published Wednesday, February 9th, 2011

Equity-index annuities entangle, jilt investors

By Chris Hopkins

Annuities have existed for a very long time, tracing their origin to the lifetime annual stipend or "annua" promised to soldiers loyal to the Roman Empire.

Contemporary versions include the fixed variety based upon a constant interest rate, and the variable annuity, which carries market risk.

However, a relatively new and nefarious innovation has gained increasing attention, particularly among retirees and those approaching retirement.

Known as Equity-Indexed Annuities, or EIAs, these instruments are costly, complex and illiquid financial contracts that should be avoided by most investors.

Often purported to provide "guaranteed retirement income", equity-indexed annuities advertise a minimum threshold return combined with the potential to share in any gains in an underlying market index like the S&P 500 upon which the contract is based. Of course, something that sounds too good to be true usually isn't.

The minimum guaranteed return is typically some percentage of the original investment (87.5 percent is common), invested at a 1 percent to 3 percent annual rate. However, the upside is limited by the contract terms. A stated participation rate restricts the share of the gain (often 70-80 percent of the index), and many contracts contain rate caps that limit the absolute gain. Some EIAs allow the issuer to alter the rate cap or participation rate, and most carry hefty administrative fees.

Dividends earned by the underlying investment are typically not reinvested. Many contracts provide guaranteed death benefits for an additional fee.

Unlike variable annuities which are considered securities and are, therefore, governed by the SEC, equity-linked annuities are not federally regulated but fall under the aegis of state insurance authorities.

Furthermore, the guarantees are only as good as the issuing insurance company. While the failure of a major insurer is rare, it is nonetheless possible. Bear in mind that the company must remain solvent over your entire lifetime.

A common marketing gimmick among purveyors of EIAs is an "up-front bonus" of 5 percent to 10 percent. However, most investors never actually realize the bonus, since the contracts require the investor to wait up to 20 years before canceling the contract without being subject to onerous surrender charges that run as high as 25 percent.

The promise of upside gain with no downside risk sounds compelling, but the reality of EIAs is much different for most investors. To paraphrase William Randolph of colonial Virginia, "like a rotten mackerel in the moonlight, it shines and stinks."

Get answers to financial questions on Wednesdays from our columnists who work in the financial services industry. Chris Hopkins is vice president, investments, at Barnett & Co. Inc. Submit questions to his attention by writing to Business Editor John Vass Jr., Chattanooga Times Free Press, P.O. Box 1447, Chattanooga, TN 37401-1447, or by e-mailing him at

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Rivieravol said...

Ha, another "Investment" advisor who lost all his clients money in the past few years. His complete ignorance is utterly overwhelming.

February 9, 2011 at 4:31 p.m.

According to their SEC Form Adv, Barnett & Co. collects fees ONLY from securities under mngt, but does not earn income from annuities. It appears the writer is simply badmouthing the annuity competition.

February 11, 2011 at 1:19 p.m.

By the way, since 1995 over 300 different index annuities have been marketed. Not one ever had a surrender period as long as 20 years. In addition, a Wharton study found that the average index annuity had a higher return than an index fund 67% of the time since 1997.

February 12, 2011 at 7:29 a.m.
nafakim said...

Mr. Hopkins begins with the false claim that indexed annuities are “nefarious.” How can a product whose owners have not lost one penny from any economic downturn, Ponzi scheme, or negative portfolio performance be nefarious? Fixed indexed annuities are a natural evolution of the traditional fixed annuity merely offering an alternative method of crediting interest. Indexed annuities offer all the insurance features of any fixed annuity including: minimum interest guarantees, the option for guaranteed lifetime income, and guaranteed preservation of premium coupled with guaranteed growth in value, even when indexed-based interest is small or non-existent. The only difference is indexed annuities simply add the opportunity to receive additional interest based on positive changes in a financial markets index.

Individuals who purchase annuities with after-tax dollars are predominantly middle class (a majority have $20,000 - $74,999 of household income). Also, fixed annuity owners are more likely to buy their first deferred annuity at age 65 or older because they have considerable concern about the risks that health and long-term care costs pose to their retirement security . Therefore, it is alarming that with over six million residents in Tennessee and an average median household income that is 25% below the national average (and well within the typical fixed annuity buyer’s income) your newspaper would print a factually flawed and misleading article. No doubt Mr. Hopkins is an expert in his field of investments, but unfortunately for your readers he does not hold the same prowess for insurance and fixed indexed annuities. It would be refreshing and educational if he made the case for his investment products, rather than making flagrantly false and misleading claims about indexed annuities.

ERROR #1: Fixed indexed annuities are “illiquid.”

CORRECTION: Fixed indexed annuities offer many liquidity options without charge that are not available in securities or other risk-based products. Liquidity – taking your money prematurely for unforeseen emergencies – should ensure that: 1) you receive your money quickly with minimal fuss; and, 2) you don’t have to pay too high a price or penalty. Most all indexed annuities waive surrender fees at death, for nursing home expenses, for payouts of five years or longer and for annual withdrawals up to 10%. The same free access to your money cannot be said for risk-based investments. For example, a bond held to maturity will pay the stated par value. Similarly holding a fixed indexed annuity to the end of its surrender period returns the annuity value (principal plus earned interest). However, if one wishes to liquidate the bond prior to maturity the value received is dependent upon undefined external factors - including the interest rate environment.

February 14, 2011 at 11:03 a.m.
nafakim said...

ERROR #2: The indexed annuity is “purported to provide guaranteed retirement income.”

CORRECTION: There is nothing purported or alleged about the indexed annuities’ guaranteed retirement income. It is a contractual and binding promise of the payments the insurance company must make to the owner should he or she need or want income from their annuity. Mr. Hopkins does not even bother to explain this. Instead he moves directly to…

ERROR #3: The explanation of guaranteed minimum interest.

CORRECTION: Mr. Hopkins is correct in explaining the calculation of minimum guaranteed interest rate, but fails to understand its purpose. The minimum interest is required by state law to protect consumers who may own the indexed annuity during prolonged and sustained negative index performance. This is because the money suffers none of the index’s losses and indexed annuity earns no interest that period. The minimum interest value is used only if the annuity’s actual value is less (i.e., the money paid plus any additional interest minus charges for early surrender).

ERROR #4: Many contracts provide guaranteed death benefits for an additional fee.

CORRECTION: The very heart of annuities and life insurance is a guaranteed death benefit and there is no “additional fee” for that insurance protection and, like all insurance, the cost is a part of the insurance contract. In addition, the vast majority of indexed annuities will even waive the surrender charges if death occurs during the surrender period.

While we haven’t even begun to scratch the surface of the important, factual information your readers have been denied in this article, we understand that space and attention are limited. Therefore, we invite you to visit to get accurate and straight-forward information so the people of Tennessee may discover for themselves if a fixed annuity in general and a fixed indexed annuity in particular may be the answers to their worries over living too long, protecting their savings, and funding a meaningful retirement.

February 14, 2011 at 11:03 a.m.
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