Sideways-market study: EIAs top stock indexes

Jul 17, 2006 @ 12:01 am

By Gary S. Mogel

NEW YORK - Some equity index annuity advocates are attempting to bolster EIAs' shaky reputation among potential clients and regulators by back testing to show their allegedly superior investment performance in a sideways market.

A consultant specializing in such annuities last month calculated that they would have outperformed the stock market significantly during various time periods since 1929.

But critics say that the back-tested results of EIAs - which have existed only since 1995 - are misleading and should not be used in adviser marketing materials or in sales pitches to clients.

More than $27 billion flowed into such annuities in 2005, up from about $22 billion in 2004 - mostly from retirees - according to Pete Winer, a financial consultant with Covenant Retirement Planning LLC in Nashville, Tenn.

A $100,000 investment in a hypothetical EIA in 1929 would have returned $427,294 by 1953, while the same amount invested in a fund replicating the Dow Jones Industrial Average would have returned $147,031, Mr. Winer calculated. And $100,000 invested in an EIA in 1966 would have grown to $202,905 by 1982, compared with $178,449 if the money were invested in all stocks included in the Dow.

Those time periods were used because they are eras of "sideways markets," and many experts are predicting a similar-type market in the coming years, according to Mr. Winer. "The buy-and-hold philosophy doesn't work if the market starts and ends at the same point," he said.

EIA results versus index results differ - even though the annuities are tied to the index - because the annuities allow investors to lock in gains and avoid losses. The annuity in Mr. Winer's example would pay 55% of the index's growth during the years it went up - with no cap on earnings and no change in the investment's value during down years.

He used EIA rating tools developed by MCP Premium Software in Santa Ana, Calif. - the same tools commonly used to show that the annuities have not performed well in back-testing analyses.

Dividends change results

"Those index result figures could not have accounted for dividends, and back testing that does not include dividends that would have been earned by investors in the underlying stocks is not a valid comparison," said Craig McCann, president of the Securities Litigation and Consulting Group in Fairfax, Va. Using only the price appreciation of the index is not an accurate comparison, he noted.

"My figures did take dividends into account, and even if they didn't, the EIA feature permitting the investor to avoid losses adds 40% to returns, and dividends have historically added that same amount," Mr. Winer said. "Back testing is not perfect or correct to the dollar, but it is one method of looking back to determine how a different asset class would have behaved."

Back testing does not produce a valid measure of past performance, said Jeremy Alexander, president of Beacon Research Inc. in Evanston, Ill. "Regulators don't allow back-tested performance for mutual funds, and it shouldn't be allowed for EIAs. There has to be an actual crediting history to judge investment performance."

Equity index annuities are considered insurance products and as such are regulated by the states' insurance departments. However, the Securities and Exchange Commission and NASD in Washington are looking into regulating them.

Projecting current economic, interest rate and volatility assumptions into the past does not provide an accurate result for returns on an investment, noted Patrick Foley, chief marketing officer of Allianz Life Insurance Company of North America in Minneapolis, the nation's No. 1 issuer of EIAs. Allianz's popular EIAs have not fared well in back testing.

'Unfairly maligned'

"Most of the people buying EIAs are in their 70s or 80s, so a long comparison time period shouldn't be used," Mr. McCann said. "Regulators think back testing is nonsense," he added. "It can be affected by anomalies in data and is not an indication of how the investments will perform going forward."

Mr. Winer disagrees.

"EIAs have been unfairly maligned," he said. "They can be sound investments during a long period - such as one that may have already begun - in which the stock market is expected to meander without making significant progress."

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