The Truth About Indexed Annuities

INDEXED ANNUITIES

An Indexed Annuity (IA), is a new type of fixed annuity designed to meet market demands. An IA offers all the safety and guarantees of a traditional fixed annuity, but it goes a step further.

The IA was first introduced in 1995. This new type of annuity has grown steadily in popularity since then, with sales exceeding $5 billion in 1999.

IA premiums are linked to the performance of various stock and bond indices, such as the S&P, the Dow Jones Industrial Average, Russell 2000 and the 10-Year U.S. Treasury Bond Index. Indexed Annuities appeal to people who want to earn competitive rates of return on their investments without the risk of loss of principal. Even though these indices are generally tied to stock market performance, Equity Indexed Annuities are not securities. They are single-premium, traditional tax-deferred annuities.

Indexed Annuities are very attractive for a number of reasons.

On the top of the list of reasons to consider an IA is the protection of principal. Unlike mutual funds, individual stocks, bonds or even variable annuities, with Indexed Annuities you cannot lose your principal, regardless of market fluctuations. EIAs also have a minimum rate guarantee. The idea is to offer greater performance without exposing the annuity owners principal to market risk.

I cannot help but think about all those people who got caught up in the stock market buying frenzy of the late 90s. Had those people invested in an IA, their principal would have remained intact, plus received a minimum guaranteed return. Will Rodgers was once quoted as saying: "I am much more concerned about the return of my money, than the return on my money."

At the same time, the IA policyholder participates in market gains, but with some IAs, you do not realize 100% of the gain in the market. Still others credit up to 125% of the index in the fund. Generally, these IAs come with a maximum interest rate that can be credited to a policy in a given policy year.

There are hundreds of EIAs on the market today and, though similar, no two are alike. Several factors (parts) play a role in determining EIA policy design, and they include:

Participation Rate

Cap
Index Term
Renewal Option
Interest Crediting Method
Guaranteed Minimums
Yield Spread/ Margin Charges
Premium Loads
Surrender Charges and Surrender Period

These are often referred to as moving parts because the issuing insurance company may have the ability to change these terms. Three critical components of an IA that can be moved are: participation rate, yield spread (annual asset fee) and the cap.

For example, a policy may guarantee a participation rate for just one year, allowing the insurance company to adjust the rate in future years.

Likewise, the yield spread design typically allows the company to change the amount of the IA’s spread after one year. Often, the cap can also be adjusted after one year.

These moving parts are clearly used to protect the insurance company and almost always operate to the disadvantage of the policyholder.

All things being equal, however, the higher the participation rates, the more frequently the averaging occurs, the lower the cap, then the higher the asset fee, or vice versa.

The Truth About Annuities