Equity Index Annuities


Wouldn’t it be nice if you could experience nearly all of the gains in the stock market without taking any risk to your principal?  For several years now, a number of insurance companies have implied that they offer just that, ‘returns based on the stock market with no downside risk.’  The primary thing to note with these claims is that while returns are based on the stock market, the actual returns over time seem to reflect little of what the stock market does.

These products, called index annuities or Equity Index Annuities, are usually sold by insurance agents sponsoring dinner seminars on topics like asset protection or tax reduction.  In spite of warnings by regulators against such sales tactics, the practice is still fairly common.  The solicitors of these high commissioned products prey upon a persons fear and their desire to obtain higher returns without taking additional risk. 

While these products do protect against losing money in a down market, the potential upside in average or even good markets is very limited.  In addition to using complicated and confusing methods for calculating returns, the returns in good years are also reduced by cap limits, spreads, participation rates, and averaging.  The dividends that are usually included in market returns are also excluded from the calculations, further reducing and limiting the returns on index annuities.  Some even require that withdrawals of the credited balance be spread out over a number of years.

It seems that the protection comes at a very high price.  We applied the crediting formulas used by several popular equity index annuity companies to market returns over the last five and ten year periods and found the returns to be closer to those of fixed rate annuities and bonds than to the stock market.  For example, applying the currently offered caps, spreads, participation rates and averaging, to the 10 years prior to December 2007, produces average annualized yields ranging from 2% to 4.11%. 

Applying the same to the Five year period ending December of 2007 gives annualized yields ranging from 3.84% up to 5.49% with most ending in the 4 percent range.  However, ‘the market’ that most of these annuities are tied to returned an average annualized yield of 12.83% over that same five year period.  Of course, individual returns will vary depending on the entry date, methods, participation rates etc. offered at the time.

If you are looking for safety and protection, you will likely have more success using high quality fixed rate annuities and fixed income products.  As the old expression goes, if it sounds too good to be true, it probably is. 

Feel free to contact one of our investment advisors if you own or are considering purchasing an equity index annuity, and would like a complimentary review. 

Written By Kimber Heaton - Certified Financial Planner