EIA's - Another Example of False Hope?

Q. Jeff, I've been approached by some individuals touting the benefits of Equity Indexed Annuities and they speak solely of a company named *****. They say my money will be safe, there is a minimum return and they did explain a cap with a participation rate of 100%. I'm confused by all this but they said that I would probably average between 6% and 7% without any risk to the money I put in. Is this true? What kind of guarantees would I be able to expect if I were to put my money into a mutual/stock fund or if I had my securities advisor fully diversify my portfolio? Any help would be greatly appreciated.

M.C.


A. Thanks for your question. First, let me applaud you for taking the time to research a suggestion an advisor has made instead of blindly taking their advice!

You mentioned '*****'. In my research I was unable to find an EIA company with that name. I did find one called '*****'. Based on what you said, that may be the one.

Recognize that when they say you should earn 6-7% per year without any risk, that it is completely false. The only 'guarantee' on any EIA is a guaranteed minimum rate. On the ***** EIAs, their guarantee is 3% on 75% of premium. You can see just by how they state this that they aren't interested in making it easy to understand. 3% on 75% of premium means that you are only 'guaranteed' a minimum of 2.25% on the full amount you invest. If you put in $100,000, they will pay you 3% on $75,000, or $2250 in interest.

Why don't they just say they'll pay you 2.25%???

The rest of the 6-7% return they say you should safely earn is entirely based on the stock market. More correctly, you are guaranteed of earning 2.25% IF you leave all of your money in the EIA for 10 years. Any additional earnings are subject to the performance of the stock market.

They aren't even straight with the market-based returns. You either have the option of "yield spread deducted from average monthly positive gains or cap with no spread ". I'm sure you're wondering what that gibberish means...

The Spread Option: The break your contract into monthly periods and calculate the return for each period. That gives you 12 one month returns each year. Then they average them (add them all together and divide by twelve). Lastly, they deduct a 'spread' from that average. I don't know what their spread is and they can probably change it from year to year anyway. But if it were 3%, they would then subtract 3% from the average I just mentioned. Let's say your average was 7%. 7%-3%=4%. So they would credit you 4% for that contract year. SIMPLE ISN'T IT (I'm being sarcastic).

The 100% option: Sure you get 100%, but only up to an amount they decide, say 9%. So if the index goes up 9% you get 9%. If it goes up 23% like in 2003 you still only get 9%.

The bottom line is that you are locked into an EIA and they control everything. They can change how your return is calculated from year to year and you have no recourse.

Tell me a little more about your situation and I will offer some alternatives.


Q. Thank you for your response I appreciate your promptness. I am a bit confused . . . I guess you are right to state that they cannot guarantee 6-7% as the return I might get but because it is going to give me a return based on the S&P 500 what has the average of that been for the last ten or so years? Isn't that what my return would be based on not the minimums? Oh and I found the ***** website at *****.com . . . They have a 100% participation rate, isn't that very good? I was told they also have a 7% cap on the interest rate. That sounds pretty decent in comparison to what I can get on a standard annuity. What do you think?

M.C.

A. I went to the website and couldn't find any detailed information. They didn't have any sort of prospectus--which is common on EIAs. That's part of the reason it is so difficult to evaluate them.

The financial strength of ***** is only OK. An 'A+' rating is nothing to write home about for an insurance company.

The average on the S&P is probably over the 6-7% over a 10 year period. That's another reason against an EIA. You say they have a 100% participation rate but that they also limit the guarantee to 7%. I would imagine they are saying you participate in 100% of the index earnings up to 7%. For instance, in 2003 when the S&P earned 23% you would have only earned 7%. Last year, when the S&P earned over 10% with dividends reinvested, you would have only earned 7%.

You shouldn't compare an EIA to a standard annuity if you are referring to a fixed annuity. A better comparison would be to a variable annuity.

I don't have a horse in this race. I don't have an conflict of interest. I'm not trying to get your account. On the other hand, the person recommending this to you stands to make probably 10% off of you and will provide little or no service after they sign you up.

There are better alternatives without handcuffs.

Your posted comments on this and other questions are welcome.
If you have a question for Jeff an answer is just a click away.
Find a wealth of information at Jeff's website.