There is NO EQUITY in Equity Indexed Annuities

The fact that someone decided to use the word “equity” in the name, when indexed annuities were first developed, is part of the reason why they have come under attack by some in the securities industry. But contrary to the claims of vocal opponents, use of this term is the only misleading thing about them, and efforts are underway to drop this confusing part of the label from this product. The reason the use of this word in the name is inaccurate, is that in an indexed annuity, the client is not purchasing equity in anything. Their money is not buying into any index either. An indexed annuity is an insurance contract, and every purchaser of one of these innovative financial products is buying a contract from an insurance carrier for a stated list of guaranteed benefits. The only connection an indexed annuity has with any index is that the annuity owner has the option to choose an interest crediting strategy, whereby the percentage of increase in the named index is used as a way to measure how much additional interest they will earn, above the guaranteed interest return stated in the contract.

Since an indexed annuity is a contract, and the client’s purchase money is never placed at risk in the market, indexed annuities are not investments or securities, but are unique savings vehicles with enormous safety, vital guarantees of security of principal, guaranteed minimal interest return, and income options that can provide the annuitant a guaranteed income they can never outlive.

If you are a retired individual or couple and you are now living on a fixed income with fixed assets, the last thing you can afford is to risk the security of either your assets or your income. Placing a chunk of your assets into an indexed annuity is an ideal vehicle for someone who wants to guarantee that their principal can never lose value, get a safe, reasonable return on their money, and have a chance to earn more than they could get at their bank in a CD or money market account. Add to that, if this person were to ever fear that they would not have enough money, they could at ANY time, convert their account to a guaranteed stream of income for life, no matter how long they might live.

Securities regulators and industry spokespeople who challenge the insurance identity of indexed annuities have wrongly used the uncertainty of this “extra” interest crediting, which is based upon the changes in the linked index, as a claim of risk. While the “extra” interest credits in an indexed annuity will fluctuate from period to period, and the results are not guaranteed, the principal deposits and all previously credited interest earnings are NEVER at risk. And the client’s money is NEVER placed in the index.

The insurance company has their own way of ensuring their performance in the contract by investing the client’s money in safe long term bonds and then buying options on the index, not with the client’s money, but from the earnings they make by investing the client’s money. This allows the insurance company to safely guarantee the client’s principal, offer a minimal guaranteed interest return, and provide the potential for a higher rate of return that merely uses the changes in the index as a clear measurement of how to calculate this “extra” interest. This one non-guaranteed feature of an indexed annuity is no more confusing than the potential for a bank to change their CD rates to existing customers upon renewal, based upon market changes. And yet, these securities regulators are not clamoring to have CDs regulated by the SEC.

Think of it like this. The index which is used in an indexed annuity to determine the amount of “extra” interest is simply a yardstick. It could just as easily be the change in the average temperature for a given year, the improvement of the number of points earned by your favorite team over last season. The fact that it uses a known stock index is not accidental, however, but the reasons are, once again, determined by the insurance company who offers the contract. Just like when you sign a contract for cellular phone service, you don’t concern yourself with HOW the company will provide the service; only that they will. If we can start calling indexed annuities what they truly are, a contract, and not an investment, then it will clear up a lot of the criticism and confusion that has been wrongly fueled by the use of the term equity in their name.