October 13, 2008
Equity Indexed Annuities are complex products distributed through an unprepared regulatory system. Insurance Agents have consistently misunderstood these products but continued to sell them because of the high commissions paid by insurance companies. Therein lies the problem, some of these contracts have surrender charges approaching 18% and declining over a 14 year penalty period. The companies themselves promote guaranteed market participation (Securities) with no downside risk, again not disclosing the surrender charges and agent commissions.
Equity Indexed Annuities can serve a very worthwhile cause if presented properly in the right instance. But if the agent cannot explain the various features in a manner understandable by the person making a purchase consideration, ie... point to point crediting, rate limits, monthly or yearly or five year crediting, crediting limits, fee adjustments, how the underlying index works and how each of the contractual provision applies then only a sophisticated and knowledgeable agent should attempt to market these products and then only to those investors who have the ability to truly understand the provisions being presented and its suitability, after all this is not a simple 5% Fixed Annuity for 5 years.
In the alternative surrender charges should be reduced according to the age of the person considering the purchase. Many companies do this now with older age policyholders, ie recognizing a 75 year old purchasing a 14 year surrender contract will likely pass away before his penalty does. For example policyholders under the age of 50 – 7 year penalty, 60 – 6 year penalty, 70 – 5 year penalty and 75 -3 year penalty the insurance companies can then adjust the agent commission accordingly but the excessive commissions would disappear (and Incentive). From an economic standpoint most of the EIA contracts only make sense for long term investors who can defer for 5-10 years so compensation should be structured to provide on going service fees on these compliacated products.
While the State Insurance Offices do a commendable job in handling the supervision of Insurance Agents, this new generation product is closer to a Variable Product than its fixed cousin. Many existing Variable Annuities have both principal and income guarantees, similar to the Equity Indexed Annuity, however the agents selling the Variable Annuities have taken the special securities and insurance licensing to be able to understand the product and they are regulated under an existing system both prepared and able to monitor these sales for compliance.
The Insurance only agents have no such specialty knowledge, nor does the regulatory system afford the necessary supervision. There are many agents across American sitting in living rooms describing the SP Index and how much the prospective insured would have made if they had invested over the previous 10 years with no down side loss, and this without a securities license.
So again my opinion is these products need to be regulated and under a unified system that is prepared to monitor the sales actives on an ongoing basis. To my knowledge FINRA is the only regulatory body that has both the infrastructure and supervision in place to adequately provide the necessary consumer safeguards.
Richard L. Cox, Sr., CFP®
Chief Investment Manager
Cox Wealth Management, LLC