EIA Returns— Past & Present    1/00        Return to Library Index
The market was its usual volatile self during 1999 and this was certainly true for the S&P 500. After ending 1998 at a level of 1229.23 the index rose to 1403 by July, dropped to 1281 one month later, rallied again before declining in October to 1247, and finally finished out the year at 1469.25 resulting in a 19.53% gain for calendar year 1999.

The volatility definitely affected index annuity returns. Depending upon the contract anniversary date and the crediting methodology used, your 1999 index annuity return ranged from zero to almost 40%.

Though 1999 was rocky index annuities still averaged double digit returns

Although daily index movement swings produced a wide range of returns, if you add all of the returns together and divide them the average returns were pretty close regardless of the crediting methodology used. The following numbers show the average return over all of 1999 for annual reset index annuities assuming you had purchased: the top performing unaveraged with cap annuities, the worst performing unaveraged with cap annuities, the best and worst performing annuities averaging monthly index values, and the typical yield spread index annuity. Average returns are as follows.

Structure Average Return
High Cap 12.43%
Low Cap 9.33%
High Average 12.41%
Low Average 8.11%
Yield Spread 9.40%

If we look at actual returns for annual reset structured index products since the first year we began tracking returns, 1997, average returns for all of the annuities from 1997 through 1999 range from just under 10% to over 14%. This means that annual reset index annuities have generated total returns over the last three years of almost 30% to over 45%.

Think about that. Index annuities were designed to be an alternative to other savings vehicles like certificates of deposit and traditional fixed annuities. Over the last three years CD’s would have credited total returns of 15% to 18%. If you had consistently picked the worst performing index annuities your total return is still roughly double that of the bank instruments!

Point-to-point structured annuities have seen the index almost double over the last three years. While these annuities don’t lock in index gains until the end of their term and the vast majority of point-to-point products won’t end their term for awhile, you need to look at the magnitude of the gain. The index would have to lose roughly half it’s value before you’d be looking at guaranteed returns. Even in a severe bear market these annuities would still significantly outperform CDs.

Keep Some Gains    2/00        Return to Library Index
If you had invested $100,000 in the S&P 500 index five years ago your initial investment would be worth over $300,000 today...an incredible return. In fact, I am hard pressed to find another five year period in the history of our country that produced gains of this magnitude. I believe in the long term viability of equity investments. I also know that the stock market ride can be bumpy.

In 1972 the S&P 500 closed at the highest end of the year value up to that time; it didn’t reach that level again until 1980. If you would have bought the index at the end of ‘72 you were under water for the remainder of the ‘70s. At the end of 1979, seven years after it had reached a new high, the S&P 500 was still 9% below where it had closed in 1972.

I don’t believe we’ll see a repeat of this calamity. However, I do believe we’ll see less severe downturns at some point in time. Even a mild bear market drops value over 20% and it usually takes at least a couple of years to recover. It would make sense to shift some of the recent market gains to vehicles protected from market risk, but clients lament that they would have to pay taxes on those gains.

“I’ll come back after you’ve lost $100k—that’ll save you $20k in taxes”

Suggest to the client that they should take some of the gain and pay the tax - especially if they’re going to need the money within the next few years, rather then risk losing those gains. An index annuity can help preserve the gains while providing equity participation.

Why Buy An Index Annuity When Fixed Rates Are Up?    2/00        Return to Library Index
Interest rates have been trending up for the past year or so. While there is a difference of opinion as to how high rates will go and how soon rates may peak, at even today’s levels fixed rates on savings vehicles are looking quite attractive. You can find certificates of deposit paying 6% interest and traditional fixed annuities locking in 7% or higher yields for five years or more.

The story behind equity indexed annuities is that they’re designed to pay an interest rate over time that falls somewhere between the returns on equity investments and fixed rate instruments, but there are no guarantees that this will happen. So, the question is whether you should risk earning a less than competitive return in an index annuity when you can lock in attractive and guaranteed rates.

Traditional wisdom says that higher yields make stocks less attractive. Equity investments can lose principal; because of this investors require a risk premium to get involved in stocks. Let’s say that investors require stocks to earn 5% more than principal protected alternatives. If one can safely earn 7% that would imply that stocks must earn 12% - after adding in the risk premium, to be the more attractive selection. If investors feel that the risk adjusted returns of stocks will be below this level they will buy the safer option which translates into lower demand for stocks which means stock prices fall. So, choosing an index annuity today means forgoing an attractive and dependable fixed return and possibly watching stock values fall until rates retreat.

One reason for opting for an index annuity is that they’re not equity instruments and they don’t act exactly like equity instruments. All index annuities promise an account value at least equal to the original premium by the end of the surrender period even if the market tanks - most guarantee an effective minimum annual yield of 1% to 3%. Due to these guarantees index annuity buyers should require a much smaller risk premium than their investor cousins and shouldn’t be as affected by higher fixed yields. However, the most compelling reason for index annuities is that their structure benefits from a higher interest rate environment.

To protect the minimum guarantee index annuities invest part of the premium dollar in bonds or similar interest sensitive instruments. Higher interest rates means less money needs to be invested in these bonds leaving more money available to generate the potential equity interest. To use an overly simplified example, suppose your index annuity guarantee is based on 90% of the premium compounding at 3% for ten years. This means that you would have to return a minimum of $1.21 for each dollar of premium. If you can earn 7% for the period you’d need to put away 61 cents in bonds today to provide the $1.21 in ten years. Let’s say that rates peak this year and are down at 6% a year from now. If you look at the same picture, you’d need to put away 68 cents to provide the same guarantee when rates are lower. What this means is that you have more money available today to buy options to create the potential equity interest than you would a year from now. If you further assume that expenses (commissions, operating expenses, profits) take a dime out of this dollar, what we’re saying is that today you’d have 29 cents available to buy options ($1-.10-.61) versus 22 cents ($1-.10-.68) a year from now.

What if today’s higher rates cause the stock market to correct. An annual reset annuity structure would simply base the starting value on next year’s lower index level. Although a point-to-point design would have some index ground to make up, since the options were purchased when rates were higher you have 32% more to spend on options today (29 cents versus 22 cents) than you would a year from now. Index values would have to drop markedly before this option advantage would be lost.

Higher rates are usually not good for the stock market, but index annuities are not stock investments. The long term benefit index annuities receive from higher interest rates can more than offset any short term declines in the market.

CD Disclosure    2/00       Return to Library Index

Before you purchase that Certificate of Deposit please read this disclosure

Inflation
I realize that the yields on CD’s have been less than the rate of inflation in one out of every five years.

I realize after subtracting taxes and the rate of inflation that the return on my CD has been negative 50% of the time

Risk
I realize that the purchase of this CD subjects me to interest rate risk and inflation risk.

I realize that while my principal will not fluctuate, my income could drop as much as 57.3% in any given year without prior notice.

Taxes
I realize that the interest earned is subject to federal and state income taxes whether I use the income or let it accumulate.

Liquidity
I realize that the bank is not required to give me access to my CD principal during the term of the CD and may prevent me from making early withdrawals.

Although up to $100,000 is insured by FDIC, I realize that in the event of a bank failure FDIC may delay in returning my CD principal to me.

________________________
CD Buyer

The S&P 500 Isn't The Only Index    2/00        Return to Library Index
The S&P 500 was the first index utilized by index annuity providers as a basis for calculating excess interest beyond minimum guarantees. Today, the S&P 500 is still the primary index for every carrier.

It was an excellent choice. In the five calendar years that index annuities have been around the S&P 500 has averaged a 26.32% annual return and this return does not include dividends. With the exception of last year S&P 500 returns have been beating the returns of the average stock mutual fund, and in 1999 the index still managed to outperform a significant number of the largest mutual funds.

Although the S&P 500 is the preferred index of most carriers it isn’t the only index. There are eight additional indices used in whole or in part to provide index annuity options for equity participation.

The Dow Jones Industrial Average is available in the index annuity offerings of three carriers; American Equity, Midland National Life and Standard Life of Indiana. The Dow’s average gain over the last five years is a little below the S&P 500, but in 1999 for the second time within this period the Dow posted a higher gain.

The Russell 2000 index is offered by two carriers; American Equity and Midland National Life. Midland National Life also offers the S&P MidCap 400. The greatest number of equity index choices is offered by Jackson National. In addition to the S&P 500 Jackson National’s ELI annuity makes available the S&P MidCap 400, NASDAQ 100, and an international index comprised of the London FTSE 100, Tokyo Nikkei 225, German DAX and Paris CAC 40. Why would one use other indices? To attempt to increase gains and provide some balance. For 1999 the S&P 500 gained 19.53%. Here’s how these other indices performed:

Six of the indices beat the S&P 500 last year. While past performance is no guarantee of future results selecting indices that react differently to conditions can provide diversity and reduce volatility. Although other indexes won’t always outdistance the S&P 500 their addition can help to balance returns.

Information is from sources believed accurate but is not warranted. Index linked annuities are not sponsored or endorsed by the Index.

Investing Facts & Figures    2/00        Return to Library Index
Index annuities are an excellent vehicle for risk averse savers. Risk averse individuals don’t own stocks, mutual funds and variable annuities because they don’t like market risk to principal. Their query is always “Don’t tell me how much I can make, tell me how much I can lose”. Index annuities are an ideal match for these savers because principal is protected from market risk. So with that in mind, let’s look at the realities of how often the market’s been nasty, how long the nastiness lasted, and how the market has treated investors in the long run.

I know there are prospects out there who like to use the crash of ‘29 as a basis for comparing investments. However, anybody who was actually in the market at that time is past the maximum issue age for any index annuity policy. We’re going to look at stock market movement over the last fifty years using the S&P 500 index without reinvested dividends.

How Bad Can It Get?
Between January 11, 1973 and December 6, 1974 the index went from 120.24 to 62.28 - a decline of 48%. It took over seven years for the S&P 500 to reach that height again. However, if you ignore periods containing those two years every other seven year period has produced a positive return. In 1987 the market shuddered but took less than two years to recover from its loss; the 1990 bear blip was recovered in a year.

What Are The Odds?
The last fifty years have included five wars, several recessions, double digit inflation, an energy crisis, one presidential impeachment and one resignation, and the beginning of night games at Wrigley Field. In the midst of all of this turmoil how often did the following periods produce a positive return?

76% of the individual years since 1949 ended with a gain for the stock market. 87% of the five year periods produced a gain, 90% of the ten year periods produced a gain and 100% of the fifteen year periods wound up higher than where they started. Once again, if we ignore 1973 and 1974 100% of the six, seven, eight, nine, and ten year period returns are positive.

What Are The Returns
We compared the median S&P 500 returns with bank account returns for different holding periods over the last fifty years. Here are the results:

The last fifty years contained some terrible economic news, but when everything is said and done the median index return is still more than double that of fixed interest instruments.

The probability is that if a saver puts their money in a decent index annuity and can afford to leave it alone for at least five years that the saver will wind up with more money than if they keep rolling over CDs. The stock market has produced higher returns over time, the problem is it can occasionally be nasty. An index annuity lets the risk averse individual enjoy the potential for a higher return while providing the safety of principal and peace of mind needed.

1999 EIA Sales Over $5 Billion    3/00        Return to Library Index
Although the Advantage Equity Index Sales & Market Report will not be available until the middle of the month we can confidently state that calendar year 1999 equity index annuity sales are over $5 billion - another record year.

Index annuity sales leaders were Jackson National, Conseco, Fidelity & Guaranty, American Equity and Allianz/LifeUSA. Final fourth quarter sales results will match or exceed previous record levels.

The equity index market continues to grow. Today, forty five carriers offer 137 different index annuities; fourteen new index annuities will be introduced during the next thirty days. A growing number of carriers are using additional indices. Today, nine market indices are utilized in whole or in part by different carriers in computing index related interest crediting.

Index annuities are performing as promised. Today, buyers of annual reset index annuities have locked in average gains of 10% or more. Point-to-point methodologies see an index that has almost doubled in three years and the first longer term index annuity produced an annualized return of 19.78%.

Index annuities are taking an increasing share of the total annuity market and these premium dollars are not being diverted from other annuities, but are additional dollars from other sources. EIA sales growth is just beginning.

EIA Performance - Reaching The Stars    3/00        Return to Library Index
On the ides of February five years ago a 60 year old gentlemen was facing a decision. Retirement was looming on the not too distant horizon and the $21,000 he had placed in certificates of deposit had matured. The gentlemen had been thinking about moving the money to mutual funds. However, he remembered the crash of 87’ and how mutual fund values fell. In fact in the previous year, 1994, many mutual funds had lost money. Even though the bank was only paying a little over 6% interest at least that money was safe and it would be there in five years when he retired.

The gentlemen and his agent were discussing alternatives when the agent said “Keyport Life has developed something that might fit your needs. It’s called an equity indexed annuity.”

“Tell me more” said the gentlemen.

The agent responded “The way I understand it is that they guarantee that if the index goes down you’d at least get your $21,000 back at the end of five years plus a little interest, and if the index goes up you participate in some of the gain.”

“That sounds interesting. You mean even if the stock market steadily goes down over the next five years my principal is still protected from market risk?”

“Yes. Your indexed annuity is backed by the insurance company. Now, if the index goes up you’re not going to get all of the increase and indexed annuities don’t include reinvested dividends. Finally, you’d better count on holding this annuity for the full term because there are penalties for early withdrawal.”

“Well, this money is earmarked for retirement and I don’t plan on touching it. The main point is that my principal is protected from market risk and I might make more than I’m getting from the bank. Let’s put that $21,000 in the Keyport indexed annuity.”

The first indexed annuity purchased returned almost five times more than the CD alternative

Although my conversation is imaginary, the first indexed annuity was purchased February 15, 1995 for a premium of $21,000. If the gentlemen had placed the money in CDs and kept renewing them his $21,000 would have grown to roughly $27,554. Over the same five year period the same $21,000 placed in a Keyport indexed annuity grew to $51,779.

Index annuities are writing a track record of performance. Index annuities with annual reset crediting structures have been generating average returns of around 10% a year. The industry’s first indexed annuity turned $21,000 into over $51,000 in only five years. Because of this performance there are today over $15 billion of index annuity contracts in place; the fastest growth of any insurance product heretofore introduced.

And yet, this is only the beginning.

Indexed annuities are designed to generate potential returns that fall somewhere between traditional fixed annuities and equity investments, and indexed annuity buyers are delighted with this potential because their principal is protected from market risk.

I got a call last week from a person who had purchased an index annuity at the beginning of 1999. The customer said that his annuity credited 6.5% interest for the year and yet he’d heard that the index used was up almost 20% for the 1999. Well, we talked and it turned out that the day in January that his contract year ended produced a lower gain for that particular period.

I told him that you had to take a long term view and over time indexed annuity returns would fall somewhere between stocks and other savings vehicles. He said “You know, the index annuity still did 2% better than my CD, I think I’ll buy another one.”

I talk to a number of people and it appears that agents are still targeting cautious investors with the index annuity story rather than the much larger market of risk averse savers. The main attraction of an indexed annuity is protection of principal from market risk. If you provide this protection the customer will accept a lower return than one might earn from a higher risk alternative.

From Keyport’s first contract five years ago indexed annuity sales have grown to over $5 billion a year. We believe that as index annuities continue to build on their track record of performance that sales will take off reaching $50 billion by 2006. Index annuities are heading to the stars.

A Primer: Why Participation Rates Go Up & Down    3/00        Return to Library Index
I have said that index annuities are the world’s simplest concept made complicated by the insurance companies. Although there are twenty eight different methods used to calculate how index movements become interest credited the same basic fundamentals affect setting participation rates. This simplified example using an annual reset design will attempt to show how these fundamentals interact.

How They Work
There are three components within every dollar of index annuity premium received. The first is expenses (agent commissions, company expenses and company profits). The second component is protecting the minimum guarantee through investments in bonds or similar instruments and the last is the price of options. Since the first component, expenses, is pretty much a fixed cost the primary variables affecting participation rates are interest rates and option costs.

All index annuities promise an accumulated value at least equal to the original principal by the end of the surrender period. To provide this minimum guaranteed return the insurance company invests in bonds or other instruments.  

Suppose you had to give somebody one dollar a year from now. If you could earn 7% interest you’d need to invest about 93 cents today at 7% to have $1 a year from now. We’d need 93 cents out of the dollar to buy bonds to back this guarantee. We’ll also say that we need 3 cents out of the dollar each year to cover agent commissions, company expenses and profits. This leaves us 4 cents to buy options.

We’re going to say that 4 cents lets us buy a “full” option. By that I mean that for every 1% increase in the index our annuity’s accumulated value increases 1%. Okay. It’s a year later. What if the index went down? Well, our option would expire worthless, but the 93 cents we invested in bonds is worth the original $1 - the premium was protected from market risk. What if our index increased 10%? Because we had purchased a “full” option the 4 cents we spent on the option is now worth a dime. We add that ten cents to the $1 produced by the bonds and our annuity’s new locked in value is $1.10.

Simplistically, this is how annual reset index annuities work. Bonds are used to protect the net locked in value and options are used to provide the potential for additional interest. But, what if rates are at 5%? You’d have to invest 95 cents to produce the same dollar. Because of lower rates it’ll cost you 2 more cents to back your guarantee...which means you’d have 2 fewer cents to spend on other things - like options.

When interest rates are lower you need to allocate more cents out of each dollar to invest in bonds to provide the minimum guaranteed return. More money spent on bonds leaves less money available to buy options. When rates are higher you can allocate less money for the bonds which leaves more money available to buy options.

We said that 4 cents bought us a “full” option. Another way to say this is that 4 cents bought us a 100% participation rate or 0% yield spread. But what if a “full” option costs 8 cents and we only have 4 cents available out of the premium dollar. We’d only be able to buy half of the option, so the annuity owner would only receive half of any increase in the index. This would translate into a participation rate on the annuity of 50%. Or, what if a “full” option cost 2 cents and we have 4 cents to work with. We’d be able to buy twice as many options. This would translate into a participation rate of 200% on our annuity.

If we have 4 cents and Options cost 8 cents we’d only be able to buy 50% of the Option

If we have 4 cents and Options cost 2 cents we could buy two Options and Offer 200%

So, you can see when a carrier offers a participation rate higher than 100% it doesn’t mean they’re over flowing the glass and when they offer a participation rate less than 100% it doesn’t mean that they’re sticking the difference in their pocket. It’s all a function of interest rates and option prices.

Options & Risk
We’re talking about options. Another name for options is derivatives and everybody knows that using derivatives may make you go blind and grow hair on your palms. What about the risk?

Both stocks and mutual funds offer the potential for gains, and long term investors in these vehicles have realized average returns that are higher than safer alternatives - but these vehicles have market risk. The stock market goes up and down and on any given day these investments may be worth more or less than originally paid. Index annuities eliminate this market risk on principal.

When a customer buys an index annuity their principal is backed by, and is as safe as, the insurance company that issued the annuity. As with all fixed rate insurance products index annuities provide a minimum guaranteed return. Excess interest beyond this minimum guarantee is calculated based on movements on an external index, but the customer is not directly involved in buying the investments.

The insurance company is also insulated from risk when they buy options on the index and not the underlying securities. An option gives you the right - not the obligation, to buy or sell something within a period of time. Buying options and bonds is a very conservative financial strategy.

Most carriers create the excess interest in an index annuity by buying options. To use a specific stock example say that you could buy a share of stock for $50. If you bought the stock and it rose to $60 you could sell it and net a $10 profit. But, if the stock price fell to $40 you’d have a $10 loss.

Instead of buying the actual stock we could buy an option that gave us the right to buy the stock for $50 at anytime over the next year. The cost of the option is $2. If the stock price rose to $60 we would exercise our option, buy the stock at $50, and make $10 (less the $2 cost of the option). If the price of the stock fell to $40, we wouldn’t use the option and it would expire. Our loss is limited to $2 - the cost of the option.

When you buy a call option you have the right to buy the stock at a given price within a set period of time. The owner of the stock will sell you this right and charge you a fee; the $2.

This is how options work. If the stock is worth less than $50 a share at the end of the period, we’d simply let the option expire. We’d be out the $2 we spent on the option, but that is the limit to our risk.

Why would the seller sell us the option? If the stock goes up the seller misses out on the gains! True, but maybe the seller feels that the stock is not heading up during the term of the option. In the meantime the seller continues to receive any dividends the stock might pay and we’ve paid the seller $200 for the option. Index options are a bit more complicated because there aren’t specific stocks backing the option, but the basic concepts are the same. There are two basic fundamentals affecting participation rates: interest rates and option prices. When interest rates are rising and/or option prices are falling companies can buy more options which lets them increase participation rates or decrease spreads. When interest rates are falling and/or option prices are rising companies have less money available for options so participation rates fall or spreads increase. It’s a simple concept.

A Bank Derivative Is Called A “CD”    4/00        Return to Library Index
One of the most volatile areas in the financial world are the movements of short term interest rates. As an example, if you were relying on interest earned from your one year certificates of deposit to help pay the bills you saw your interest income drop 44% from the Fall of 1991 to the Fall of 1992. If you have been using CDs to fund your retirement you’ll probably need to work a few more years. While the average annual yield in the ‘80s on short term CDs was 10.03% the average return in the ‘90s has been 5.41%.

The viability of certificates of deposit as long term savings vehicles is doubtful, and yet many people continue to view CDs as a safe haven because they confuse risk and volatility. Volatility is an aspect of all financial instruments; risk is a function of financial goals. Let me try to explain what I mean.

You probably wouldn’t place money needed in a year in the stock market because over the short term the stock market can be very volatile and you could lose principal. However, if you can leave the money alone for five years the risk of loss becomes much smaller. As your holding period increases beyond ten years the risk of loss becomes statistically insignificant. With a diversified portfolio of stocks your risk of loss decreases as the amount of time increases because volatility becomes less of an issue and the probability of an inferior return drops significantly as your time frame increases.

The potential for higher returns increases as the stock portfolio’s holding period increases. However, certificates of deposit retain a high degree of volatility regardless of the holding period so using CDs as a long term financial vehicle has a high degree of risk because of the strong probability of inferior returns. This is not to say that certificates of deposit are bad. It merely illustrates that all financial instruments have risks of which one should be aware.

Another Record Year For EIA Sales    4/00        Return to Library Index
According to the Advantage Equity Index Sales & Market Report equity index annuity sales for 1999 were $5.16 billion - a 25% increase over 1998 calendar year sales. Fourth quarter sales also reached a record $1.46 billion increasing 33% over sales for the same period for the previous year. The top five carriers represented 61% of annual sales with the top ten producing carriers capturing 79% of the market.

Sales trends shaped over the past two years continued. The typical index annuity product sale probably utilized some degree of averaging in their crediting methodology (83% of sales) and had an annual reset design (71% of sales). The participation rate and/or yield spread was not guaranteed for the surrender period (67% of sales) and the surrender period was ten years or longer (63% of sales).

Agents increased their domination of this market. 95% of 1999 sales were conducted by insurance agents with financial institutions representing less than 4% of sales and broker/dealers failing to capture even 1% of total sales. In 1997 banks accounted for 23% of EIA sales and in 1998 banks represented 12% of sales. In a market that has grown by 67% in the last two years banks have failed to profit.

The composition of the field changed in 1999, but arrivals and departures were fewer than the previous year. Delta Life, General Life, Guarantee Life, Modern Woodmen and Pekin Life exited the EIA arena; Midland National introduced their index annuity products last Fall. So far this year BMA has birthed two new products and SAFECO has returned from the sidelines.

The story for this year will be increased use and increased sales in annuities using other indices or alternatives. Two thirds of the annuities introduced last year had a fixed rate option. While at the end of 1998 only Jackson National offered indexes beyond the S&P 500, today five carriers offer crediting based on movements of the Dow Jones Industrial Average, two offer the Russell 2000 as an option and two make available the S&P MidCap 400. In addition, carriers are beginning to offer bond indexes and “non-index indices” are growing in popularity.

EIAs - A Modern Fable    4/00        Return to Library Index
A wonderful feature of equity indexed annuities is that the crediting of excess interest above the minimum guarantee is linked to the movements of an equity index. The use of an equity index provides for a potential return that is greater than one might realize from other fixed rate long term savings vehicles.

Many index annuities use an annual reset or annual ratchet structure. This structure locks in any gains each contract year and treats years of negative index movement as “years without growth’. Previous credited gains are maintained and negative years are simply noted with a zero.

A growing number of equity indexed annuities permit the owner to move the accumulated value on each policy anniversary between the equity index crediting method and a fixed rate account. This flexibility gives owners more control over the future of their annuity.

On January 1, 1950 Mr. and Mrs. Smith decided to invest $1,000 for each of their four children. The only requirements are that the children can’t touch the money until January 1, 2000 and that the same investment style must be used for the entire period. How did the children do?

The first child’s money was invested in one year U.S. Treasury Bills. On New Years Day Two Thousand the $1,000 invested in T-bills had grown to $15,393.13. *

The second child’s money was invested in an index that became the Standard & Poor’s 500 index. In fifty years the starting point of $1,000 became an end point of $87,669.76.*

The third child used an S&P 500 index with a difference. While the account recognized any years with positive index movements it treated down years as years with zero growth. A half century later these positive reset years resulted in $1,000 becoming $389,396.54.*

The final child was prescient and used both the T-bills and the S&P 500 index; each year determining which alternative would provide the highest return and positioning the money accordingly. On January 1, 2000 the original $1,000 had grown to 978,381.09.*

The last half century witnessed double digit interest rates as well as double digit inflation, the greatest bull market of the century as well as the most severe bear market since the 1930’s, and times of opportunity and setback. Two aspects of this period should be noted. The first is that equity instruments achieved far greater returns than fixed rate vehicles. The second is that attempting to minimize the risk of loss of equity instruments can substantially enhance those returns.

Equity index annuities eliminate market risk to principal and market risk to realized returns. Even if one had only participated in a fraction of the equity index’s growth over this period the return would still have outdistanced the returns of the other savings vehicles. EIAs can be a vehicle for the next half century.

*Source: 1 Year Treasury Constant Maturity Rate, Federal Reserve Board; Standard & Poor’s 500 and S&P 500 are trademarks of The McGraw-Hill Companies, Inc and must be licensed for use. S&P does not sponsor, endorse, sell or promote any index-linked products. S&P 500 data does not include reinvested dividends and is for informational purposes only.

A Primer: Equity Index Universal Life    4/00        Return to Library Index
Life Insurance
Life Insurance provides unique benefits that are unmatched by other financial planning instruments. Although the primary benefit of life insurance is to provide cash upon death, in the final analysis life insurance is for the living. Permanent life insurance gives you a solid foundation and may be used for:

* Paying Final Expenses - Bills, medical costs, funeral needs

*Dream Fulfillment - Ensuring the mortgage will be paid off or the children go to college

* Spouse Income - Benefits may be used to replace salary or pension income

* Estate Planning - Covering estate taxes and completing bequeaths

* Emergency Fund - Any cash values may be withdrawn or borrowed against if needed

Only life insurance can provide an immediate estate. If others are economically dependent upon you life insurance can provide the cash to take care of those needs. Life insurance may also be used to preserve an estate by providing cash to pay estate settlement costs.

Permanent Insurance
There are really only two types of life insurance - insurance that does build a cash value or insurance that doesn’t build a cash value, otherwise known as term insurance. Term insurance provides a specified benefit for a specified period of time; when the time is up the coverage expires. One example of term coverage is flight insurance. We pay a few dollars at the airport kiosk for an insurance policy. If the plane successfully completes the flight our policy expires.

This is how term insurance works. One difference between flight insurance and regular term insurance is that the cost goes up as we get older. You can delay the increase in premium by selecting a policy that levels the premium for a period of time, but if you still want the coverage to continue at the end of the period you will pay more.

Permanent insurance is designed to provide lifetime insurance protection. The premium you pay covers the current costs of the insurance protection with the balance used to build up a cash value. This cash value helps to keep premiums level for the life of the policy or may even eliminate the need for premiums at some point down the road.

Universal Life
A popular type of permanent life insurance is Universal Life or UL. UL gives you more control and greater flexibility than traditional whole life insurance. UL permits you to increase or decrease the specified benefit if your situation changes (increases are usually subject to evidence of insurability) and premiums can be adjusted. If your cash value growth is sufficient it may even be possible for you to quit paying premiums at some future date. Of course, if cash value growth is below expectations you may need to continue paying at least the minimum required premium.

Another type of permanent insurance is Variable Universal Life or VUL. Over time stock investments have generated higher returns than fixed interest instruments like bonds. VUL uses part of the premium to cover the current costs of the insurance protection with the balance invested in subaccounts containing diverse portfolios of equities.

It is hoped that these VUL accounts will increase cash value growth at a faster rate than typical fixed rate UL. One risk of VUL is that the accounts are fully exposed to the swings of the stock market. In a declining market cash values could decrease and additional premiums be required.

Equity Indexed Universal Life
The dynamics of the last few years have resulted in a new approach to permanent life insurance. Consumers like the higher return potential of linking cash value growth to equity markets, but some of them didn’t like the possibility of losing cash value if the market went down. To meet these needs insurance companies developed equity indexed universal life or EIUL.

EIUL shares the coverage and premium flexibility of other universal life policies, but the crediting of interest is unique. Typically, cash values increases are linked to positive changes in an equity index. If the index is higher at the end of the policy year the interest credited to the cash value will reflect this. So, if the calculated index is higher at the end of the year the cash value will participate in a percentage of this increase.

What if the index goes down? If the index stays flat or declines the cash value is still credited with a minimum guaranteed interest rate! This is the attraction of EIUL. When the index goes up the policy owner shares in the increase, but if the index goes down the policy still earns at least a minimum interest rate.

Now, it should be noted that the cash value will probably not reflect all of the increase in the index nor are dividends or capital gains included in the index calculation. Protecting the cash value from market loss and guaranteeing a minimum return costs money. Even so, EIUL offers many features:

Tax-deferral of interest earnings & Tax-advantaged insurance protection

Guaranteed minimum annual returns & Annual lock-in of earnings

Premium flexibility & Cash value access

How Interest Is Credited
Let’s say that we have an accumulated value of $10,000 and a minimum interest rate of 2%. We’ll further assume that we receive 60% of the calculated index gain for the year. At the end of the year the calculated index gain is 20%. The accumulated value would earn 10% for the year (20% x 50%) or $1,000. So, our accumulated value would now be worth $11,000 ($10,000 plus $1,000). But what if the market dropped 10% the following year? The locked-in value of $11,000 would be unaffected by the market decline and would earn 2% or $220 ($11,000 time 2%) leaving an accumulated value of $11,220.

Why Would I Consider EIUL?
Equity Indexed Universal Life is for people that need life insurance and desire permanent protection. They want greater flexibility and greater control than is available with traditional insurance. EIUL owners:

Like the opportunity for higher potential interest with equity linked returns

Don’t like the volatility and risks of VUL

EIUL is available as a flexible premium personal insurance plan with premiums typically paid monthly or yearly. EIUL is also available for estate planning purposes as survivorship life. And, EIUL is available as a single premium insurance instrument.

Where IS EIUL Available?
EIUL policies are available from agents appointed with the insurance companies that offer them.

Basic Concepts    5/00        Return to Library Index
Some agents tell me that the reason they don’t sell EIAs is because the concept is too complicated. I tell them that index annuities have a very simple premise; it’s that some of the products have gotten very involved. If you understand what EIAs were first designed to do, and how they have evolved, you can then select the appropriate EIA products for your market. To do this, it is helpful to go back to the basics.

EIAs Are Fixed Annuities
As with other fixed annuities, insurance companies buy bonds or similar instruments to provide a minimum guaranteed return. The difference with an equity indexed annuity is that some of the premium dollar is allocated to buy options instead of additional bonds. If the index goes down the bonds provide at least the minimum guarantee. If the index goes up you get the minimum guarantee plus part of the increase in the index.

This is a simple story. However, even at the beginning EIAs modified this story in response to changing financial markets and desires of the agents.

In The Beginning
The current generation of EIAs were introduced early in 1995. Why then? The financial tools had been around for several years.

One reason is that interest rates had increased over the previous year. This meant that the yield on the bonds was enough to provide the minimum guarantee and still leave money left over to buy the options. Another factor was that option prices were relatively low.

While there is a wide range between the nominal rates of the different crediting methods the effective rates have a much narrower span. Indeed, the difference between the highest and lowest effective participation rate is only ten percent and most of the crediting methods are tightly grouped. What this should mean is that regardless of the crediting methods, these annual reset index annuities should deliver similar returns over time, and this is what we’re finding in the real world.

It also means that agents shouldn’t get hung up on the initial participation rates of annual reset designed index annuities. While point-to-point structures usually guarantee their rates for the term of the contract, most annual reset structures can change their participation rate and/or yield spread and/or cap every year or so. In the final analysis your selection of an annual reset annuity should be based on the integrity of the issuing insurance company.

2000 may be the year of EIA awareness, whereby agents understand the placement of the product. For cautious investors and risk averse investors EIAs with point-to-point based designs are ideal for those consumers that want to still enjoy participation in the equity market and preserve existing gains or prevent future losses.

Annual reset structured EIAs have delivered returns that are double those of certificates of deposit and traditional fixed annuities. These annuities provide the potential for higher returns than other fixed vehicles while still protecting realized gains from market loss.

Equity index annuities are now in their sixth year and they are delivering competitive actual returns. The story is a simple one. EIAs may be used to preserve market gains, prevent market losses and give consumers a chance to earn higher returns than they might earn on other savings instruments. Agents need to select the EIAs with which they feel comfortable and that are best suited for their market.

Finally, the psychology of the market was right. 1994 had been a rocky year. Bond fund returns were poor, the S&P 500 ended the year on a down note, and many stock funds and variable annuities had marginal or negative returns. There was a genuine concern that the four year old bull market might be at an end.

The initial EIAs were designed for cautious investors;
Individuals that were afraid that future market downturns might impact market gains.

The first few EIAs were designed to cope with the fear of loss. They either locked in gains every contract year, or they locked in the highest anniversary index value for the term. These designs played to consumer fears of recurring negative market years.

EIAs were then designed to attract risk averse investors that wanted protection of principal and maximum potential gain

The stock market did very well in 1995 and some companies questioned whether consumers would rather have an index annuity that simply tracked the index movement from start to finish - and participated in more of the index growth, than a higher cost crediting structure that locked in the high point, but had lower participation. 1996 witnessed the introduction of several point-to-point crediting products.

Early EIAs with annual reset structures typically provided a percentage of any index gain subject to a ceiling or cap. This was well received by agents as long as the percentage and cap was deemed high enough. But, in 1997 option prices began to rise and ceilings had to fall. Agents asked for higher participation rates. Companies responded by changing the structure and using the average of index values. Since averaging moves returns to the middle of the range companies were able to offer higher listed or nominal participation rates because the final effective returns would be in line with absolute capped structures.

1998 was a rough year for index annuities. Falling interest rates meant more pennies from the premium dollar needed to be allocated to bonds to protect the minimum guarantee leaving fewer cents to purchase options. On top of this, option prices rose dramatically. Participation rates dropped. Agents said they needed higher participation rates. Insurance carriers responded by using averaging structures to maximize nominal participation rates. They then coupled this averaging with an asset fee or yield spread that decreased net effective participation rates to market levels.

In 1999 end point oriented structures trudged steadily along because agents realized that these were longer term vehicles and that it would be premature to judge their performance early in the game. In other words, consumers purchased these point-to-point annuities with a five, seven or nine year horizon; it doesn’t really matter how the market does today. However, the reaction to the performance of annual reset structures created an awareness of the need for agent education.

On average, all annual reset structured annuities have delivered similar returns over time. As an example, if you had purchased annual reset index annuities each and every month for the last three years, your average annual return ranged from 10% to 13% depending upon the annuity you purchased. But, because different methods react differently in different markets the actual credited return will differ from what is listed in the newspaper for that index. Agents need to understand the difference between nominal and effective index participation and communicate this to consumers.

The chart shows nominal or stated rates for different annual reset crediting methods over seven year periods. The far right column shows how much of the actual index movement is effectively captured if you apply the nominal rates over fifty years of index movement.

Equity Index Life Insurance Sales    6/00        Return to Library Index
Equity index life insurance sales were over $60 million in 1999 posting a small decline for the previous year. Three carriers (American General, ING Southland and Conseco) account for 85% of sale.

Equity index universal life offers the flexibility of universal life insurance with the potential for higher returns in a low interest rate environment and may be more attractive to the risk averse buyer than variable products.

Today, 14 carriers offer equity index life products. These companies and life products are:

Tax Control Is Golden    6/00        Return to Library Index
We’ve all seen charts showing the power of tax-deferral. Usually the chart shows a sum accumulating on a tax-deferred basis and another sum growing on a taxable one. The two lines begin together, but by the time twenty or thirty years has passed the tax-deferred growth line has surged into the stratosphere while the taxable line is struggling to maintain altitude, thus illustrating that tax-deferred growth really adds up.

If you were in the 20% combined federal and state tax bracket, deferring that $100 in interest would save you $20 today in taxes. (put down a $20 bill) I know that you are in a higher tax bracket and that the annuity would save you even more in taxes, but let’s simply use 20%.

Although at some point in time somebody will need to take the interest and pay the taxes, in the meanwhile you get to earn interest on the taxes that you don’t pay today. If you could earn 5% on those tax dollars you’d have an extra dollar at the end of one year (roll out the gold dollar). I know you could earn more than 5%, but let’s simply say you could make 5%. Even if you decided to pay that $20 of deferred taxes back at the end of the year you’d still keep most of that dollar. So, tax control has made you a buck; enough to buy you a cup of coffee.

EIA Stories    7/00        Return to Library Index
The Millionaire
The most successful new television show of the year that doesn’t involve eating rats is Who Wants To Be A Millionaire. Through a demonstration of knowledge and nerves contestants can increase their monetary gains until they reach their ultimate goal. The game even provides ways to lower your risk - three lifelines and insurance stages that lock in gains once certain levels are reached.

Some players quickly lose their lifelines and show that due to a lack of knowledge or nerves that they really shouldn’t have been in the game in the first place, but even the better players in the game develop a crisis of confidence as the stakes go up and they realize they risk losing much of what they have gained. Because of this, contestants often withdraw from the game before they reach their final goal - even when they know they should keep playing, due to the risk of loss.

The stock market is a lot like the game show. There are people that due to temperament or training probably shouldn’t be in the market and there are many other people with an unrealistic view of the risks of the stock market. Equity index annuities may be an answer for both because they provide unlimited lifelines if the market goes down. And, EIAs even let you bring in money from another game and protect any transferred gains from market declines. EIAs lock in gains and still let you play the game.

Tic Tac Dough
Financial vehicles are selected based on their “risk/reward” merits. Certificates of deposit are very low on the risk spectrum because the principal is protected from market risk, but the reward is limited.

Stock investments have an unlimited upside, but the possibility exists that one could lose all of their money. Index annuities protect the principal from market risk (they even provide at least a minimum return if the market goes down), and a potential return that is significantly higher than the CD.

EIA Hockey
An analogy of where index annuities fit in retirement planning might be to compare the investment world with a hockey game. Many people would agree that the most important player on the ice is the goalie. The goalie’s job is to protect the net; to safeguard the team. The goalie’s task is similar to the fixed rate investments in a portfolio. These fixed investments protect the portfolio from market risk. However, goalies very seldom score goals. Their job is protection, not performance.

There are other players on the ice like wingers. Their job is to take the offense and score goals. They’re flashier than the other players and they go for the big plays. They would be like the mutual funds or stocks in a portfolio. Their main job is performance, not protecting their goal.

But, there are other players on the ice - the defense and center. They skate up and down the rink. Sometimes they help in scoring points and other times they help protect their own goal. Equity index annuities are like these players. At times they’ll be helping the overall performance of the portfolio, but when they’re needed they’ll be there to help the goalie protect the goal.

EIA Blackjack
Blackjack is a simple game to play. If you win you get back double your money. If you don’t win you lose all of your money. EIA Blackjack is played a little differently.

You can’t go bust playing EIA Blackjack. As long as you stay in the game long enough you’ll always get back what you started with, plus maybe a few extra pennies. Now, the house charges for this no loss provision; what percentage would you be willing to give up of your winnings if you knew you couldn’t lose?

If you ask clients this question the most common answer is that they’d be willing to give up half of the potential gain to be protected against loss. Depending on the EIA you’ve chosen the “give up” could be less

EIA Potion
Index annuities are the Viagra® of financial products because they never go down.