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AARP article: "Don't buy equity indexed annuities"

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Well, here we go again. This time, it’s published by AARP in the April/May 2014 issue of their magazine. Titled “Don’t Buy It” and written by a stock broker, professor and financial writer named Allan Roththe article describes equity indexed annuities and several other products as “some of the worst investments and financial products you can can sink your money into.” 

The section on equity indexed annuities begins, “This product, now rebranded as a ‘fixed indexed annuity‘ by the insurance industry…” Roth doesn’t explain why this was done, as though there was some sinister motive for the rebranding. In fact, it came about because the Securities and Exchange Commission tried to categorize these products as securities several years ago when trying to impose Rule 151A. This would have meant that life insurance agents who sold these insurance products would have been required to get a securities license in order to continue selling them. The only thing it had to do with securities was the name “equity” (no joke). 

The insurance companies were looking for a way to give their customers a higher crediting method than that offered by traditional fixed annuities. Since interest rates were low and were probably going to stay that way for quite a while, insurers came up with a way to credit the accounts by using a market index such as the Standard and Poor 500. What they would do is buy a call option (upside) on the Standard and Poor 500 index with the interest they were making on their bond portfolio to give more credit over time. The day of the contract, they would buy the option for what they could afford to buy with the bond interest. A year later, when the option expired, they would exercise the option, or it would expire if the market was down. They never bought stock, just an option on the stock to give interest credits. So, the name change was appropriate. 

In the AARP article, Roth says an equity indexed annuity “is often sold with a promise to link returns to stock market gains, without risk — you don’t lose a cent if the market tanks. It’s among the most complex financial products I’ve examined.” 

Well, let’s see how they work: Let’s say I invest $100,000 in the stock market and $100,000 in a fixed index annuity. The market goes up 6 percent in the first year. The stock holder has a 6 percent gain. The FIA has a cap (a limit on what is credited due to how much of an upside of the market they can afford to buy with their bond interest). So, let’s say the cap is 4 percent. That is what the FIA holder receives.

Let’s say that next year, the market goes down 10 percent (lots less than in 2008); then the FIA holder keeps his 4 percent because it’s locked in, but the stockholder not only loses his 6 percent gain, but 4 percent of his principal. So the insurance companies’ promise must be true. 

Roth writes, “…you’ll find the guarantees are mostly illusion. How can an insurance company take your money, pay the planner a commission, invest the rest mostly in conservative bonds and still give you market returns without risk?” Well, I just told you how they do it. 

If Roth had studied these products, he would not have written such a biased article. The guarantees are contractually given under the State Department of Insurance where the product is approved. 

The last thing Roth references are “the thick disclosure documents.” He must be writing about the prospectus that accompanies variable annuities that are sold by our stock broker buddies since those products can lose principal. 

I wish writers like Roth would do more research about fixed index annuities instead of trying to demonize them. The very people that he is writing to are the most in need of these valuable insurance products. Sales were up 5 percent last year to $230.1 billion, so not everyone is believing the misinformation.