All About Annuities

Index Annuities-Protection in a Volatile Market
by Mike Rowan, eInsuranceAdvisors.com

What is an index annuity ?

There are two major types of annuities in the world, fixed and variable.
An indexed annuity is a deferred annuity whose return is tied to the performance of a particular equity market index. Your investment principal is usually protected against severe market downturns, in that you may have an annual return of 0% but not less than 0%. However, earnings are generally capped at a fixed percentage, so any index gains that are above the cap are not reflected in your annual return.

Since interest is based on an index, isn't this like a variable annuity?
No. If a variable annuity account goes down, you could lose principal. Index annuity principal is protected from market risk - you can't lose principal if the index declines. Variable annuity gains are typically not locked in. Once index-linked interest is credited in an index annuity it cannot be lost, even if the index subsequently declines. And, variable annuities include reinvested dividends, neither the index nor index annuities reflect reinvested dividends.

So do I get all of the index gains and none of the losses?
No. It costs the insurance company to provide this protection against loss. This typically means that you won't fully participate in all of the gains when the market increases, but you also won't lose any principal in a falling market.

What kind of interest will I earn?
Typically, we try to gain about 2% more on average than you could in a bond fund or fixed interest CD or similar vehicle. Remember though, an annuity provides you with tax deferred growth as well, so your taxable yield is much higher.

How could I earn zero?
The primary goal of the minimum guarantee is to protect the principal from market risk. So if the market drops, the worse thing an index annuity owner would say is "Zero is better than -20%". Many companies minimize the minimum guarantee so that if the market stayed down for years, the owner would only get back their money and a few dollars of interest. By minimizing the minimum, and only crediting the minimum guarantee at the end of the term, companies can let index annuities participate in more of the index performance.

Do index annuities have fees?
Not in the same way that a variable annuity or mutual fund does, but more like the way a bank does it. Index annuities have penalties for early withdrawal if you surrender the annuity early. You need to match the period with your goals, keeping in mind that all annuities are designed to be long term savings instruments.

What returns have index annuities actually credited?
The highest index annuity interest rate credited for one year was over 40%. In 2001 and 2002 the stock market was down and most index annuities credited 0%. Index annuities have been around since 1995. During this period we've seen the strongest bull market in ages, with five years of high double-digit stock market gains, and the worst bear market in a generation; hardly a normal period. Index annuities are designed to provide a return somewhere between stock market vehicles and savings instruments and they've been performing as intended.

Are index annuities safe?
Both principal and credited interest are protected from index declines, so the worst thing that could happen is the stock market drops for years and you still get back your principal plus a little interest. The index annuity is as safe as the insurance company issuing the annuity. No index annuity owner has ever lost money because the insurance company failed.

States and independent rating firms on a regular basis examine the financial books of insurance companies , and they look to make sure there's enough money to cover everything, which is why you very rarely hear of an insurance company going bust.

What if a company does go belly up?
An annuity contract is an asset of the insurer, and in the past another insurer has bought the annuity contracts of the troubled company and life goes on. And every state has a guarantee fund to dip into and protect annuity contract owners (up to a certain limit) if a company tanks. It is possible to lose money if an insurance company fails, but based on history it is not very likely.

Who buys an index annuity?
People purchase an index annuity because they want the potential to possibly earn more than they might make from another savings vehicle. If you have sufficient time to recover from potential losses (and the stomach for it) direct stock market investments should give you a higher return than index annuities. However, if your timeframe is too short to recover from a possible bad market, or you simply don't like the idea of possibly losing principal, index annuities are used as an alternative savings vehicle to bank instruments, fixed rate annuities, bonds and bond mutual funds