Wednesday, June 23, 2004

Equity Indexed Annuities Are Improperly Sold

I have never been a fan of the Equity Index Annuity. An EIA is a fixed annuity that allows for some extra growth tied to an index, typically a stock index.

They are sold by uneducated insurance agents everyday to an unsuspecting public that doesn't understand a word coming out of the agents mouth. In most cases - the agents don't understand the product either. The agent tells a great story and the customer buys it hook, line, and sinker.

Imagine this scenario.....Let's say that I could give you the returns of the market without the risk, would you like that? This is the basic pitch that agents use to sell high commissioned (typically 10%) EIA's. Who wouldn't want the market return without the risk? Unfortunately these products are mostly hot air - they have littl substance to them and are easily manipulated by the insurance company producing them.

In the latest issue of Senior Market Advisor, an annuity sales rep had the following to say about how he "uncovers risk aversion," as follows:

"To uncover risk aversion, Abedeen asks clients if they would prefer an investment that's earning 15% but could lose 20%, or an investment that's earning 8%, but can't ever have a return less than zero. Clients invariably choose the 8-percent option."

The unwitting prospect would almost always pick the latter option - if you could earn a guaranteed 8% (which is what he is insuating) versus 15% with a major loss potential why wouldn't you. There is so much wrong with this line of quesitoning this agent uses that I don't even know where to begin.

I will start with the fact that all people are "risk averse" - nobody wants to lose money if they don't have to. What is really bad is that stocks do not average 15% annually, sure they have in the past 15 - 20 years, but historically they have barely returned 10% - half of that from divideneds (which we will get to later). Next, stocks can fall by more than 20% - yes, i know that this helps boost his arguement, but it is still worth pointing out. The real point I am attempting to make is that he is telling people that they have a choice (and basically only one) between a 15% return with lots of risk (of which doesn't exist - the 15% at least) or an 8% with zero risk. I am here to tell you that there is no way Equity Indexed Annuities will return 8% or even close to it in the decades to come. Why? I don't have enough room to tell you why - but I will lay out a short case. An EIA's return is based on the growth of the market - not the total earnings (as is insuated by the agent in the above quote), the growth of the market has not average much above 5% in this last century and doesn't appear to be headed higher. EIA's do not include the return of dividends. Dividends have made up a siginificant portion of the return of the stock market in the last 100 years. Even if we say that the market will return in the 7% range for growth - highly unlikely for the market as a whole - the EIA annuity will not return anywhere near that - at best perhaps 5%. There will always be years where index annuities will have a great year and return double digits, but they will be few and far in between and the years in which they return zero will offset the double digit years.

EIA's may be an alternative to a fixed annuity, but I wouldn't put my clients money into them - if I did I would explain the actual risks and the actual potential returns possibilities and not lie in order to make a sale.

By the way - for every $10,000 in EIA sales an agent could make about $1,000 (which comes out of your return) - so in order for an agent to make $100,000 in a year he/she only needs to sell $1,000,000 worth of EIA's - not a difficult thing to do.

Next time you are approached by an agent about buying an Equity Indexed Annuity or anything that sounds similar - just say no, then tell your friends to stay away from that person.


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