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Can I Lose Money with Equity Index Annuities (EIA’s)?

Equity Index Annuities (EIA’) are one of the biggest “hustles” in the market place today. I thought EIA’s were a fantastic product? That’s what the insurance industry wants you to believe. They pay the highest commission payout of all annuity products sold. I have trained thousands of agents in “advanced recovery planning,” which uses traditional CD fixed annuities, which pay the smallest commission in the annuity arena…but offer the best guarantees for the public. Yet, 90% of all agents will opt to sell the latest hot product in the EIA arena (for the highest possible commission payout), versus selling the best product & solution for the publics best interests. EIA’s have some serious dangers to them…and one of these dangers is the “minimum guarantee” for the product. So, let’s examine the minimum guarantee first.

The minimum guarantee is the least understood component of EIA’s. The minimum guarantee is the main feature that you rely on…to save you if the stock market falls. Currently the minimum guarantee only applies to 87.5% of the initial investment premium. Based on the new Non-Forfeiture Obligation Law, the minimum guarantee is set at a percentage rate (usually 3%)…and only applies if you withdraw your money from the EIA…based on certain index conditions not being met! Sounds tricky…and it is!

If the EIA index crediting formula returns are greater than 3%…the minimum guarantee provision does not apply. First you must understand how the minimum guarantees is calculated, and when can the minimum guarantee be applied to your account.

The key to the minimum guarantee is the following:

1. Is the guarantee based on simple or compound interest calculations?
2. Does the minimum guarantee only apply if owner of the EIA holds the policy to the end of the surrender period, or can the EIA policy be liquidated before the surrender period is over (and be accredited with the minimum guarantee)?

There are three scenarios which the client may get less than the original investment principal (by taking a withdrawal):

1. Early Surrender/Simple Interest – Example: Client invests $10,000, the market is bearish, he receives 0.00% return on the EIA Index Formula, and he withdraws his money just before the surrender period is over. Calculation: $10,000 x 87.5% = $8,750 x 3% (the min. guarantee yield) = $262.50 = Total Amount Paid to The Client = $9,012.50

2. Early Surrender/Compound Interest – Example: Client invests $10,000, the market is bearish, he receives 0.00% return on the EIA Index Formula, he withdraws his money early…before end of the surrender period. Calculation: $10,000 x 87.5% = $8,750 x 3% (the min. guarantee yield) over three years = $811.36 = Total = $9,561.31 x 5% early withdrawal penalty (on an 8 year charge product) = $478.06 = Total Paid Out to The Client = $9,083.24

3. Early Surrender/No Interest Accredited - Example: Client invests $10,000, the market is bearish, he receives 0.00% return on the EIA Index Formula, he withdraws his money early…before end of the surrender period. The contract stipulates the policy owner must hold the contract to the end of the surrender period…to receive any minimum guarantee interest. Calculation: $10,000 x 87.5% = $8,750. The product is surrendered in the 5^th year (within a 7 year surrender charge product as example) = $0.00 interest accredited = $8,750 x 2% early withdrawal charge = $175 = Total Paid Out to The Client = $8,575.

Agents are marketing EIA’s as the product to save the public from market disaster…yet the product can lose money!

Now, let’s examine an EIA policy based on the following features:

1. The minimum guarantee is based on 87.5% of the initial premium at a 3% yield (compound interest).
2. The contract term is 8 years.
3. The market is negative for 8 straight years. Remember, the EIA policy has a 0.00% floor when the index return is negative.
4. The Client withdraws immediately after the surrender period is over.
5. Initial investment principal is $10,000 dollars.

Example: $10,000 x 87.5% = $8,750 x 3% (compounded) over 8 years = $11,084.23

The client made $1,084.23 over 8 years (which is a total yield of 10.84% over 8 years), which is $135.52 per year or 1.355% effective yield per year. I can get better yields in a money market! If you factor in inflation, you’re right back were you started.

To receive the Minimum Guarantee in an EIA…you must hold the investment to the end of the surrender period. In addition, most EIA compute simple interest. Example: $10,000 x 87.5% = $8,750 x 3% (simple interest) = $262.50 = $10,262.50 accredited to the client if he takes a withdrawal after the surrender period has expired, and there was a 0.00% accreditation each year for the term of the product (based on his EIA Formula).

Based on history, the stock market has failed to produce a 3% return over 10 years only 5 times (or 7% of the time). So, from the annuity company’s point of view, there is only a 93% chance the 3% minimum guarantee will ever happen. Yet, we are in a recession, and it is likely to get worse. The possibility of the having a 0.00% return every year (within an EIA product)…is very likely! 

Sincerely,

John Bagwell

The Truth About Financial Products.com

www.thetruthaboutfinancialproducts.com