100, and not $105.20.
Again, I could be wrong on this, and it could vary from annuity to annuity, but if I am right, just another point to your arguement. Also, I believe guaranteed priciple only guarantees the amount you put in, and not the interest gained. So if you doubled your money the first year, then lost a little over the next 3 years to bring you back to the original investment, you only get your original investment. Some companies recalculate the principle to include the interest every couple of years.
September 14th, 2007 at 7:53 am
Art said: “By regulator’s definition, a fixed product is one which is not an investment. EIA’s are not investments.”
I think he may mean to say it’s not a security; a fixed product may still be an investment.
Securities are regulated on a federal level, while fixed annuities are regulated by each state’s insurance commission.
One of the reasons EIAs are so controversial is they look a lot like a variable product, which would be a security, and if it were a security, those selling them would have to follow the same regulations that all securities dealers and reps have to follow. But, as of right now, they are regulated by the states as “fixed” annuities.
If an annuity doesn’t involve a sub account that can used to invest in securities, it will likely fall into the “fixed” category.
September 14th, 2007 at 8:55 am
Good stuff here. Thanks JLP for stimulating the discussion.
Mossy - I agree with you when you wrote “compared to just T-Bills (good proxy for CDs) or T-Bonds alone, an 0%-10% EIA looks to be a good deal. Obviously, it underperforms the S&P500 but the standard deviations are so much lower, they’re not in the same category.” That is what I originally meant when I said the S&P comparison was unfair.
I also agree that you can replicate EIA like performance with a portfolio of conservative securities. However the only thing you are avoiding is the surrender charges. Fees and commissions are included in the returns, not charged in addition. While early EIA’s had long surrender charge periods (I have seen in excess of 15 years!), modern ones (within the last year or so) are often 10 years or less. Many new issues are 5 years of surrender charges or less. Not really all that different from a long term CD. Add that to the guarantees (which a securities portfolio does not have especially in time frames of under 5 years) and tax defferal… once again, I am not saying EIA’s are the answer for everyone… I am just saying they do serve a role for the right person.
You do bring up a good point about inflation. Keep in mind that CD’s suffered the same ilk in that time frame too. I have never seen an EIA designed to provide inflation adjusted returns.
juanny - You’re close, but not correct. If you have a $100 EIA balance and the market return is -5%, you get 0% crediting and your balance is still $100. Next year if the market return is 6% your new balance would be $106. (keeping the assumption of a 100% participation 1 year point to point with a 10% cap). Now your surrender value may be less than your account value if surrender charges still apply…
Dylan - You said it better than I did. A fixed product is one that is not a security. As for EIA’s being investments, I still disagree. As others have pointed out there are many better investments. All the problems with EIA’s stem from people who sell/buy them as investments and then later realize that they are not. EIA’s are CD (or equivilent) alternatives.
Hey JLP! I have never commented so much on a topic. Let me know if I should just shut up and move on!
September 14th, 2007 at 10:21 am
Art said:
“Hey JLP! I have never commented so much on a topic. Let me know if I should just shut up and move on!”
I would never do that. I let the discussion carry itself. If there’s still people commenting, then there’s still a discussion going on.
I do appreciate your comments as well as the comments of all my readers.
September 14th, 2007 at 11:10 am
[...] A Look at an Equity-Indexed Annuity. AllFinancialMatters analyzes an annuity similar to those pitched in seminars full of people who aren’t given the time to take a deep look at these products before receiving the hard sell. [...]
September 14th, 2007 at 11:30 am
I find it odd to be talking about 70 year S&P timelines when a client may already be 50-70 years old themselves. That is as fair as taking a comparison only during a bull market. Fixed Indexed Annuites are appropriate whe mixed in with other vehichles depending on the client. I have one client age 41 who has changed jobs about every 3 years. She rolls her 401K into an FIA when starting a new job. With the guarantees in the anuity she then goes super aggressive with her new 401k enrollment. This has worked fantastic for her and she has sent me thank you notes during the last Bull years. Also the mjority of FIAs I sell now have a 2.75-3% monthly cap, my own IRA has had returns as high as 24%, with no concern, and the gains locked in. I and many others are willing to give up some possible upside for the peace of mind on some of my dollars. It is a personal purchase decision just like buying a nicer car instead of more common stocks. Any blanket statement of good or bad shows lack of knowledge or posturing.
September 14th, 2007 at 11:54 am
Kelly,
It’s a 57-year timeline (at least in my example) and I ONLY used it because that’s how far back the seminar presenter went back. Besides, you said you have a client who is 41. The chances are really good that she will be a 50-year investor.
Personally, I think you are doing your client a disservice by allowing her to roll all her money into an EIA. Did you spend time showing her the long-term trends in the stock market?
You say her strategy has worked well. How do you know? Have you done comparisons with other strategies to find out? I may think I’m tall because I’m the tallest member of my 5-member family. However, that doesn’t mean I’m tall.
Finally, how much more commission did you earn from the EIA than you would have earned had you invested her money in traditional mutual funds? Why is it that everytime someone challenges these products, the people who sell them claim that we are making blanket statements and that we lack knowledge? What, we lack knowledge because we think a product is inferior?
I’ll take my lack of knowledge over your superior intellect any day.
September 14th, 2007 at 2:32 pm
Good post. There was an article in the Sept. 24 issue of BusinessWeek that readers may also want to check out. Here’s a link….http://www.businessweek.com/magazine/content/07_39/b4051073.htm. The article is called, “Retirement Made Complicated.”
September 14th, 2007 at 5:00 pm
Apologies to JLP…couldn’t let this one pass.
Kelly,
You state: “It is a personal purchase decision just like buying a nicer car instead of more common stocks.” “my own IRA has had returns as high as 24%, with no concern, and the gains locked in”.
You sound like you’re selling cars and returns.
And you bought an “indexed annuity” for your own qualified account? I doubt it. We know the insurance sales game. The annuity is an insurance product right, not an exchange-traded security?
“the mjority of FIAs I sell now have a 2.75-3% monthly cap”
Let’s be clear. You’re just an insurance agent representing the products of insurance companies. Why should we care what you have to say?
JLP is on the right track: “how much more commission did you earn from the EIA…” We all know if there was no commission you wouldn’t know anything about IAs.
Don’t insult the many, well informed, educated, knowledgeable readers here who see right through that propaganda.
September 14th, 2007 at 5:38 pm
There is a way to buy EIA-like products inside a qualified account. Fidelity Brokerage offers something called Principal Protected Notes.
http://fixedincome.fidelity.com/fi/FICorpNotesDisplay?name=PPN&refpr=obrfind22
You are depending on the credit risk of the issuer. If you buy a PPN from Lehman Brothers and they have serious troubles due to the subprime mess, they made decide to default on their notes. (Same for EIAs — you are dependent on the financial health of the insurance company.)
Of course, when you think on it carefully — any bond held to maturity is “Principal Protected” if the issuer doesn’t default. There probably is a premium for PPNs because they are non-liquid and currently not tradeable on the secondary market.
September 15th, 2007 at 10:10 am
A good resource for comparing equity index annuity performance can be found at http://www.personalyze.org. You can input the EIA you want to analyze and see hypothetical returns for bull markets, bear markets, and last ten years.
September 15th, 2007 at 1:47 pm
man oh man. a discussion this lengthy might actually delude someone into momentarily concluding annuities aren’t that bad . kinda like entertaining theories of holocaust didn’t happen or we didn’t land on moom in 1969 as if just maybe there’s some sanity in that argument. there’s no sense in mincing niceties when it comes to this insurance product. all annuities suck and are inappropriate for everyone except the salesperson. period. there is no other side. check my previous posts to see reasons so i don’t have a heart attack restating. and a saleswoman had the frickin’ nerve to post here after putting a “client” in an annuity in a 401k? sick.
September 15th, 2007 at 2:01 pm
Two things no one is really addressing in detail here: 1.) That the “annual reset” feature of an EIA in addition to the “no downside” adds huge value to the client - especially when taking income via withdrawals; 2.) That the choice of crediting method used will also have a HUGE impact on what the client receives.
Unlike the “variable annuity”, there are NO initial or ongoing account fees or other maintenance costs in an EIA. “Annual reset” means that not only does the client not lose principal, but all gains earned are “locked in” and the account value is restarted/reset from that point for the next year. There are never “drawdowns” or losses to recover from or make up for! The effect is similar to a balanced portfolio, but for many people easier to implement and offers an extra level of protection (guaranteed) from losing principal that securities can’t offer.
Now - Suitability assumed, you MUST look at the way the EIA will “capture” gains. For example, annual caps are terrible and throttle the whole beauty of the EIA concept. Monthly point to point (a.k.a. Monthly Cap) is one of the worst credit methods ever designed, for a long-term investment like the EIA. But you’ll never know unless you look at the differences yourself. And they are surprising!
As you noticed, spreadsheets are cumbersome and nearly impossible for some of the more complex methods. Use a software tool - the free one noted above is provided by my company for consumers but others are available for agents and advisors from several companies, including mine.
You’d be surprised at how well a rightly-configured can meet growth needs for the more conservative investor. Don’t rule out the EIA or consider them all “worthless” simply because a capped product configuration you were shown doesn’t perform well.
September 15th, 2007 at 3:00 pm
muddlehead, “all annuities suck and are inappropriate for everyone except the salesperson. period.”
At least you are open minded…
September 15th, 2007 at 7:47 pm
The concept of the IA is valid. Market “participation” with a limited upside, coupled with a TRANSFER OF RISK for any losses to an insurance company. A legitimate strategy.
However, in my opinion software that “analyzes” EIAs is of practically no value to the consumer. Of course in the hands of a skilled agent, this type of illustration can be a highly effective sales presentation and closing tool.
This is the same old historical review ” well look how well your money WOULD HAVE performed”. Give me a break. It sounds impressive and authoritative but means nothing.
The producer software from that firm allows the agent to choose the historical comparison period. Given a half hour most readers could select a time period that will look very compelling (and would probably generate a sale).
Of course contracts offered by annuity companies do vary widely, so an individual should read the offered legal agreement thoroughly. And not just the flashy charts and “hypotheticals” that are NO PART of the agreement.
For that’s what we’re discussing, CONTRACTS; not securities like stocks, bonds, notes, or shares of a fund.
Do your homework (which is what most readers are trying to do so cheers to JLP), ask questions, and choose wisely.
Regards,
Jim
September 16th, 2007 at 10:14 am
art, i’m in. the floor is yours. give me a specific example where an annuity is appropriate.
September 16th, 2007 at 10:26 am
[...] A Look at an Equity-Indexed Annuity by JLP @ All Financial Matters. Go ahead and read the interesting comments by Art Dinkin and MossySF on this one. I am sure you will have a good idea of what Equity-Indexed Annuity (EIA) is by the end of reading this one. [...]
September 16th, 2007 at 10:21 pm
[...] All Financial Matters lets us peek at an equity-indexed annuity. [...]
September 16th, 2007 at 10:23 pm
Interesting post, I was just having a discussion with a colleague about “Fixed Indexed Annuities” last week. We are in the financial services business and both of us absolutely hate these things. The thing is, we came to the conclusion that the reason we really hate them is that they are almost always mis-sold and almost always misunderstood by the person buying them.
That being said, I suppose that there is probably some limited use for this product; I just haven’t found it yet. In my opinion, the indexed annuity product was cooked up in the back room of an insurance company as a way to give non-securities registered agents something that looked like an investment to sell.
Some of the important points from the comments above are really, really valuable.
1. Don’t use “total return” to compare. The indexed annuity doesn’t participate in the dividend portion of the total return.
2. So much of the performance of this product is tied to the “crediting method” that it has to be investigated very closely.
3. These products have so many moving parts that they are very complex and aren’t easily understood.
4. These products should not be compared to a stock market investment, but rather to a fixed savings vehicle like a CD or fixed annuity.
September 17th, 2007 at 2:24 pm
To DeltaBlue: Don’t assume that all analysis software tools are the same - they aren’t. You should explore a bit before dismissing them all in one fell swoop.
For example, the online program mentioned by Joe Taylor (www.Personlyze.org) is a great example. You CAN’T “cherry-pick” a time period with this one. And it weighs in factors like correlation coefficient and Beta in addition to return.
There is even a software tool for running Monte Carlo simulations for EIA credit methods… but that’s another story.
And to “TJ”: The strategy of index investing is well researched and proven by top minds in the industry (J Bogle, B Malkiel, etc.) to be superior to active/subjective investment strategies. For non-qualified, conservative dollars, whose desires include tax deferral and growth that outpaces fixed interest rates, the indexed annuity is a sound choice. Add to that the ability to take annual withdrawals for income - without worry of taking income amidst a market downturn - and it is appropriate in many situations as a key part of a retirement portfolio.
Finally, even though penalty-free annual withdrawals of 5-10% are pretty standard, many EIA’s are now shorter surrender term (5-9 years), and with much lower commissions, too. As with any other investment, shopping around for the best product structure for your client is imperative. So - using the EIA doesn’t automatically make an advisor a ‘commission pig’.
Can you imagine choosing a mutual fund or bond without looking at the investment method to be employed, and reviewing its historical behavior? No educated advisor looks at the past to forecast, but rather to understand relative behaviors to aid in making decisions.
Hope this helps!
September 17th, 2007 at 5:22 pm
Ms. Maynard,
First, you start with a HUGE bias in my opinion. You sell software to insurance companies and their agents. This IS your business model correct?
Your fees are based on the dollar value of insurance premiums generated by these companies when they sell EIAs to consumers correct?
Second, you DO NOT dispute my statement that the “producer” version of your software allows agents (the proper legal title) to choose the time period they wish to illustrate.
You could have said, “indeed the insurance agent version does allow customized reporting periods, but this is not available in OUR consumer version”.
You instead say something like “Can you imagine choosing a mutual fund or BOND (my emphasis) without looking at the investment method to be employed”.
Huh, what??
The investment method of the bond I own? Simple. It’s a loan to General Electric for ten years, at 6.33%, callable in five. There is NO investment method. I evaluate the credit worthiness of GE to pay me back period.
And that ” it weighs in factors like correlation coefficient and Beta in addition to return.”
Yawn….This is the point consumers glaze over. “Well, I trust you TOM. We’ll go with Allianz if you think it’s the best for us”. Tom gets a 9% commission on a $250,000 premium and pockets $22,500 for the pay period. SWEET!
Don’t give us a naive, sales oriented, canned answer that we won’t buy. You’re not addressing a room full of Seniors who don’t know any better.
Ms. Maynard says “annual caps are terrible and throttle the whole beauty of the EIA concept. Monthly point to point (a.k.a. Monthly Cap) is one of the worst credit methods ever designed”.
Add value for the readers and tell us which methods are more favorable then?
Perhaps Joe Taylor (who touts your software and thus the legitimacy and virtue of EIAs), as a fee-only advisor with Oak Street can give us an example (or three) of a no-load, no-commission IA that readers might investigate further.
TJ is not far from the mark: “the reason we really hate them is that they are almost always mis-sold and almost always misunderstood”.
September 17th, 2007 at 6:47 pm
Ms. Maynard,
It is quite a stretch to equate the idea of index investing as conceptualized by Bogle with an indexed annuity. I have no problem with “index investing” but (as I am sure you know) that isn’t exactly what you get with an indexed annuity. Hence the confusion that exists for the average consumer, and, I’m afraid, for many agents/advisors.
You wrote “For non-qualified, conservative dollars, whose desires include tax deferral and growth that outpaces fixed interest rates, the indexed annuity is a sound choice.” Maybe, maybe not. But I can think of better choices for almost every case. Further, you wrote “Add to that the ability to take…withdrawals…without worry of taking income amidst a market downturn….”. Again, I can think of options that are much better than an indexed annuity.
“Finally, even though penalty-free annual withdrawals of 5-10% are pretty standard, many EIA’s are now shorter surrender term (5-9 years), and with much lower commissions, too.”
About this you are correct, although I still see plenty of new clients in these things that have 10+ years in surrender. And let’s face it, the caps (regardless of crediting strategy) in the short surrender products are pretty low.
“As with any other investment, shopping around for the best product structure for your client is imperative. So - using the EIA doesn’t automatically make an advisor a ‘commission pig’.”
Again, you are right, not every agent selling these are “commission pigs”. But some are. And some are agents that can’t (no securities registration) sell other, perhaps better, products.
For me, the bottom line is:
1. IA’s are often mis-sold by greedy or uneducated agents.
2. The public misunderstands these products in a bad way. In my experience, most consumers think they are getting something that they are not.
3. There are better solutions than IA’s in practically every case that I can think of.
So I ask this: Why buy (or sell) an IA when you can buy (or sell) a better solution?
September 17th, 2007 at 11:08 pm
Thanks, TJ - I do think we agree about more here than we disagree on.
Actually, carrying over the concepts of index investing to the EIA really isn’t that much of a stretch. I’m assuming you are referring to the “no dividends” thing, since the EIA issuer is getting the market participation through derivatives purchases (call options) and not actual securities purchases. Are you saying then, that derivative strategies aren’t really “index investing”? I know some large mutual fund companies who would disagree with you.
In a way, the EIA effects “Separation Property Theory” (Tobin) for many individuals who for lack of account size wouldn’t get access to more sophisticated portfolio management. As I mentioned before, there is NO upfront fee, NO ongoing account or management fee, and NO transaction costs to implement this strategy in the EIA; along with its inherent benefits of tax deferral, asset protection, and income options (guaranteed payments for a set term or for life, or annual withdrawals).
EIA’s can indeed be mis-sold by the greedy or uneducated. But so can be mortages, stocks, mutual funds, timeshares, refurbished appliances and new cars. I know many more upstanding agents and advisors who sell the indexed annuity.
Don’t take me wrong, I agree that many consumer’s aren’t getting a straight story on what it means to own an EIA contract. However it’s an education problem, not a product problem. And both Consumers and Agents can be educated. (So why aren’t they required to be educated? That is another peeve of mine, but I digress…)
Should advisors stop selling all Mutual Funds or stocks just because reps of several well-known brokerage firms were hard-selling them? Or avoid all ETFs just because it’s a new way investment companies have found to draw in assets under management? Perhaps one should never refinance a mortgage again because of the recent scams? It’s the same thing with the EIA.
The EIA rates change annually under most contracts. The reason rates are low now is because of index volatility - option prices are murder (see the VIX index). When the indexes stabilize, rates will increase again. That’s “market participation”. But no contract holder ever faces losing their premium deposit. That’s a fixed annuity guarantee.
So all that being said, what other similarly priced plan, product, or program can accomplish all that for the average Joe and Joan and their modest nest egg?
“Better Solutions” for them? I don’t know. The client’s needs should dictate, of course. One can make a good case that index investing (in some form) should be a part of every retirement portfolio. The EIA may actually be a better solution in more cases than one might think.
I guess I’m still saying to all advisors to take an analytical look at the product - to do some real “due-diligence” research - before painting a whole product line with the same brush.
September 18th, 2007 at 2:52 am
I think we will have to agree to disagree on the idea that an IA is a form of “index investing”. At best I think any debate we might have on this point could easily devolve into one of semantics. Regardless, you illustrate a point of contention that I have when you wrote “…since the EIA issuer is getting the market participation through derivatives purchases….” In essence, the IA issuer is getting market ‘exposure’ through the use of derivatives, but I wouldn’t call that market ‘participation’ and I know one too many agents that represent an IA as providing market ‘participation’.
Regarding Tobin’s “Separation Property” I will concede your point as I agree that this is largely what the strategy within an IA does. The problem is that in theory this sounds great. In practice, anyone who lacks sufficient investment assets is either:
1. Young enough such that they have sufficient time to “absorb” the negative effects of volatility on their portfolio (and consequently take advantage of the lack of limits on growth), or
2. Poor enough such that they ‘need’ growth vehicles that do not have upper limits.
Also, you mention the lack of fees and/or transaction costs. On it’s face you are, of course, correct. But the IA issuer isn’t manufacturing (and agents certainly aren’t selling) this product for purely altruistic reasons. We all have to eat, and while an IA lacks a denominated fee, it is simply built in to the platform by way of floors and caps, adjusted so that an IA provides a profit for everyone involved in the manufacture and distribution. In this regard, I suppose, one might argue that the lack of transparency is a bad thing. The rest of the benefits of an IA (tax, income options, etc.) are available in every other form of annuity as well as the indexed variety.
I also don’t disagree that every other financial product can (and has) been mis-sold. Among those you mentioned, though, I would say only mortgages come close to the IA in terms of product complexity. This makes these products particularly easy to “mis-sell” to an unsuspecting public. You are right when you say that it is an education problem. Consumers ’should’ do their own due diligence, and agents/advisors should be held to the highest standards of ethics and honesty.
Now, all that being said, what other similarly priced product can accomplish the same thing as an IA? Well, that depends on the client. I do know that a modern VA with living benefits can offer similar (but not identical) protections and benefits of an IA. In fact, I’d argue that in most cases, the VA is a better solution than an IA.
Finally, and your point with which I most agree with:
“…all advisors to take an analytical look at the product - to do some real “due-diligence” research - before painting a whole product line with the same brush.”
As much disdain as I have for the IA, there are a number of them that really aren’t all that bad (short surrender, decent caps, etc.) Enough diversity exists in the world of IA’s so that a ‘good’ advisor can’t “paint them all with the same brush” and still be a ‘good’ advisor.
Nevertheless, I’d still take a good VA w/ living benefits any day (well, almost any day)…
September 18th, 2007 at 10:20 am
Gentlepersons,
I am not recommending anyone’s software nor have I ever ’sold’ or recommended an EIA. I do not know of a no-load EIA product but If you know of one I am always open to learning more. I simply posted the link because as you can see from AFM’s spreadsheet analysis, it is time consuming and very hard to know all the intricacies of all the EIA policies marketed today. I believe the free web based analyzer is a good resource for consumers who probably heard at a seminar that they will get the upside of the market with no downside. Or if a monthly cap product that they can earn up to 20% or 30% a year without any chance of losing money (yes, I have heard these claims in radio ads here in my hometown) I posted the link in hopes of saving you some time and trouble with you initial analysis.
EIA’s are probably the most mis-sold financial product I have ever seen. I do thank personalize for providing a free resource that can take some of the hype out of the product for non professionals.
EIA’s are not unlike many structured product manufactured by large investment bankers, that allow some market participation with limited downside risk. (Merrill Lynch MITTS, Bear Stearns Principle Protected Notes, etc.) For more info on these look here http://www.amex.com/ under structured products. These products are very similar to EIA’s but have not garnered as much vitriol because the marketing has not been as egregious.
I believe investments are neither good nor bad on their on. They are useful or not useful, well chosen or misguided.
At any rate this has been a good thread, and for the most part very civil.
September 18th, 2007 at 1:35 pm
Part 1:
According to Beacon Research (reported on Yahoo Finance) the top-selling Indexed Annuity product for the last 12 months in a row was MasterDex, issued by Allianz Life Insurance Company of North America.
This product has a surrender charge of 10% in year ONE, declining to 4% in year SEVEN. Although there are a few different “flavors”, MasterDex5, & MasterDex10 that offer illusory premium “bonuses”, with different schedules.
Even using Ms. Maynard’s highly suspect online software (more about that in a moment) the “hypothetical” return (simple average) for the MasterDex over the last ten years was 4.22%. A quick glance at the Federal Reserve site tells us we could have purchased a 10-year Treasury Bond (with complete liquidity) in 1997 with a 6.58% yield. The BEST SELLING Indexed Annuity product on the market was 200 basis points BELOW the risk free rate over the last ten years.
Part 2:
Here’s one example of why readers should be very cautious with these vehicles. These contracts are unilateral and as such favor the insurance company. Often the issuer retains the right to raise or lower the monthly caps at the end of the year but the consumer is stuck with a rigid surrender schedule. Even in contract year five the MasterDex will levy a surrender charge of 6% on full withdrawal even if they decide to lower the monthly interest cap to the minimum of 1%. Fine you wish to lower the cap and the potential interest I’ll receive, then allow me to surrender with no charge. Good luck with that!
Part 3:
Just read what the regulators like FINRA (formerly the NASD) has to say about these products:
http://www.finra.org/InvestorInformation/InvestorAlerts/AnnuitiesandInsurance
Part 4:
I try hard to debate only the merits of the product, vehicle, or strategy in question. But occasionally it’s difficult to avoid challenging a specific individual’s comment. Back to the credibility of the Maynard comments. Readers can verify for themselves with the State of Vermont Department of Banking, Insurance, Securities & Health Care Administration (BISHCA):
http://www.bishca.state.vt.us/news_releases/Maynard_fin_1-16-07.pdf
Quoting from the BISHCA press release:
“Former Colchester Couple, Mitchell and Dorice Maynard Ordered to Repay Investors $400,000 for Securities Fraud”
“Deputy Commissioner of Securities Anna Drummond announced that an Order has been issued finding a former Colchester couple liable for hundreds of thousands of dollars in restitution and penalties for their conduct in violating Vermont’s security laws. In particular, Mitchell M. Maynard, and his wife, Dorice A. Maynard, were found to have acted at times as unlicensed investment advisers and to have defrauded eleven Vermont residents by enticing them to purchase high risk, speculative investments with the promise of exaggerated investment returns. The Maynards’ scheme included setting up a mutual fund and an investment advisory company called LIMCO and circulating false account statements.”
I stand by my earlier comment that this type of software provides no value for the consumer. In the hands of a skilled agent it can be very valuable indeed; to the agent that is.
September 18th, 2007 at 1:50 pm
It has been a few days since I checked in on this discussion and it looks like I have missed out on a bit.
Muddlehead, I just posted to my own blog which I think addresses your comment. Check out http://www.momentonmoney.com/2007/09/understanding-i.html
JLP, Thanks for starting a good conversation.
September 18th, 2007 at 3:37 pm
Joe,
Respectfully, you say:
“EIA’s are not unlike many structured product manufactured by large investment bankers…These products are very similar to EIA’s but have not garnered as much vitriol because the marketing has not been as egregious.”
Those Merrill Lynch MITTS are exchange-traded, uncollateralized, completely liquid, DEBT SECURITIES. They are just nothing like the insurance contracts we’re discussing.
I know you’re participating with good intentions and I don’t wish for my comment to seem harsh. Insurance agents & companies are allowed (by all of us) to blur the lines between their unregulated, illiquid, and without question highly profitable products and REGULATED, exchange-traded, completely liquid securities.
What if I offered (through an agent) a product that pays interest based on the (potentially) rising cost of Milk? Say the Milk-Index Annuity or MIA. You invest, oops I mean pay a premium of $100,000 and I’ll add a 10% bonus for an annuity value of $110,000. Next year I’ll measure milk prices and if they’re up 7%, I’ll credit you with $7700 of interest. Your annuity value is now $117,700. Impressive!
I’ll guarantee you at least your original premiums back (after ten years) so even if the Milk market tanks you’re OK.
Sounds good but try and redeem it early. I’ll levy a 15% surrender charge and keep my bonus so you’ll only get a surrender value of $85,000. (I had to pay an agent a 10% commission, which’s $10,000, to make the sale and need to recoup that money). You can’t redeem the full amount for ten years without a substantial penalty. It can’t be sold to anyone else.
You never own milk, or milk futures, or securities issued by milk producers. I could choose to invest your premiums in pretty, shiny marbles, my decision. You just have my promise. Sound familiar?
Now Joe, there are many, many ways to limit market risk but by all accounts the EIA is an expensive, clumsy way to do so.
Regards (sincerely),
Jim
September 20th, 2007 at 8:29 am
The problem is you have professionals in all areas who simply do not know what they are talking about. It then is the aged ole story one bad apple destroys the bunch. One reason the “Master Dex” was the number one selling product is because it paid the highest commision. So a bunch of short sleeve short tie guys run around knocking on doors trying to sell something so they can make rent. However, before we beat the product up, which can be good for some people not all and it is certainly not a place for all ones money. All states approve these products before they hit the shelves of thieves if I am not mistaken. Sometimes I do believe as well that BROKERS find themselves a little more high and mighty than someone selling EIA’s. Trust me in my time in the industry I have seen many Brokers making unsuitable investments for Granny. However,you almost never here of a 70 year old loosing 1/3 of his porfolio because his broker told him to wait, and now he is waiting being a greeter at the Wal Mart. But it is most of the time justified because the market goes up and down not the Brokers fault. Past performance and all that jazz. Sorry my grammer may be sliglty off I am in a hurry. But some other issues in the financial world need to be addressed, before we get on our soap box.,Annuities are constanly being changed. It is one of the fastest growing products today, and I find in hard to beleive that everyone who chooses to invest into one are all idot’s sitting at a nursing home.
September 20th, 2007 at 10:27 am
Your study is only semi-accurate. One thing you didn’t mention is that EIA’s aren’t the ideal vehicle for EVERYONE. Particularly people with more than a 15-20 year accumulation horizon. For examply, if you are a 20 year old, looking to accumulate the most wealth you possibly can before retirement, then of course an EIA may not be the ideal vehicle for you!
An EIA’s potential return is more conservative(or potentially lower, to put it blatantly) than say, a mutual fund or stock, due to it’s guarantee of principle protection and never to lose money. However, the potential loss in a mutual fund or stock is far greater than that of an EIA. And it is for this reason that only people with long-term investment goals (more than 20 years, I would say) should invest in risky vehicles, like the abovementioned (MF’s and stocks etc.). A 20 year old can sustain more loss than say, a 70 year old. Or even a 60 year old. That is why an EIA is more suited towards a retiree or someone with extremely conservative (i.e. safe) needs/wishes.
If you really want to do a totally accurate study/comparison of these products, draw up a chart that illustrates 15 years (instead of 50). Try using the time frame of 1998-2007. Compare the EIA’s growth (using a hypothetical, yet realistic, ROR) to the performance of the S & P 500. You will find that, over that short time period, with the crash of the markets, 9/11 etc., that the performance of the EIA far surpassed that of the S & P. This is not my opinion, but rather a proven fact.
In summary, if you are in the accumulation phase of your life (20’s, 30’s, even 40’s), perhaps an EIA is too conservative for you. However, if you’re in your 50-60 or 70’s, and you don’t ever want to outlive your money, and you want to go to bed at night knowing that tomorrow morning and every day thereafter, you’ll never be worth less than the day before, an EIA is an ideal (I believe) product for you.
September 20th, 2007 at 3:03 pm
Hi Jen,
I agree with most of what you said. Of course if you were to do a back-test of returns today, it would give you a far different result than it would have given you yesterday! For example, an actual ten-year history of the S&P 500 from September 13, 2007 would have given you a 10.28% average annual return. Just one month earlier, the 10-year return for the S&P 500 going back was only a 4.99% average for 10 years! Many EIA’s beat last months’ 10 year track record of the S&P 500. Very few did today!
September 21st, 2007 at 11:56 am
Will comments: “…the “Master Dex” was the number one selling product is because it paid the highest commision.”
That’s the whole point. The distribution costs of these products (issuer, wholesaler, & agent) MANDATE a lengthy surrender period. Only in the context of simply ridiculous 10-15 year surrender periods would 5-9 years be considered a better deal. Consumers have no idea how much agents make selling these things.
He continues: “All states approve these products before they hit the shelves of thieves if I am not mistaken”
Agents use this pitch all the time. Implying that because the contract is approved for sale it has somehow been evaluated by a state insurance department and found to be without flaw. The states (with the exception of NY perhaps) give issuers wide latitude regarding the insurance products they sell. Try getting a mutual fund with a 20% and fifteen-year deferred sales charge past FINRA or the SEC.
Jen comments: “Try using the time frame of 1998-2007…You will find that, over that short time period… that the performance of the EIA far surpassed that of the S & P. This is not my opinion, but rather a proven fact.”
“Compare the EIA’s growth (using a hypothetical, yet realistic, ROR”
What are you comparing to the index, a hypothetical EIA growth rate you’ve picked?
Even if we concede your fact, it just doesn’t provide much value. How does that time period compare with the risk-free rate? Ten years ago I could buy a 10-year T-note paying + 6.50%, while the Vanguard Index 500 fund had a +6.67% return over the last ten years. Complete liquidity with both. In fact as interest rates fell to 4.65% in December 1998, the value of my ten-year Treasury Note appreciated nicely.
So how much return ABOVE the risk-free rate did your EIA generate for me based on your sample time period?
If I was trying to sell these things too I could cherry pick all sorts of time periods to show how well it performed. Ed is right on the money. Move the period back a day, a week, or a month and the results are completely different.
September 26th, 2007 at 11:37 pm
O.K. I’ve read through all of this and the fact is that we’re talking about several different things.
First of all we’re talking about investment vs. insurance. To everybody trying to compare an FIA (Fixed Indexed Annuity), it shouldn’t be done. An FIA is insurance. The risk is taken on by the insurance company. Hence the ability to guarantee that the there will be no loss in the value of the contract, as long as the individual follows the rules.
Secondly, nobody should have all of their money in one type of vehichle. There needs to be diversification. However, as an individual gets closer to retirement the “time horizon” reduces. This requires an individual to reposition their funds from an investment to insurance.
Third, as the individual is getting older and is needing to preserve more of their funds, or in retirement and decumulating their funds, we need to look at the type of vehicle the individual is in. One of the things that I feel everybody can agree upon is that we’re living longer. I feel that we’re going to be looking at many “boomers” needing to take a stream of income. There’s only one vehicle that will GUARANTEE that they can never outlive their funds, annuity.
Fourth, to all the people that state that FIAs are high commission products. I will agree that in the past there were some rogue companies that were paying outragous commissions. However that arguement is outdated. Side note, the MasterDex is not the highest paying FIA.
Fifth, and finally, what is the risk tolerance of the client? What are the goals for the clients funds? How soon do they need to get at the money? We need to look at suitability. We need to take care of the client. We can argue which is better, however no one vehicle can meet all the clients needs.
September 27th, 2007 at 4:09 pm
I hate to wear out my welcome JLP as this thread is a bit worn by now, but had to this pass this along.
The consumer site 403bwise.com has a posting on their front page about an EIA being pitched to school teachers. They have a scan of the flyer an insurance agent posted in a school in CA.
http://www.403bwise.com/pdf/tsa_flyer_match.pdf
Quoting:
“Receive an 11% match on 403(b) TSA deposits…earn higher interest rates with NO stock market risk”
End of quote
According to the site this EIA has a 22% surrender charge that lasts (likely declines) over 14 years.
Chris,
Maybe you’ll have the nerve to identify some of those EIAs you think are fairly priced and pay “lower” commissions with shorter surrender periods. We’d love to know.
September 29th, 2007 at 11:30 am
[...] Commenter Chris left this response to my post, A Look at an Equity-Indexed Annuity: O.K. I’ve read through all of this and the fact is that we’re talking about several different things. [...]
October 1st, 2007 at 7:58 pm
[...] I never even knew. JLP takes a look at equity indexed annuities. {via: All Financial Matters} [...]
October 3rd, 2007 at 12:13 pm
[...] Commenter Chris left this response to my post, A Look at an Equity-Indexed Annuity: O.K. I’ve read through all of this and the fact is that we’re talking about several different things. [...]
October 5th, 2007 at 12:33 am
Ron,
It’s too bad that you didn’t write your comment in an easier-to-read format.
If what you say is true, then you are the exception to the rule when it comes to EIAs.
October 5th, 2007 at 9:20 am
Ron,
Are you a salesman or client?
October 5th, 2007 at 10:56 am
Long term projections are very interesting to securities sellers - because their high principal risk is muted by time.
In this article, you show a 50 year time horizon - something almost no one has - especially a senior.
How happy is the Indexed Annuity buyer who has had his annuity for the last 7-10 years!
Most securities holders are just now recovering from the losses of 2000-2002. IA holders, by contrast, are up significantly - and they are still subject to no market loss risk!
Indexed Annuities are a much safer alternative for seniors because of their shorter time horizons.
October 5th, 2007 at 11:10 am
M. Coleman said:
“Indexed Annuities are a much safer alternative for seniors because of their shorter time horizons.”
Not with a 15-year surrender period they’re not.
A balanced low-cost portfolio is a MUCH better alternative to an EIA.
October 6th, 2007 at 11:49 pm
“Not with a 15-year surrender period they’re not.”
It is *idiotic* crap like the comment above that show the true motives of a securities agent.
There may be a few idiots out there selling 15-year annuities but they are the EXCEPTION and are no different then the SECURITIES Agent who sells unsuitable stocks, bonds, Timesahres, Variable annuities to older clients.
I sell 7-year Index Annuities. Full liquidity at the end of term and CONSTANT LIQUIDITY each year as well as SAFELY SECURE client’s principal and declining 7% surrender fees.
Clients FULLY understand all the moving parts before they put money in. I don’t own a short sleeve shirt and my ties are the proper length.
There IS a place for SAFE money in everyone’s portfolio and the only one who says differently is the GREEDY securities agent who doesn’t want to lose there AUM fees.
For every bad Insurance agent, I can show you 3 bad Securities guys.
PERIOD.
October 7th, 2007 at 2:13 pm
Readers pay attention. This is the way these things are sold!!
Ron,
You said: “other ones i have seen have had a very nice return. up to 19% with a 10% first yr. bonus, thus turning it into a 29% return.”
Four questions:
1. Exactly how much premium was placed into this contract? 2. Exactly what was the SURRENDER VALUE at the end of the first year?
3. Exactly how much was the agent commission?
4. Name the product and terms.
There was no 29% return because the bonus is an ILLUSION! You can’t withdraw the bonus. Do you think an insurance company can pay a client 10%, plus an agent 10%, and still give a client the entire market return? Seriously, where’s the margin? The insurance company is in the hole 20% on day two of the contract.
Coach:
It is fair to say that many of these products offer 7 & 10 year surrender periods not 15, but this is still a LONG time. Constant liquidity does NOT equal FULL liquidity. SAFE money? How about a government bond or an FDIC insured CD?
If a mutual fund can publish performance numbers for their funds (Jan 1-Dec 31) then how about EIAs? Show us something beyond a HYPOTHETICAL and give us hard data to support this product.
By all accounts these products provide incremental return above the risk free rate for significant restrictions on liquidity. Of course give us data and I’ll review it with an open mind.
October 7th, 2007 at 2:55 pm
[...] Commenter “Muddlehead” doesn’t like my posts about annuities (he/she thinks I’m shilling for insurance companies! LOL!). I’m not trying to beat a dead horse here but I do want to take a minute to follow-up on a few comments that were left on a my post, A Look at an Equity-Indexed Annuity. [...]
October 7th, 2007 at 10:50 pm
The 7 and 10 year EIA’s are great! I have been selling them with happy clients for years! The liquidity in the first year and beyond is beautiful! It can be cummulative! I think the issue with many of the planners here is that they fail to realize the needs of clients in different areas of life! Dont plan for a senior like you would plan for a 20 year old! Money in an annuity IS safer. The only way you could lose the money is to take it out before the surrender period is up ( I sell nothing over 10 years) or taking it out before 59 1/2. Mutual funds have the possibility of loosing, stocks the same. Granted there are some funds that have great history but, senior client dont like knowing that there is still the possibility of loosing. Why not give them some of the gains but NONE of the losses. How would you feel is you are constantly loosing money in a bad market. There are some annuties out there that even in a bad market will guarantee at least 3%! So while you guys are loosing 10% + for your clients I can call mine and tell them that the grew! And as far as providing a prospectus for our clients — we dont need to as there is nothing hidden — we dont have to hide what we do — its simplified. No funds to manage simply an index thats it. Also as someone else mentioned GAINS ARE LOCKED IN. Someone spoke on the fact the bonuses are not really yours….personally I dont sell bonuses simply because that means something else is lacking in the product ( in many cases) But I have Hundreds of client that have had gains over 10 % — 10% is not the cap on all products — Of course there are some that are capped — but you dont have to have a cap! What about the gains in non-secure/safe products ….NO GAIN IS REALLY THEIRS….They could possible gain it one month and loose it the next. CAN YOU GUARANTEE ANYTHING UP OR DOWN TO YOUR CLIENT? The answer is no….but I can!
October 8th, 2007 at 10:09 am
Stanley More, CFP says:
“But I have Hundreds of client that have had gains over 10 % — 10% is not the cap on all products — Of course there are some that are capped — but you dont have to have a cap!”
But of course you won’t TELL US WHICH PRODUCT has performed so well. This is all smoke.
Here’s my REAL example…see post #41: “A quick glance at the Federal Reserve site tells us we could have purchased a 10-year Treasury Bond (with complete liquidity) in 1997 with a 6.58% yield.”
This is the benchmark risk free rate over the last ten years. Give us an example of an ACTUAL product. Surely with hundreds of clients you can pick one off the top of your head. No need to do any lengthy research. I’ll hold my breath. Ha!
Readers: These agents always pitch the fear of market loss, and that these products are safe and secure. Retirees are SCARED TO DEATH that they’ll lose their money.
We’ll be waiting to hear back Mr. CFP.
October 8th, 2007 at 8:12 pm
After reading Stanley More’s comment, I looked up Stanley More on the CFP Board’s Web site and there is no CFP certificant listed by that name.
October 11th, 2007 at 9:15 pm
Delta and Dylan,
It is obvious nothing said here will ever pursuade you. I get it. That’s okay, you are entitled to your opinion. But that does not invalidate every dissenting opinion.
I had not checked in on this thread for quite a while, since I posted Understanding Indexed Annuities and frankly I thought it was over, but it was still sending some traffic to my blog so I thought I would see if it was still active and it was.
As for some good indexed annuities, check out Midland National’s MainStreet 4. Four year surrender, 10% liquidity per year, no surrender charges after 48 months. Or AmerUS’ MultiChoice Income 5. Surrender charges last only 5 years. I’m not endorsing anything, but just wanted to point out that these products do exist in the marketplace.
Yes, you may have been able to buy a 6% bond in 2007, but hardly anyone did. Those were the days of the “New Economy”… if you couldn’t day trade to 20%+ per year you must be an idiot, right? Look where that whole mess ended up.
Look, I’m not going to fight. If you were a client then I’d tell you “Fine, don’t buy any indexed annuities”. I have NEVER said they were the best solution for everyone.
Go ahead and look my name up in the CFP database. Here is a quick link to save you time.
October 12th, 2007 at 10:22 am
I enjoyed reading this blog and would add a comment.
Why are all the remarks about commission on the annuity?
I am an agent and make 9% on a 15 year product from Allianz.
But the Finacial advisor who managers the same amount of money earns 15-30% over the same period of years.
the client pays the loads and fees out of their money.
Who’s being overpaid?
October 12th, 2007 at 3:03 pm
Art,
Finally a professional, who is licensed to sell insurance, identifies several “good indexed annuities”. Respectfully, I appreciate you doing so. And I regret the flip CFP comment I made; it was uncalled for. If EIAs can stand on there own as an alternative vehicle then they should withstand scrutiny.
I am only making sure the readers know how these things are sold; with completely false claims that are used to scare people into buying.
The EIAs you mention deserve serious review. They have limited surrender periods reducing the liquidity problem nicely. But to be fair, they have serious limitations (Midland, S&P 500 Credit Method, 7% CAP) and just have NO ability to earn the outrageous returns CLAIMED by other posters.
JLPs original blog post:
“Well, this guy went and took the S&P 500 Index, went back to 1950, and pulled out all the bad years and told the audience that it returned 15.75% per year”
Kelly W.:
“Also the mjority of FIAs I sell now have a 2.75-3% monthly cap, my own IRA has had returns as high as 24%, with no concern, and the gains locked in”
Joe Taylor:
“he quotes a radio ad he heard in his hometown:’Or if a monthly cap product that they can earn up to 20% or 30% a year without any chance of losing money’”
Jen:
“You will find that, over that short time period, with the crash of the markets, 9/11 etc., that the performance of the EIA far surpassed that of the S & P.”
M. Coleman:
“Most securities holders are just now recovering from the losses of 2000-2002. IA holders, by contrast, are up significantly - and they are still subject to no market loss risk!”
Ron:
“other ones i have seen have had a very nice return. up to 19% with a 10% first yr. bonus, thus turning it into a 29% return.”
Stanley More, CFP:
“I have Hundreds of client that have had gains over 10 %”
Not one of these folks have provided any information to support these statements. This is COMMON PRACTICE; SEVEN biased, misleading claims in just this short thread.
This is not unusual. The SEC just completed and published a joint report on these “seminars” where EIAS are often pitched. An “seminar” prompted JLPs original post.
http://www.sec.gov/spotlight/seniors/nofreelunch.htm
Quote from the report:
“Half of the examinations found that firms used advertising and sales materials that may have been misleading or exaggerated or included seemingly unwarranted claims (in 63 of 110 examinations, or 57%)”.
I stand ready for an insurance agent to specifically identify the EIA product used, terms, and holding period to justify these, well too be nice, exaggerations.
But the chance for a 7% yield with a 4% guarantee, and a relatively short 48 month surrender period (The Midland product you mention) deserves consideration. BUT I can get over 5% in a money market account today with complete liquidity so my improvement would be at best an incremental 200 bps. This isn’t attractive to most people, which is why we hear the hype of 10%, 15% ,20%, 29% returns. THAT SELLS!
October 12th, 2007 at 3:06 pm
Mark,
Wow, at least you admit that you take 9% off the top and lock your client’s money up for 15 years. Pretty gutsy, but your are 100% correct. The “financial advisor” is probably ripping them off too. Who’s being overpaid? Both of you.
October 14th, 2007 at 8:33 pm
Art Dinkin, I’m not really sure what I said to ruffle your feathers so much. I checked on someone’s credentials and couldn’t find them. That hardly qualifies as an effort to invalidate every dissenting opinion, just the credibility of one comment. I don’t believe that I’ve said anything to call your credibility into question.
You are correct that nothing said here will convince me that EIAs are a good thing. I’m glad you get that, but I will continue to comment as I see fit. Please feel free to skip over anything else I write once you get my point.
My lack of endorsement for the EIA is not from a lack of understanding; I just haven’t come across, or can even imagine, a situation where such a product is the best solution for anyone. If it actually were, why then don’t fee-only financial planners with a fiduciary responsibility to advise in their client’s best interest recommend these products to their clients? Why is it that the only people who seem to be advocating these are the insurance agents that are paid to do so? And, if they are such a good solution for some people, why do the insurance companies need to pay such a high commission? That doesn’t seem like good business sense on the part of the insurance company unless, of course, people would not recommend them without the monetary incentive.
October 30th, 2007 at 2:37 pm
Nice thread…the one thing I didn’t see here was a link or connection to a Monte Carlo simulation of EIA’s. This would let you at least put a hypothetical EIA thorugh the paces.
Equitrust has an EIA with no Cap, 65% participation and 10 year period. It credits annual point-to-point with annual reset.
It seems that, like Mutual funds, as the market matures the competition will increase and the terms will get better.
There is no magic in an EIA, you could go and create your own portfolio with all of the liquidity of the “normal” bond and derivative markets. The reality is that most investors cannot (or won’t) create their own insurance with derivative products, so they are willing to pay others for the service. Is the fee high, yeah, but so is paying .5% of my return to buy the S&P stocks in a mutual fund. Remember when mutual funds charged all kinds of front end loads, back loads, sales commissions and fees? Most people today are way away from those products. I expect EIA’s to get there too.
As I found from selling cars years ago, the more obscure the product (i.e. car lease vs. car purchase) the more money you make. Will regulation and competition help…you bet it will. Regulation would probably allow a secondary market for annuities that could obsolete surrender fees. Wouldn’t that be cool.
November 6th, 2007 at 8:04 pm
Hi,
You all need to read the White paper on Indexed annuities. The biggest problem is that they are misunderstood. As an agent I think having more choices and not less choices are better. The consumer can choose a traditional annuity or any number of indexed annuities. It is the job of the agent to educate the prospect and make sure the annuity is suitable for his or her situation.
I sold one of the first indexed annuities in 1995. It netted my clients about 24% over the 5 year period. At the end of 5 years they could take all the money out. It is a product, if propably priced, can potentially get a hire interest rate than a traditonal annuity. It is a fixed product.
November 11th, 2007 at 10:34 am
Larry,
Another outrageous claim. You said: “I sold one of the first indexed annuities in 1995. It netted my clients about 24% over the 5 year period”
Are you still telling customers about that 24% return? Even if your claim is true, it’s all but impossible now given the way these products are designed. But that doesn’t stop agents like you from touting these types of illusory performance claims. That’s what started this whole thread of comments.
The biggest problem is the bogus claims (OK, I’ll say it) LIES told by agents who sell these things.
Readers:
TWO major emotional buttons are being pushed here. Don’t fall for it. FEAR and GREED. From the SEC report in comment #66:
GREED: “Get double digit growth potential…”
FEAR: “… with no risk of loss and no fees”
Can you name an EIA product (and terms) that provide the opportunity for the 24% return you tout? (or did you mean 24% total for the five years)
November 12th, 2007 at 11:42 pm
Wow. I had not check in on this post in a month and people are still commenting!
Delta, you are correct. EIA’s are not the next coming of the financial messiah. 7% caps are pretty common right now (and I have seen a lot lower lately). A realistic target return for an EIA is somewhere in the neighborhood of 5-8% per year depending on several variables of the specific product and indexing strategy. Of course there is risk. The average return could be less than 5%. It could be 0%.
Dylan, whatever ruffled my feathers I have either forgotten about or got over. My appologies if I ruffled yours in return. I respect your opinions. By the way, I am a fee based planner and as such have a fiduciary responsibility. I have never pushed EIA’s on my clients but there have been situations where I have not advised against them. They can fit as an alternative for a fixed annuity when the client is willing to risk a known small return in exchange for an unknown, but potentially slightly higher return. Not for a big piece of their pie, only a part. Who cares what the commissions are? (and they have been falling as surrender charge periods have gotten shorter - for the record, I think that is in everyone’s best interest). If an auto mechanic quotes me a repair cost I don’t care how much of that is profit. Is it unreasonable that retail stores mark up their merchandise over 100%? Anyone who misrepresents financial products should suffer the consequences. But that does not make the product evil.
November 13th, 2007 at 1:04 pm
“Who cares what the commissions are?”
Well, for starters, those who regulate investment advisers like the U.S. Securities and Exchange Commission, every state’s equivalent securities authority, and let us not forget the Certified Financial Planner Board of Standards. They all care and say you, as an adviser, should too. In fact, they all require the advisers they regulate to clearly disclose their compensation to clients, all of it, including the commissions earned and disclose all conflicts of interest, even those associated with compensation. If the amount of the commissions were not relevant, why would these groups care whether or not you were adequately explaining your compensation to your clients?
There is a large, clear cut, division in the merits of equity indexed annuities that just cannot be ignored. Whether of not they get paid seems to dictate which side of the division one resides. Is this coincidence? On one side are all of the people that get paid money when someone buys one. On the other side we find every other finance professional, including financial academics, finance journalists, and FEE-ONLY financial planners.
“Fee based,” while similar sounding to, “fee only,” is an entirely different animal. Being a “fee based planner” does a not automatically make one a fiduciary. Whereas if you hold yourself out as a “financial planner” and are “fee only,” meaning the client pays a direct fee to the adviser for financial advice (not for a product), the adviser is compelled to become a Registered Investment Advisor or representative of one, which caries a fiduciary duty to clients. The term, “fee based” is not regulated at all; anyone can say they are “fee based” whether or not they are registered and have a fiduciary duty to clients.
“Fee based” usually means that you represent a third-party’s interests in addition to your clients, such as an insurance company (annuity) or investment company (mutual fund) by selling their products for them. That’s what it means to be an insurance “agent” or a registered “representative.” The interests of the third-party company are not the same as the client’s interests, yet someone that is fee based represents both sets of interests at the same time, thus creating an immediate conflict of interest.
I am not questioning whether or not Art has a fiduciary responsibility. I’ll take him at his word. I am simply calling into question the implication included in his statement, “I am a fee based planner and as such have a fiduciary responsibility,” because being a fee based planner does not automatically translate to having a fiduciary responsibility.
A fiduciary duty to a client, even if an adviser is fee based, means that the adviser is expected and obligated to always place the client’s interest first. However, conflicts of interest relating to compensation can interfere with an adviser’s ability to be completely objective, regardless of the adviser’s intent to remain objective.
It is expected that any ethical adviser will believe that they are objective in the face of such conflicts, and therein lays the problem. If they are not being objective and they are ethical, they likely do not realize that their judgment is being colored. The only way to know for sure is to remove the source of the conflict and see if the advice changes. This takes us back to the observation that different advice concerning equity indexed annuities is given by those who are paid commissions on them.
Art, I don’t expect to change your mind anymore than you expect to change anyone else’s, and I have no reason to believe that you are anything but an ethical person. But you cannot be objective enough about your own objectivity to claim that the commissions that you receive in no way influence you, no one can. The only way test this is to give up your securities license, resign your appointments with your insurance companies, and never accept another commission again. Then see if your philosophy changes. Are you willing to try this?
Make no mistake, I’m not claiming that this removes all conflicts and magically makes someone completely objective or ethical, but it does remove one major source of influence on financial advice (and money has a well-established track record for being a motivation tool). Adviser compensation is a divided issue as well, but notice again that one side is heavily weighted with the advisers that receive additional compensation when the client buys something that they advise them to buy.
Every ethical, commission earning advisor claims that their method of compensation does not influence their advice, but how could they possibly know whether or not that is true? It’s a belief that they *must* maintain if they view themselves as ethical. Do you see the paradox?
November 16th, 2007 at 1:57 am
Art said:
“JLP, I think that we are closer than you think. I t