Annuity IQ

When it comes to equity index annuities there has been both harsh criticism and praise from both camps, the critics and the EIA producers. I myself have even gotten in the middle of the argument as I have a tough time explaining them as a reasonable investment.

What make these products so difficult are the crediting methods. Different companies offer a wide variety of different crediting methods that seem reasonable to the naked eye, but as you dig they are not as reasonable as they might seem. What I find disturbing is most firms do not readily provide illustrations and if they do they show you an ‘assumed’ rate of return….assuming anything does make an ass out of you and me by the way.

When we assume conditions in the market, based on a steady interest rate or return, of course things look fantastic. After all, when we use assumed rates of return we are talking about an ideal world, not what really happens in the market. The market does not have a steady rate of return, it never has, and that is what bothers me the most when people refer to the market.

Everyone says the market ‘averages’ X return over the last 10 years. What they fail to tell you is the market went up 20% one year and then had negative 15% return the next year and you end up with an average return of 2.5% over two years. That rate of return does not look bad, compared to a negative 15%, but it is not showing you the drastic movement of the market. Using an average rate of return is important, but there needs to be full disclosure on how the average works, it would just make all of our lives easier and litigation attorney’s jobs harder.

Anyhow, back to EIA’s…

When the crediting method that seemed so good to the naked eye turns out to be not very good the following year what happens? The issuing company will then come out with a new fantastic new method no one has ever heard of before. They do this because the previous product usually fails to deliver what was promised, or assumed. Instead of illustrations and showing real market returns you get a story to tell your clients, with little regard to what will actually happen.

This is when I started to try to find some way to track equity index annuities and their performance over time using actual market returns. You would think that this would be EASY to find, but I can assure you it was not. Well, not until I found a website call eiatestdrive.com.

This is a broker only site that allows you to input today’s hot products specs and see how it would have performed over the last 50 years in the real world market. For example you can see how a monthly average product worked out, or how an annual cap with monthly averaging looks, or spreads and caps etc…all this using real life S&P 500 rates of return over the last 50 years.

So, here is what I did…

I went and imputed the data from a couple of the best selling EIA products in the market place and the results, well, were amazing. Most of today’s best selling products did not perform very well…at all.

All these examples are showing $100,000 investment over 50 years and unless otherwise noted 100% participation in the S&P 500. All caps and spreads remain constant throughout the 50 years as well, which we all know does not happen.

Case #1

$100,000 initial investment into the S&P 500 over the last 50 years grew to 6.1 million dollars. One of today’s better selling products offers a crediting method that is fairly common. It is a contract that offers monthly averaging with a monthly cap of 2.6%.

Theoretically, this contract COULD return in upwards of 30% on an annual basis, in an ideal world using simple math to calculate that potential return (12 x 2.6%). So how did it do? Not very good, over the last 50 years that monthly averaging with a 2.6% cap only grew to 1.6 million dollars.

Compare that to the 6.1 million the S&P 500 returned it is not very impressive. Now, some will argue that you suffered no loses over that time frame and you are correct, but monthly averaging compared to other crediting methods just did not do well in general.

I then upped the monthly cap to a huge number, which is very unlikely to ever reach, of 3.5%. Over the last 50 years this crediting method would have grown to 3.78 million dollars. This is better, but I am using an unreasonable monthly cap I just wanted to put the neigh sayers away right away.

Case #2

A contract that offers monthly averaging and an annual cap. 100% participation and an annual cap of 10% over the last 50 years your investment would be worth 1.45 million dollars. Compared to the S&P 500’s 6.1 million dollars it just does not stack up.

I then moved the annual cap up to 15% to see how it would perform and it was a mild improvement. Your investment would be worth 2.75 million dollars, but still far behind other methods.

Case #3

Bonus EIA….I do not even want to show you this, but I will. 10% bonus is paid to your investment, so in this case you will start with $110,000 instead of $100,000. I also picked the best option, 100% participation NO monthly averaging point-to-point annual reset, it has a 6% annual cap.

I did not like the 6% cap so I ran it at a 10% cap…Remember we started with $110,000, annual point-to-point, NO monthly averaging and the cap is at 6% currently…

Over the last 50 years your account value would have grown to 2.7 million dollars. Compared to the S&P 500 this did not perform and considering you started with more money and had no negative returns it just goes to show you that it does not work and should not be sold, period. This contract is 14 years before it is out of surrender charges and you have to annuitize the contract to realize the gains.

Case #4

I picked this because the web site actually says it has potential to return 31.2%. This contract offers a 12% bonus, YES 12%! 100% participation without any spreads or fees. The best option available is an annual point-to-point with NO monthly averaging and an 8% cap.

Remember, we started out with $112,000, not the regular $100,000. After 50 years the contract grew to 1.61 million dollars. Not very good and this is a 12 year contract as well. So much for the 31.2% potential.

Case #5

This was a crediting method I have actually never heard of before, it is called ‘threshold’. In a nut shell, you get 2.5% of a threshold return predetermined by the insurance carrier. The current threshold is 10%, this means on the first 10% rate of return the client only receives 2.5%, but they get 100% on everything over 10%. This product also does not have any caps, spreads or monthly averaging it is a straight point-to-point contract.

Over the last 50 years with a 10% threshold this contract would have grown to 5.1 million dollars. I was shocked to see that as this sounded like the poorest contract in the group, but it was only 1 million less than the naked S&P 500 and compared to the other products listed above it totally blew them away.

Since this product gave you 100% of the return on anything over 10% your returns were much higher. Shocking to say the least.

I will gladly tell you the names of the products and companies I ran the illustrations for if you email me at scottdemonte@annuityiq.com. If you wish to use this illustration software go to EIATestDrive.com and register for the site at PlatinumIM.com, remember this is a broker’s only web site. Let them and your friends know you saw this on Annuity IQ’s blog! Thanks for reading.