Big Returns, No Risk?
Here’s the pitch: A special type of life insurance policy may be better than a Roth IRA. Tax-free growth! Stock market returns! No risk! Who wouldn't want that?
A Roth IRA can possibly provide you the return of the stock market and give you tax-free growth. Desperate to generate big commissions, many in the insurance biz are telling investors that an indexed universal life (IUL) policy can do the same things. Wrong!
The claim: IULs grow tax-free. Wrong. If you withdraw earnings from life insurance it is taxed as income. You can borrow against a policy with a taxable event, but let your policy lapse and, wham, the loan becomes taxable income.
The claim: get stock market returns with no risk. Wrong. You will receive a percentage of a particular stock indexes growth, less the dividends and up to a maximum on only the cash value of the policy (not the premiums paid). For example, you might get 80% of the S&P 500s appreciation only up to a maximum of 10% in any given year.
The claim: You can’t lose. Wrong. Thanks to low cash value (they take most of your early dollars to pay the agents commission), if you need to get out in the first five to ten years, you will likely get back less than you paid in.
There is no magical way to make a lot with no risk. Yet far too many product pushers will tell you what you want to hear.
Another very similar product sold by financial product peddlers is called an Equity Indexed Annuity. Back in 2009, I wrote a detailed piece about these products and the tactics used to sell:
Part One - No wealth without risk!
My wife alerted me to an ad she heard on the radio that concerned her.The ad was for an investment that claimed to offer high returns, in the range of 12%, with no risk to your principal. She stated that it sounded a lot like an ad that Bernie Madoff might have run, if he had used radio advertising.
I went online and found a similar ad from the same firm that alluded to returns as high as 25% stating,“our clients that made between 10 and 25% two years ago and still have all those gains.” Dying to know what the catch might be, I visited their flashy website, retainyourgains.com.
The first thing that leapt off the page at me was the promise of a “10% cash bonus to transfer your accounts today!” They dangled the prospect of an immediate $50,000 in cash when you transfer $500,000.Who could possibly pass up a deal like that?
I imagine that many prospective clients of Mr. Madoff or Allen Stanford’s firms were saying much the same thing. What a deal! High returns. No Risk.And a cash bonus to boot.This sounds good.Too good. Possibly even too good to be true? Bear in mind that I am not implying that these people are involved in anything illegal.
From the little I can gather (I have called the company, and did not received a call back), it looks like they are promoting equity-indexed annuities (EIAs).These are relatively new products that are selling like hot cakes in the current investment climate.With a “no risk, high return” sales pitch, I can see why!
The ads and the websites are part of an entity called The DeJohn Advisory Team. RetainYourGains is a marketing umbrella for a number of smaller insurance agencies across the country. Steven DeJohn also teaches two-day annuity classes for an annuity sales training firm, Dressander & Associates.
Both of these firms are contributors to a lobbying group, SEC151a.com, that is working to defeat a proposed Securities and Exchange Commission (SEC) rule that would bring tighter regulation of equity-indexed annuity sales. Such regulation would put a halt to some of the misleading sales practices of this very lightly regulated industry.
Equity-indexed annuities are the insurance firms latest attempt to convince investors that they can get something for nothing.Why invest in mutual funds when you can get stock market returns with no downside? Those of us who have built diversified portfolios of no-load mutual funds sure look stupid, don’t we?
I lost 40% on my equity funds last year (which only make up a small portion of my total portfolio), while these brilliant equity-indexed annuity clients made 25% two years ago and lost nothing during the decline? What was I thinking? Plus, the insurance companies made a ton of profit on these products and the agents collected substantial enough commissions that could afford to pay a guy like Steve DeJohn to run thousands of radio ads on their behalf. What are we missing here?
We’re missing a lot, because current regulations require almost no disclosure of the realities of these hybrid products.That is why the SEC is considering rule 151a. Some of the proponents of this rule are former regulators like those at the Securities Litigation & Consulting Group (SLCG). In a letter to the SEC, SLCG said that the rule “is needed because issuers of existing equity-indexed annuities obfuscate the investment risks to which investors are exposed by repackaging what is actually a simple underlying investment with a layer of virtually worthless bells and whistles.” [This SEC regulation was removed from the financial reform legislation by Congress in 2010 due to insurance industry pressure.]
The truth is that equity-indexed annuities do not offer the return of the equities market.While each offering is different, equity-indexed annuities provide a fraction of the market’s upside.Typically, they provide only a percentage of the returns and none of the dividends.The rest goes to the insurance company. In addition, most equity-indexed annuities charge high annual fees and steep surrender charges. In some cases, the formula for calculating your piece of the action is so complicated it takes several pages to explain.
These are badly sold, extremely complicated investments that rarely deliver anything near the client’s expectations. Even the guaranteed minimum rate of say, 2% is rarely what it seems.That is because many policies only pay that on a 80 or 90% of the account’s value.
From where do you think the money comes to pay you a 10% upfront bonus, the agent a big commission, and a nice profit for the company? That would be YOU! All of which must leave you with a smaller return!
There is no true “free lunch.” These insurance firms and agents are not financial alchemists who have discovered a way to turn iron into gold. Although they have discovered yet another way to line their own pockets with gold, at your expense!
Part Two - DIY vs. EIA
Imagine the following in the voice of an old-time “snake-oil” salesman: “So, you say you want an investment with no risk? Yet, you still want the exciting growth of the stock market? Well, my friend, you’re in luck. Step right up and feast your eyes on one of the greatest financial innovations of our time...”
When you respond to the insurance industries compelling pitch, you will likely be sold a complicated equity indexed annuities (EIAs).You will then have the privilege of knowing that you have helped some needy stockbroker or insurance agent collect a 7% or 8% (maybe even 9%, 10%, 11% or higher) commission from a product you cannot begin to really comprehend and which will probably fail to deliver anything near your expectations. Simply hand them $100,000 and, magically, $7,000 or more appears in the salesperson’s pocket and vanishes from yours.
Here’s another option, assuming a $100,000 investment:Take $70,000 and place it in an 10-year U.S.T-Note at about 3.7% (as of 2/18/11).Then take the $30,000 you have left and invest it in a globally-diversified, passive equity portfolio.
In this way, should the entire stock market of world plummet to zero, you will still have more than your initial $100,000 investment after 10 years (which is a ridiculous premise, given that a valueless stock market means that the world has pretty much ended). In the very unlikely scenario that stocks do not move at all over 10 years, you will still have over $130,000.
However, if the value of the world’s stocks rises by only 7% per year (well below the norm for the past century), your portfolio will be worth over $160,000. Better still, if we enjoy a more normal, historical annual equity return (about 10% per year), you would almost double your money over 10 years - without any risk, confusion, or high fees.
Given the fact that higher fees always mean one of two things; you must either make less money or take more risk, how can an insurance company possibly beat, or even match, a strategy that invests in the entire world with total expenses of 4/10th of one percent annually? Seems to me that it will be pretty tough, given the fact that they start with 7+% less money and must overcome annual expenses that far exceed 0.3%.
I just can’t see how EIAs can ever manage to beat DIY (doing-it-yourself). If someone can explain it to me, I would love to listen. In fact, consider this an invitation to any equity indexed annuity salesperson. Please show me your 10- year projections and e-mail a copy of the policy and fee disclosure on which these are based. I will give your case an entire column and a radio show.
Part Three - Not Alone in My Distaste
There seem to be a lot of well respected publications that see equity indexed annuities (EIAs) in a less than positive light (and that is an understatement). From what I can see, the only positive voices are those of the insurance industry or affiliated cronies. Considering the serious money to be made from selling EIAs is it any wonder?
In a recent issue of Barron’s, Frederic G. Marks wrote an article on EIAs entitled,“Designed to Deceive.” Even before reading the piece I knew it was unlikely to be a ringing endorsement of the indexed annuity concept.
In this well researched piece, Mr. Marks discovered that, in one EIA example, the promised 3% guaranteed annual return actually ended up being 0.37% per year, for the first seven years. Over 14 years, it rises to a whopping 1.67%. Thanks to the miracle of complex qualifiers, embedded deep in the policy, they can magically reduce the number 3 by almost 50%.
He calculated a real world, average annual return for the good market years of 2003-2006 (based on the insurance company’s own explanation of how gains are calculated - monthly average return) at 4.2%. He went on to look at what the gain would have been on this EIA over every rolling 10-year period since 1975 (there were 241 of them). Using the monthly average return method, an EIA would have returned 62% less than the S&P 500.
Then, he provides a string of examples of the complex calculations used to baffle the potential EIA client with BS (a common method used to sell investments). All of them show just how misleading the “return of the stock market with none of the risk” pitch really is. Mr. Marks concludes his piece with this important paragraph:
“Equity-indexed annuities are insurance contracts so complex that it's virtually impossible for customers or even brokers and agents to evaluate them.Yet salesmen can readily determine that their commission for selling an EIA will be much larger than commissions on mutual funds and even on other annuity products.”
You will find similar pieces from The Senior Journal in two pieces, Equity Indexed Annuities Exposed as Dangerous... and Equity Indexed Annuities: 'The Investment from Hell' . Money magazine called EIAs one of 3 retirement deals you can do without. Check out Smart Money’s article, Many Planners Pan Equity-Indexed Annuities or a piece in Forbes entitled, Unwise at Any Age. Even the securities regulatory body, FINRA has an Investor Alert about EIAs. There are hundreds more just like these.
So, before you invest in an equity indexed annuity please carefully consider whether you believe the sales pitch of a person and/or organization that stands to profit from the sale or almost every financial publication, respectable fee- only financial planner (who are required to act in their clients best interest), and investment regulatory agency in the country.
A few articles about equity indexed annuities can be found at the websites:
http://online.barrons.com/article/SB123940700134809981.html?mod=googlenews_barrons&page=1
http://seniorjournal.com/NEWS/GuardWealth/6-04-05-EquityIndexedAnnuities.htm
http://seniorjournal.com/NEWS/GuardWealth/2007/7-03-12-EquityIndexed.htm
http://money.cnn.com/magazines/moneymag/moneymag_archive/2006/09/01/8384575/index.htm
http://www.smartmoney.com/investing/economy/many-planners-pan-equity-indexed-annuities-23534/
http://www.forbes.com/2008/05/09/equity-index-annuities-oped-cx_tba_0512equity.html
http://www.finra.org/Investors/ProtectYourself/InvestorAlerts/AnnuitiesAndInsurance/P010614