Equity-Indexed Annuities Can be a Shell Game for Consumers

The first time I visited New York I was taken in a sidewalk shell-game within 45 minutes of being in the city—no kidding.  Shell games involve trying to guess where a card or any other item might reside after being shuffled among various covers by a dealer.

There are basically three reasons why I lost $40 within 45 minutes of arriving in NYC: 1) I was naïve; 2) I was overconfident in my card-spotting abilities, and; 3) there was a large amount of asymmetric information—in other words, the “dealers” (to use a polite term) had a heck of a lot more information about the position of the card than I did.      

There is an excellent article on equity-indexed annuities in the most recent issue of Barron's¹, and the article reminded me my experience with shell games—particularly the part about the pitfalls of asymmetric information.

The author looks at equity-indexed annuities from the consumer's perspective.  The article title--"Designed to Deceive"--conveys the gist of his opinion.

The above said, much of the article discusses product features that are: a) confusing to many including those in the industry, and; b) variable features that need to be communicated effectively at the point of sale.  Some of the features that have shell-game potential include:

• Interest crediting - whether simple (bad for the customer) or compound interest is used.
• The effect of dividend exclusion with equity market indexing.  Excluding dividends will understate index returns.
• The methods used to calculate changes in the underlying equity index (e.g. monthly average return).  The monthly average return method significantly reduces overall returns and crediting levels in a rising market.
• Participation rates, caps, spreads and fees (all of which potentially reduce the payout to an equity-indexed annuity owner.

The point being that it is highly debatable whether product manufacturers (insurance companies) design products with the intent to deceive customers.  It can be argued that the products themselves are a bit like any technology in that it can cut both ways. 

Further, like any financial services product sale, there is the potential for intermediaries to sell what they know and are paid to sell, and for customers to hear what they want to hear (think sub-prime mortgages).  If something seems too good to be true (all upside and no downside), then it likely is.

Ultimately, the value of equity-indexed annuities to consumers may depend on whether the financial advisor is acting as a fiduciary and representing the best interests of their customer.  An agent—whether captive or independent—may have strong incentives to complete the sale and avoid clarification of features that may create sales friction.  On the other hand, an independent advisor likely has financial and legal incentives that are better aligned with those of the customer.

With equity-indexed annuities (or really any other financial services product), ask good questions, be patient, and try to distinguish between a financial advisor who is simply trying to sell and the advisor who is actually serving in more of an advisory or consultative role.       

¹Barron's

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