The question of whether equity-indexed annuities should be classified as a fixed or variable product was headed for resolution last summer. The NASD in August announced it would issue guidance on the controversial issue, and members anxiously awaited an answer. But in what is all too characteristic of the self-regulatory organization, advisors were left scratching their heads, and compliance departments were scrambling to make sense of “Notice to Members 05-50.” In it, the organization issued “guidance” on the subject by refusing to take a stand one way or another.
Despite regulatory confusion, equity-indexed annuities have proven themselves an effective tool in addressing the investment needs of the elderly. According to the American College’s Fundamentals of Insurance for Financial Planning, equity-indexed annuities are a variation of fixed-interest deferred annuity products. They offer guaranteed minimum interest rates, and at the same time pay higher returns if a specified stock index increases. They are designed to appeal to investors who want to participate in high-equity investment yields without bearing the full downside investment risk of a variable annuity.
Like all investment products, they’re subject to abuse from a small number of unscrupulous individuals bent on making inappropriate recommendations. So what are some of the more appropriate situations to recommend EIAs for senior clients?
Ken Bradford, LUTCF, manager of Carlton Group Insurance Services in Springfield, Tenn., recently had a client situation where a husband died and his younger wife received a large insurance payout.
“She came to us for help and didn’t need the money right away,” Bradford relates. “We purchased an EIA that returned 18 percent the first year. Obviously, this type of return cannot be sustained and we told her it could easily go flat the following year, which she understood.”
While Bradford admits annuities are not for everyone, he notes that a high number of investors are still scarred from the recent economic downturn, resulting in millions of dollars that remain on the market sidelines. For seniors who need equity exposure due to increasing life spans but are wary of an increase in the associated risk, EIAs are a good fit. And most companies allow the contract holder to withdraw up to 10 percent annually after the first year, allowing for limited liquidity.
“EIAs work well as an investment strategy, but we think a better description is an aggressive saving strategy,” says Dan Crane, an advisor with Senior Financial Services Group in Springfield, Ohio. “For the appropriate client, we’ve had great success in limiting market risk while providing a better than average return.”
Because of the high number of EIA products that are currently available, Crane does much of the legwork himself. His strategy is to evaluate each product for his clients and then narrow it down to one or two companies. He then narrows the choice further by identifying the best products among the selected companies. Only then does he present his findings to the client, making the process as simple as possible to ensure the client isn’t overwhelmed.
“People are used to sitting in front of the TV and being spoon-fed information,” he adds with a laugh. “Shouldn’t we do the same? Initially, explain the product in the simplest way possible, with the bells and whistles it might have attached to it, then revisit it in a year when they’ve had some time to digest it.”
For clients that are 75 years and older, Crane says it generally takes more time to explain the EIA concept. But companies are increasingly adept at tailoring their marketing material to the senior set, and easy-to-understand visual aides are currently available to help in the process.
The product’s complicated nature led Columbus, Ohio-based Nationwide Financial to release its Clear Horizon Index Annuity last summer. Developed with simplicity in mind, the company claims the product is well-suited to “enable registered representatives to abide by recent regulatory guidance that was communicated regarding index annuities. [The goal] was to create the simplest index annuity on the market, and we think we’ve succeeded.”
John Kawauchi, vice president of business development with Nationwide’s Individual Investment Group, explains that the product offers a way for seniors to earn more than a money market, without a corresponding increase in the potential downside. As long as the contract is held past the surrender charge period, there’s no loss of principal. All index gains are credited annually, up to a cap, and are locked each year so they’re guaranteed, even if the index later declines. It also allows clients to allocate premium between the index and fixed accounts and can be exchanged between the two each year.
“In any situation, there are three things that can happen,” Kawauchi says. “If the market goes down, nothing is lost. If the market goes up more than the cap, the owner receives the cap. If the market goes up, but less than the cap, the owner will receive whatever that percentage is. So there is no negative effect relative to the owner’s original investment. And if the market does go up, that will be the new floor for the next contract period. The client can get anywhere between zero and 8 percent a year, which in today’s market environment is pretty good. It’s an alternative to a CD, but still contains some of the advantages of a CD. It’s almost like having your cake and eating it too.”
Ultimately, EIAs make sense for seniors who want to grow their money, but can’t afford the potential downside risk. As Crane concludes, “If they don’t intend to use the money right away and they don’t want to risk their principle, they can invest at least a portion of their assets in one of these vehicles.”