What if you could invest in the stock market with little or no risk of loss?
It sounds perfect, and that, basically, is the marketing pitch for equity-indexed annuities, an insurance product that tracks stocks.
But, like most too-good-to-be-true opportunities, there are some catches. If the market goes up, “caps” on gains may prevent you from making as much as you could with a straightforward index fund or exchange-traded fund. And you could pay high fees and penalties for early withdrawals.
Worries about how the industry treats its customers have produced a tussle over whether the federal government or states should have final regulatory authority. In 2008, the Securities and Exchange Commission approved rules to regulate indexed annuities, starting in 2011, but the U.S. Court of Appeals for the District of Columbia recently struck the rules down, leaving oversight with the states. For the time being at least, these products will continue to be sold by insurance agents rather than securities brokers, as the SEC had ordered.
Despite the shortcomings, indexed annuities, including some that track the bond market, have attracted many investors. The SEC says these products, introduced in the 1990s, enjoyed sales of nearly $25 billion in 2007, compared to just $4 billion in 1998. The insurance industry estimates sales topped $30 billion in 2009.
Because these products have many bells and whistles, it is very difficult for consumers to make apples-to-apples comparisons. After receiving many complaints about these products, the SEC was concerned that high commissions were inducing some insurance agents to use deceptive practices to push index annuities on consumers.
The basic product offers investment returns tracking the performance of an underlying stock-market index, such as the Standard & Poor’s 500. Often, an insurance component guarantees against loss or limits losses to a set portion of the initial investment, such as 10%. Some indexed annuities guarantee a minimum return of 1% to 3% a year.
But gains are usually limited as well. Some products use a “cap” which limits gains to a maximum percentage rate. If the cap were 8% and the stock index went up by 12%, the investor would get just 8%, while an investor in an indexed mutual fund or ETF would get the full 12%.