Pushing The Envelope

The appeal of Equity Index Annuities is that the product purports to provide downside guarantees with potential for upside gains depending upon the performance of a stock market index to which the annuity is linked. Or, as some describe it in their literature, "the best of both worlds." But any guarantee has a cost, or, as the old bromide goes, "there is no such thing as a free lunch." Typically, the cost of the guarantee is covered by limiting the potential gain on the upside. But what if there is no upside gainhow is the cost covered?

This is already becoming a concern to rating agencies that recognize that any such cost must come from company reserves and is therefore a burden upon the company and affects its strength. An article in the July 21 issue of The Wall Street Journal also alleges that "Cost of policy guarantees on some business lines may be underestimated." A major concern of some analysts is that explaining the product is so complex that it easily leads to misunderstanding by buyers. Stating that the product protects you on the downside and rewards you on the upside is not a satisfactory explanation.

Recently I was involved as a witness in a lawsuit regarding a product with similar complexities. The agents presumably had covered themselves by having the insured initial a whole litany of possible adverse events. However, the insured was able to demonstrate convincingly that she was given private assurances that this was just a perfunctory exercise and that indeed there was little or no risk. When 60% of her assets disappeared, she successfully sued for restitution on the basis of misrepresentation.

Complex products may be very useful, but they do lend themselves to misunderstandings. Make no mistake about it, an Equity Index Annuity is a complex product in every sense of the word. That is why the proper marketing of the product is so critical and must not succumb to overzealousness.

Of particular concern, I believe, is the sale of Equity Index Annuities by banks. Bank employees typically are not trained to explain complex products. I am sure there must be exceptions, but most would be hard put to explain even the simplest insurance product. If my concern becomes reality, then the banks will pocket the profit and our business will inherit the scandal.

I always have been an advocate of creativity in product development, but when marketing loses touch with reality, then the envelope gets pushed. Government reaction is the inevitable result and we do not need another rerun on the pain we endured as a result of marketing abuses that became attached to an otherwise workable premium offset plan.

Reproduced from National Underwriter Edition, August 5, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.