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October 29, 2014 at 07:06 AM
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 Roth, the 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.
