John Milone is a big fan of equity-indexed annuities and CDs. He's been selling equity-indexed annuities (EIAs) for more than a decade to his clients at Charlotte State Banc Investor Services in Port Charlotte, Fla., and more recently has been adding equity-linked CDs. "The people who have those products in their portfolios are my happiest clients," because they don't have to worry about losing money, he asserts proudly, "I sleep better too!"

Both equity-linked products had a good run in 2009-2010, as the S&P rose by 86% from March 9, 2009 to Jan. 1, 2011. Lately though, with a more volatile market and low bond rates, they are a harder sell.

The annuities and CDs both offer buyers principal protection and a chance to participate in any run-up in the stock market, and the EIAs often add a guarantee of some limited return and sometimes an income rider, which provides an annual income for life at the end of the surrender period.

The two main differences between the products is that the CDs have no cap, but pay point-to-point—meaning that whatever the index, usually the S&P, has done over the term of the CD (usually five or six years) is the gain the holder receives (principal is guaranteed), while EIAs are reset annually, locking in any market upside. The trade off is that there's a cap on how much of that market upside gets captured by the owner, plus a "participation rate," that limits the share of the gain that the owner receives.

For example, if you had no cap you would get the whole increase in the index. If you have a participation rate of 70%, you'd only receive 70% of that appreciation. If you have a cap and a participation rate of 100%, you get 100% of every gain over the appreciation up to the cap. So for example, if the index rises 15% and your cap is 6%, with 100% participation, you would get a 6% gain. This is important, because even one significant downturn can hurt the indexed CDs' performance, while the annual gains in the indexed annuity are protected.


EIAs have been gaining ground over other fixed annuities in the bank channel, says Scott Stathis, managing director and COO at consultant Kehrer-LIMRA. They wildly outperformed the S&P from 1995 to 2009, thanks to the ratchet feature that protected investors from the 2008 downturn. Stathis says EIAs represented 19%, or almost one-in-five, of the fixed annuities sold through banks in the third quarter of 2010, up from only 13% in the third quarter of 2009. Indeed, he says fixed annuity sales would have been falling as a category in the past two years if not for the growth of EIAs.

The most popular EIA in the bank channel has been Lincoln Financial's Lincoln New Directions, according to Jeremy Alexander, CEO of Beacon Research. As of the third quarter of 2010, it was outselling the annuity of the next-ranked player, CUNA Mutual, by a factor of 20, with ING running a distant third. The Lincoln Financial product features a six- to eight-year surrender period, a 5% cap, and offers an optional lifetime income rider for 40 basis points. Kris Kattmann, Lincoln Financial vice president for fixed annuity products, attributes the product's popularity to its "simplicity and flexibility," and to the company's wide distribution network.

Meanwhile, equity-indexed CDs, a much simpler product, are gaining on EIAs. In general, Stathis says banks like it "because the clients' money stays in the bank as a deposit, but generates income," whereas client money spent on an EIA, minus a fee to the bank, goes to the insurer that issued it. In general, too, advisors have preferred EIAs to CDs, because the CDs pay minimal commissions, while EIAs can be quite lucrative.

Equity-indexed CDs have grown from just over $200 million in the third quarter of 2007 to $500 million in the second quarter of 2009 and $900 million in the third quarter of 2009. Though there was a slight dip in sales in early 2010, by the third quarter, sales were back up to $800 million and appear likely to pass $900 million for the fourth quarter of last year.

One reason for this growth may be increasing investor confidence in the direction of the economy and the stock market, which makes clients both less concerned about the need for an annual lock-in of gains and more interested in a product that lets them receive a larger share of that gain.

The FDIC factor is another plus to the equity-linked CDs, says Milone. Although EIAs yield a slightly better gain in a rising stock market than the indexed CDs, some clients prefer that knowing the CD is FDIC insured, he says. "They'll say, 'Give me the bird in the hand. I don't need the extra gain' that EIAs get with annual resets. My clients are mostly bank customers who were already invested in ordinary CDs. And for them those FDIC letters are really important."

Jack Marrion, president of Advantage Group, a St. Louis index-product tracking service, says there are pros and cons for the client in both equity-indexed products. "Index CDs let you participate in more of the market gain if you have a period where there are three to five years of an up market," he says. But if the market is volatile people would be better off with an EIA, where the annual reset can lock in the up years.


Some problems may lie ahead for ­equity-indexed products. Stathis says that FINRA is “really looking at them” because of their relative complexity. “Equity-indexed annuities are not sold as a registered product, but they ­probably should be,” he says.

Another point to consider is that with interest rates still low, and the stock market at a new high, the gains that equity-linked products have been earning may be hard to repeat in the near future. With EIAs, insurers guarantee the principal and some limited gain. To do that, they have to invest in bonds, but with bond yields low, that means they have to buy more of them, leaving less to invest in stock options, and thus less upside potential. That's why the caps being offered on these products, which were once as high as 9% or more, are now about 5%.

EIAs aren't likely to outperform the market as they did in the past decade, unless the market tanks again, says Scott Stolz, president of Raymond James Insurance Group. "I'd be very surprised in 2021 to see the performance of equity-linked annuities be as favorable as it was over the past decade." Still, unless the market has a five-year run-up, which seems unlikely, having that annual lock-in of gains in the good years could make EIAs a wise buy for some clients.

It's critically important how financial advisors explain and sell these products to clients, says Stolz. "Some insurance agents, who aren't licensed to sell stocks, have been touting the equity-linked annuities as equity investments when in reality, they are just products that can be hedged."

Raymond James believes advisors should think of equity-indexed annuities as a CD alternative, not as an equity alternative, says Stolz. "It's really a different kind of money. People segment their portfolios, some as 'guaranteed money' and some as 'speculative money,' and the equity-linked products should be a part of the client's 'guaranteed money,' the part of a portfolio that they don't want to move backward, not the part that they hope will grow a lot."

The equity-indexed annuity can give the client 1.5% to 2% better return than a CD, he says. "If you explain things that way, your client won't be disappointed." After all, the main use for equity-indexed annuities and equity-indexed CDs is security with just a dash of spice. "We tell advisors these can be for your clients who think they want to be in equities, but you know don't really want to be, because they don't want their assets to go down," says Stolz.

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