Also called an equity-indexed annuity (EIA), an index annuity is a contract with an insurance company to receive periodic payments, in exchange for payments or premiums paid up-front. The element that distinguishes index annuities from other types of annuities is the link to a securities market index, such as the S&P 500. If the index goes up, the interest rate of the annuity goes up. If the index goes down, so does the interest rate earned by the annuity. Most index annuities have provisions which limit such losses, often guaranteeing a certain minimum return.
The participation rate of an index annuity is a measure of how much impact changes in the index have on the value of the annuity (in other words, how much that annuity is "in the market"). This may also be expressed as a spread, the difference between the increase in the index and the increase in the annuity's interest rate.
Index annuities have enjoyed growing popularity, with sales exceeding $23 billion in 2004. Like other annuities, index annuities pay high commissions on sales, creating an incentive for very aggressive sales tactics.Issues with Index Annuities
Index annuities are not intrinsically fraudulent investments, and may be suitable for some investors. Issues arise when they are sold to investors without regard to whether the investment is suitable for the investor. Index annuities, like other annuities, generally carry stiff penalties ("surrender fees") for early withdrawal of funds, making them unsuitable investments for people who know they will need to access their money within a short period of time.
Other issues arise regarding how index annuities are sold. They are sometimes touted as "investments without risk," or a way to invest in the stock market without the risk of losing money. These claims are not true, particularly for investors who need to withdraw money before the maturity date. And the vast majority of index annuities are sold not by stockbrokers or financial advisers, but insurance agents, who are not bound by the same regulations imposed on sellers of securities.