I was reading kurilla’s Pit thread about her sister-in-law and an unethical insurance salesman, and I’m confused about the Equity-Indexed Annuities she mentioned.
She says:
Curious, I went over to the Wiki page about EIAs to learn more, but from the information there they look more or less like an ordinary investment vehicle without any glaring inherent flaws or absurd risks.
What am I missing? Is it something about the type of investment itself, is there some loophole that allows the unscrupulous to exploit them over other investments, or is it a perfectly ordinary investment that just happens to have attracted more than its share of scumbags?
I’m posting here to subscribe, myself. I saw the same Pit thread and read the same articles that the OP mentions, and just didn’t see glaring flaws in EIAs as a low-risk, low-yield investment instrument. As such I can see why the OP of the Pit thread would not think that an EIA would be a good idea for her SIL, but there was a clear condemnation for the EIA concept, as well as that particular instrument, above and beyond her concerns for her SIL’s situation.
Of course, my understanding of investing and finance is pretty simplistic: Yield rates are tied to risk, i.e. for a high yield one has to accept higher risk; annuities tend to be decent income generation devices for the short term, while protecting the principal, but they’re tools that are more useful for husbanding resources after having established a nest egg.
I’m familiar with the Allianz Master Dex 10 for several reasons. One, because Allianz US is based in Minneapolis so it’s in the news, Two, because my wife works for them, and Three, because I have money invested in a Master Dex 10.
The gist of the lawsuit (which has been settled by the way) was that during the last market fall people panicked and yanked their money out of their stocks and mutual funds and wanted something safer. The annuity guaranteed to never lose money. So everybody suddenly wanted in.
Problem was that a lot of these got sold to older seniors and between the salesmen being too eager for their commision, the seniors rush to put their money there, and the combined failure of the salesmen to explain what they were selling and the senior not looking at what they were buying, the fact that your money would be tied up for 10 years with penalties for early withdrawls got overlooked by many.
So you had a lot of seniors who wanted access to their money whenever they wanted it with no penalties and cried FOUL claiming they were sold the annuity under false pretenses. The CEO was quoted as saying complaints about the annuity were less than 10% of 1% of total sold.
The State Attorney General went on a witch hunt and targeted Allainz because they were the biggest. Now that they have come to a settlement she said she will be going after smaller companies.
So I guess if you’re 70-80 years old and on a limited income it probably wasn’t the smartest investment to make and the salesmen really should have explained it better. However, for myself (37) it was a prefectly safe investment vehicle for money I don’t inted to touch for 10 years. (If you want details on how they work I can explain). For kurilla’s SIL who is 54 it seems like a perfectly fine safe investment if she doesn’t need the money now.
EIAs frequently have an upside cap on how much your money earns in a year – no matter WHAT the stock market does. For example, the market might return 12%, but the EIA caps your earnings at, say 4%.
The particular MasterDex 10, though, has a TON of restrictions on how you can access the money, and when, and if you EVER take it out as a lump sum, you lose ALL the bonus gains you’d earned. You can read more about the problems with this particular EIA here. The guy who runs the site also has a pdf report available (or did) for free download, but I can’t find the link. If you still are interested, PM me and I’ll send it to you.
For my SIL, who’s not in great financial shape and may need to access the money in lump sums, it was a very Bad Idea ™.
Equity Indexed Annuities are not an investment product that is appropriate for the great majority of investors. First, I think it is worth understanding why they are so popular, I think there are two reasons. One, it is a compelling story as an investment, ‘you can’t lose money, but you participate in the upside of the market’. Second, you do not need to be a licensed security professional to sell EIAs. This is vitally important. An insurance salesperson can fill their ‘investment’ niche with EIAs because they can not sell managed accounts or mutual funds. This leads to situations where the only investment arrow in the quiver of the person you are talking to is an EIA, which leads to unsuitable sales. I strongly believe that EIAs are close enough to a security that they should be regulated as such.
So why are they a bad idea? I will pull some research from work tomorrow, but I will cover some of the basic reasons;
They are very complex - Your account doesn’t go up with the market, it is a fixed annuity tied to the stock market. You get some portion of the gains, which is usually capped at a maximum amount. To properly understand what you are buying you need to know more than that you make money if the market goes up.
They usually have long surrender periods with high fees. If you pull your money before the specified time frame you pay a hefty penalty. Agents often get a comission in the range of 5-10% of your investment and additional trail commissions. They are a profitable product for insurance companies and restrictive for the customer.
They don’t provide a benefit to most people. This is from the excellent Craig McCann and Dengpan Luo’s study of EIAs. They compared an EIA held for ten years to buying a simple portfolio of treasuries and the stock index directly. They say:
“the investor is better off with the Treasury securities and stocks than with the equity indexed annuity. . . . investors sold this example annuity would be worse off 96.9% of the time, even if they held the annuity to maturity and it worked exactly as designed”
The difference of course is that your stock and bond allocation can be sold in whole or part at any point in that ten year frame for its current value. The EIA can only be sold after the surrender period is up if you don’t want to be charged.
The study goes on to demonstrate the cost benefit ratio of the EIA is an amazing 153 to 1, you pay $153 in cost for every $1 of benefit.
This study is really a stunning indictment of a product that I view as larcenous, poorly understood, and overly sold. The frightening thing is I didn’t touch on many of the worst features of the product because I didn’t want to type more than people would read. You will find the study I linked is easy to read though and covers many of the authors’ other objections.
If anyone ever tries to “sell” you an investment, ask them:
(1) what their percentage is,
(2) how many shares they’ve bought with their own money,
and
(3) what’s keeping you from buying it on the open market and avoiding the commission.
As soon as I saw “5% commission” I was done; that means that for every $1000 you put in, you start out $50 in the hole. That means you need to earn 5.26% plus whatever inflation is… just to break even. :eek: It sounds kind of like the Thunderdome of investments to me: two bucks enter, one dollar leaves.
I’ll agree they appear complex on the surface but are actually fairly simple. On the Masterdex 10 you choose which index you want to be linked to (S&P or Nasdaq or a mix of both). Every month they take a reading of how the indexed fund did (+8%, -3%, -8%, +10%). If it is a + month they cap the reading at 3.5%.
At the end of the year they add up all the +s and -s and figure out your rate of return. Obviously if the market shot up consistently all year long the most you can get in a year is 3.5 x 12 or 42% return. Highly unlikely. This past year my rate of return was 10%. Now sure if the market had a great year overall and had a gain of 25% there is a chance you may only net 6-8% depending on the ups and downs over the months. The protection you get is that if the market overall has a negative year you lose nothing. If the market crashes- you lose nothing.
So while you don’t reap the benefits of the great years of market upswings, you also don’t risk the hurt of the downswings. Risk/return.
I’m not sure why this is a suprise to so many? Your employers 401K also has hefty penalties for early withdrawl and is not liquid and I don’t see people saying 401Ks are larcenous? It’s a long term (10 year) investment and is not meant to be liquid. Put it away and don’t touch it for 10 years. It’s pretty straight forward going in so people who voice this as a complaint really weren’t watching what they were buying. Like people who got adjustable rate mortgages then cried when the rate went up.
Again, it really depends on what the investors goals are. If “most” means retirees who need access to their funds then I’d agree. For a 40-50 year old who wants a conservative long term investment for retirement and won’t be touching the funds it’s safe.
For someone like myself I fail to see any downside to it. I got an initial and immediate 10% bonus on my investment, year one gave me an 8% return and that money was immediate locked in and secure, year two gave me a 10% return and that money is now locked in and secure. I won’t be touching any of this money because I am aware of the penalties and know it’s not meant to be liquid.
I also have the peace of mind that if the market crashes badly I won’t suffer any of the consequences.
Now I’m sure you can give me examples of places where I can get better returns historically (stock and bond allocation) but can you guarantee me 100% I won’t be taking loses for any given year?