Equity-indexed annuities credit an interest rate linked to an equity index, usually the S&P 500. They also provide downside protection in the form of a minimum guaranteed rate. EIAs were developed in 1995 partly to give insurance companies and non-registered producers a variable annuity alternative.
Sales of these products have shown some impressive gains and accounted for almost 20% of fixed annuity sales in 2003 for participants in the Beacon Research “Fixed Annuity Premium Study.” In addition, the EIA share of study participants fixed annuity sales generally increased from month to month in 2003, from some 15% in January to almost 25% in December (see Chart I).
What are the factors behind the increased popularity of equity-indexed annuities in 2003? Not surprisingly, the most obvious driver seems to be rising equity prices. Beacon Research looked at correlations between EIA sales and several independent variables. By far the strongest relationship was with the S&P 500 (see Chart II).
But EIA sales didnt move in lockstep with the stock market. Sales of these products dropped from June 1, 2003, through Aug. 1, 2003, even though the market was tending up. Why did this happen?
There was a 40% increase in 5-year Treasury rates during this period. Independent producers may have switched back to traditional fixed annuities when rates rose. And, these same producers may have shifted away from EIAs because they are more complex, and hence more difficult to explain than Treasuries.
Equity-indexed products also tend to have lower minimum guarantees and longer surrender periods, making them less attractive to the conservative fixed annuity investor.
Independent producers accounted for more than 92% of our study participants EIA sales in 2003, so their choices of product types have an enormous impact.
However, equity-indexed products have many advantages. They provide the consumer with more upside potential than traditional fixed annuities with less risk than VAs. According to various EIA providers, many of the index products outperformed products in other asset classes (such as 5-year FAs and equity funds, index funds and bond funds).
As noted, EIAs provide the non-registered producer with an equity-linked product to sell. EIAs also tend to offer sizable commissions in relation to other annuities. There are newly designed products offering fewer “moving parts,” shorter surrender periods and even fixed-rate options with competitive yields, addressing disadvantages that EIAs have been perceived to carry in the past.
There have been other innovations as well. Consumers now can choose from a number of indices including the Dow-Jones Industrial Average, the NASDAQ-100 and the Lehman U.S. Aggregate. But the 4th quarters 6 best-selling EIAs tracked in the Beacon Research “Fixed Annuity Premium Study” all offered the S&P 500. The very first EIA offered the S&P 500, which remains the gold standard.
All of the top 6 products use an “annual reset” crediting method.
An annual reset product provides the return of the underlying index on the contract anniversary and then “resets” itself to that level for another year. Over the past 5 years, the market has rewarded annual reset products.
These EIAs were able to participate in index gains in 1998 and 1999, protect those gains in the declines of 2001 and 2002, and then reset to those lower levels to take advantage of the index climb in 2003. Of course, future market conditions may favor other crediting methods.
With these advantages and innovations, it appears that EIAs will capture an increasing share of fixed sales in 2004, assuming no major shifts in interest rates and the stock market.
Distribution is still confined mainly to the independent producer channel. (See Chart III.) This tends to limit sales and share of the fixed annuity market. But there are signs this is beginning to change. EIA sales through captive agents and banks increased significantly in December 2003, and several carriers are making a concerted effort to market indexed annuities through new channels.
The EIA appears to be a product type whose time has come. There has been a tremendous increase in company activity in exploring new EIA launches. Several new carriers are poised to enter the EIA market. Although much could change with unfavorable market conditions, 2004 promises to be an excellent year for EIAs.
Jeremy Alexander is president and chief executive officer of Beacon Research, Evanston, Ill. His e-mail address is [email protected].
Reproduced from National Underwriter Edition, April 30, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.