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INSURANCE EXPERT WITNESS - Areas of Expertise

Equity Indexed Annuities
These annuities, while technically a fixed annuity, can loosely be described as a hybrid product in that the interest credited to the contract is a combination of a fixed declared rate in the contract and the performance of a given index, usually the S&P 500. If the chosen index increases in value above a certain percentage, excess interest is credited to the contract up to a preset level. If the index looses value, for example it drops by 5% in a given year; the owner receives only the guaranteed rate. The loss in the market does not extend to the contract value. There is only an upside and no downside as it relates to interest crediting.

However, as with all things, there is a tradeoff when market growth is most significant. Since there is the contractual feature of not experiencing losses in the market, when the market moves significantly higher, there is a limit to how much the owner will participate in the gains. These limits are often called “participation rates”. These levels of participation are declared in advance of renewal so the owner knows at the beginning of each contract year what his participation rate will be. He will not know what the market will do. If it loses value he will gain nothing and lose nothing. If the market goes up significantly he will participate in a percentage of the gain, but not all of it.

A major difference in these annuities and variable annuities is the fact that the contract value in a variable annuity can decrease by each year and losses to principal can occur depending on the performance of the underlying fund values. With fixed annuities the rate is declared in advance and guaranteed by the carrier. Equity indexed annuities offer some features of each.

Another major feature of equity indexed annuities is the allocation of premium to any given strategy. For instance there are usually options as to when a valuation will occur, annually, quarterly or even monthly. How one chooses these options can have a major impact on the performance of the contract. For example, if the market is up for 11 months of the year and suffers a significant drop in the last month, an annual allocation would show little or no gain, while a quarterly or monthly option would have potentially locked in the gains experienced before the drop in value occurred.

Conversely, if the opposite had occurred, a long decline followed by a steep increase in value, the preferred allocation would have been annual.

Another variable is the index to which the value is pegged. In addition to the S&P 500, some carriers allow for the Dow and the NASDAQ to be used as a measure. The choice is up to the owner and can usually be changed on an annual basis.

Finally, most equity indexed annuities also offer a fixed rate portfolio from which to choose. This portfolio can be equated to a fixed annuity and it performs in a very similar fashion.

The appeal of these annuities is the fact they are not locked into a set rate of return, rather owners have the opportunity to participate in strong markets without risking loss of principle. The disadvantage of them is the fact markets can and will show little or no growth for extended periods of time. During those down cycles owners would probably be better served by being in fixed annuities. The problem is no one can accurately predict the future and all that might happen to influence markets.

There are other features of these annuities that make them more complicated than simple fixed annuities. The complexity of the products and thus the willingness and ability of the sellers of these products to do all they should in the sales process to identify needs and discover the suitability and appropriateness of the products in many situations have caused carriers issue guidelines and even some states to pass legislation regarding annuity sales, particularly in situations involving elderly people.

These annuities have enjoyed enormous growth in recent years. They are the freshest face in the annuity business. They have a place in the marketplace and serve a useful purpose. They are not however a panacea for any financial ill or the answer to every financial question.

A serious turf war has developed in recent years between the NASD and the insurance community offering equity indexed annuities regarding licensure and compliance. At this time there is no requirement for the sellers of these products to be securities licensed. Many in the NASD have made the argument that since the interest rate paid is a result of the movement of regulated securities markets that the licensing should be equal with other products, namely the variable annuity.