You can't turn your back on Congress for a minute. Just when you think an issue will be settled in favor of investors, a Senator oozes under the door and slides a quick pro-business, anti-investor change into a bill.
That's how the equity-indexed annuity -- a costly product with a woeful past -- slipped out of the hands of a potentially strong regulator and into the cushioned lap of a weak one.
The Securities and Exchange Commission had planned to regulate these annuities, widely sold to older people, pending a review of the industry. A court decision last year affirmed that the products lie within the SEC's jurisdiction.
The insurance industry fought back -- using, as a weapon, Iowa Democrat Sen. Tom Harkin. A last-minute change in the financial reform bill last week, inserted at Harkin's behest, left oversight (such as it is) in the hands of the states. For savers and investors, that's not good news.
An equity-indexed annuity sounds like a conservative investor's dream. You hold the annuity for a certain term -- typically, five to 10 years, although some run longer. Your gain depends on how well the stock market does. If it rises, you get a share of the gain. If it falls, you get a minimum return, guaranteed by the insurance company that issued the product. All gain, no pain. (Some annuities are tied to other indexes but stocks are the most popular.)
What's wrong with this picture? The disclosures (or lack or them), the sales tactics (high risk of abuse), and the cost (a secret). Taking them in reverse order:
You don't know what you're paying for an equity-indexed annuity. You're promised a return that's calculated in a particular way. The price is built into the calculation so you never see it. Salespeople might tell you that there's no commission or that you don't pay it because the insurance company does. That's effectively a lie. They earn 5 to 10 percent on the sale, one of the highest commissions in the business, and their payment comes right out of your returns. The longer the salespeople lock you into the product, the more they earn.
The sales materials themselves might say, "no annual fees, no investment charges," but that's misleading, too. One way or another, you pay. Had the SEC been in charge, the companies would have had to tell the truth.
You might not understand your risks because the salesperson didn't explain them. For one thing, a 10-year contract is inappropriate for a buyer who's, say, 80. If you run low on cash and need to retrieve your money from the contract, there's a large surrender charge. These annuities are only for people who are sure they can afford to hold them to the end of the term. A few state attorneys general have prosecuted salespeople who sold them to older people as a one-stop savings account.
Aggressive insurers offer "signing bonuses" that might bring your first-year's apparent return to 10 percent. But believe me, that's not a gift. You pay for the "bonus" yourself, in reduced returns during the annuity's term. Signing bonuses are a sure sign that the product is high in cost and low in final yield. The SEC would have forced disclosure on the effect of bonuses, too.
If the stock market does poorly over the term of your investment, you do get the minimum guarantee -- typically 2 percent.
You might be confused by the way the insurance company calculates returns. You typically get only a percentage of the market's gains, excluding dividends. There might be a cap on the amount the annuity credits you with. Your yield might depend on the level of the market at the end of the term compared with your starting point, regardless of any gains that were made in between. Annuities that credit you with gains in between will lower the portion of that gain you're allowed to receive.
If the insurance company wants to earn more on these annuities, it can reduce your share of the stock market's gains (the contract lets it change the terms of the deal any time it wants). Because of these differences, it's impossible to compare the various equity-indexed annuities on the market, to find one with a lower cost.
The states mostly ignored these problems until lawsuits were brought and the SEC got involved. To fend off federal regulation, the National Association of Insurance Commissioners recently approved a model "suitability" law for stronger state oversight. It requires more training for salespeople, and holds the insurance companies responsible for seeing that the product suits the needs of the people buying it.
So far, Wisconsin has adopted the law, Iowa is close, and 29 others are considering (or planning to consider) it, says Jim Mumford, Iowa's first deputy insurance commissioner. Typically, a state will require its own insurers to apply the suitability law to sales in states that haven't yet passed it themselves. Reports of abusive sales have diminished in recent years, Mumford says. Given the states' past history, however, I'll believe in tougher oversight only when I see it.
Texas Securities Commissioner Denise Voigt Crawford worries about the aftermath of the Harkin coup. Congress might decide to block SEC regulation of other hybrid investment/insurance products, too, she says.
FINRA, the Financial Industry Regulatory Authority, has posted an Investor Alert about the complexities and risks of equity-indexed annuities, which any potential buyer ought to read. Use this product only for a small part of your savings. No one should invest heavily in any vehicle that socks you with huge charges for taking your money out before the end of the term.