The hottest trend for investment firms is planning for income distribution for the Baby Boomers. As the Boomers age they are seeking investments that will provide income for their retirement needs. The insurance industry has had a lock on the guaranteed income angle for the better part of 200 years through annuities.

Now, mutual fund firms are trying to get in on the action. The hottest trend, besides ETF’s, are income replacement funds which will allocate the investors money and then start to pay a stream of income after a set number of years. The income is derived from income paying securities, dividends and good old fashion withdrawals. The big question is will these products work?

Well the jury is out because all of these products are brand new and have zero track record. With the existing strategies it seems feasible that they will work if the market only goes up and interest rates increase, but then again all investments look good in that scenario. The truth is only time will tell.

They can as part of a diversified portfolio, but not as a stand alone solution. Like investing at any point in a persons life diversification is key and having guaranteed income mixed in with mutual funds can make perfect sense. In a recent article a person from Morningstar was even quoted as saying that for guaranteed income the variable annuity, with living benefits, makes much more sense than just income replacement funds.

While some annuities are less than appealing, EIA’s for example…huh, hum, Steve, a variable annuity with a living benefit can provide guaranteed income along with inflation protection by keeping money invested in equities. As with any type of investment a variable annuity should be considered an asset class and not as a stand alone solution. By using mutual funds and an Annuity the investor will reduce their risk and improve long term returns, Ibbotson has proven this.

The only thing is how do you know what variable annuity is good and which ones are below par? Sign-up for Annuity IQ to find out.

In response to multiple lawsuits filed by 8 states, with more states likely to follow suit, Iowa’s insurance division has issued a new set of rules for equity index annuity producers. Now, in order to sell EIA products in Iowa the producer will have to complete a class covering suitability and other issues EIA’s may bring to the table. The producer must complete this new class by January 1^st 2008.

This is fairly interesting because the course that the producers have to take will cover the features and benefits available on equity index annuities. It will also cover the basics such as early withdrawals, surrender charges and the advantages and disadvantages of the product.

Now, this sounds like a good idea, but how stupid do you think people who sell equity index annuities are? Producers, generally speaking, know how annuities work and how the benefits work and most know these basic things about EIA’s because most annuities work the same way. The only thing different are that they will, apparently, show producers how certain benefits work.

This is a very weak attempt to say it is not the products that are the problem, but it is the producers that are the problem. I hate EIA products, but even I know there are some good ones out there and I know it is not the agent who is usually at fault, it is the products basic design. If you foresee a problem and you want to nip it in the bud, so to speak, early why not make the insurance carriers deliver a product that is actually user friendly?

Seriously, if I were an EIA producer I would be very upset over these new rules. Why you ask? Simple, every adviser knows continuing education is a joke and you learn very little from it. This is the same thing and it addresses only the agents, not the real problem which is the product itself. This class is another way the state can cover its self and collect more fees from EIA producers and does nothing to address the actual problem.

We know there is a problem in the industry so address it. Get rid of two tiered annuities and ridiculous bonus products and many of the moving parts found in EIA’s. The state insurance supervisor has control over what is approved in his/her state, so fix it that way!

Now, as many of you already know I am no fan of equity index annuities as most of them are big on promise, but short on delivery. I also cannot believe I am going to utter these words, but I just got done reading an article from my favorite Mr. Burns titled; “Equity Index Annuities Fall Short” and I agree with him. To be perfectly clear, I hate index annuities and I think the vast majority of the products are very bad for investors.

Not because it was an anti-equity index annuity, but because everything he wrote was true. In my own comparison on these products I found only one that performed well over the long term. All of the more widely sold products performed pretty badly and those popular products happen to pay the highest commission.

The numbers do not lie and he used real studies to show that the average rates of return on these products are on par with traditional fixed annuities. The problem with EIA’s is the fact that they have so many moving parts and the insurance carrier can change the caps every year. This means you have no idea what your cap is going to be year over year. That is the biggest problem, but not the only problem.

The surrender schedule is usually way too long and the commissions, some of which can be as high as 14%, are high. There is simply too many benefits for the agent and not enough benefits for the consumer. You would be much better investing into a variable annuity with a living benefit or into a traditional fixed annuity instead of an EIA. Do not get me wrong, not all equity index annuities are bad, but most are.

The biggest problem I have with these products is you have people making outrageous claims about the product. Need I remind you of this:

[youtube]http://youtube.com/watch?v=XWQVUuwUook[/youtube]

In the annuity world there are traps and pitfalls, this is not news though. What is news is that Allianz will finally be called out on their sales practices and product line. In my opinion, it is about time.

Not all of Allianz’s products are bad, but their most popular products are. Typically, their popular annuities are structured like this, low rate of return, long surrender schedules, forced annuitization and they pay high commissions to the agents selling them.

Being an annuity lover, these products have always left a bad taste in my mouth because they simply do not deliver the promises they say they will. I know many people love EIA’s and that is fine because there are some good ones out there.

With that being said, how can anyone say that a product that offers a 10% bonus, has a 10 year surrender schedule and you have to annuitize it to realize the products gains is a solid investment? In some situations it may be good, but not at the levels Allianz was selling this product at.

Does the lawsuit have merit? In short, yes it does. Do I agree with the attorneys claims? No, not all of them. Allianz has been a powerful figure in the IMO, insurance marketing organizations, for years now. They have a dedicated IMO based in San Diego, California that specializes in helping you sell more Allianz products, to seniors especially. This, I am sure, will all come out in the lawsuit.

Now, the attorneys say that seniors should never buy a deferred annuity because of surrender schedules and liquidity. They are partially right, a senior should not buy an Annuity if they will need access to more than 10% of their investment. Long surrender contracts, over 7 years, should be the main thrust of the lawsuit not all annuity surrender schedules.

To put all annuities at the same level as these products Allianz is being sued over is incredulous. There is a vast difference between an equity index annuity, a variable annuity and a fixed Annuity. They all work differently and should never be compared to each other as equals.

Anyhow, the question at hand is can Allianz win? I will predict they will not, but either will the clients. As with most class action lawsuits the real winners will be the attorneys and the people who actually got hurt will receive very little.

A good example of a class action lawsuit is the Google click fraud settlement. Google was sued over not identifying people intentionally clicking ads and it cost advertisers millions upon millions of dollars in fraudulent clicks. Google settled for 90 million, or so, but the attorneys received 30 million in fees. The people who got hurt only received a few dollars in the settlement….I should have been a lawyer, but, unfortunately, I have a soul I wish to keep.

Allianz will probably not win because the plaintiff’s attorneys will parade hundreds, if necessary, of elderly people who were sold these annuities. No jury in the world will disregard people that are probably their grandparent’s age. The tragedy is people did get hurt by these products, but they will see little return from this upcoming long process they will have to endure.

Equity index annuities are a tough and complex game with many moving parts. Great care should be made when recommending these products. Any annuity that can afford to pay the agent a 10% commission and the client a 10% bonus cannot be good for the client, as they will have to pay for the insurance carrier’s generosity at the end of the day.

I love the internet you can find anything you want on the net. Unfortunately, many people will probably fall for this ad.

[youtube]http://www.youtube.com/watch?v=4B79bwYpOyg[/youtube]

Just tell us Tony, it’s an EQUITY INDEX annuity! I can tell you for a fact that wealth strategists do not invest much, if any, of their wealthier clients money in equity index annuities. I signed up for his ‘special report’ and it is just a joke. He does not even call the product what it is. Instead he calls it ‘indexing’ instead on index Annuity.

Basically, to get the 13.68% guarantee he is talking about you would buy a 10% bonus EIA and put the money into the money market account for the first year. After that he would invest it into the index side of the annuity where it will track the S&P 500 or a similar index.

Again, he fails to tell you about the steep deferred sales charges that last for 10 years. He also fails to tell you about the fact that you will have to annuitize the contract to receive the full contract value. I mean, come on, these are the same products that Minnesota and other attorney generals are suing insurance carriers over.

I love annuities, as you all know, but this is ridiculous and this is a product that can cause severe damage to peoples futures. Every product has its place, but I fail to see how this ‘wonder’ product will actually help many people. I have to side with the media and critics on these products, they stink.

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.