By Brooke A. Masters
Washington Post Staff Writer
Sunday, April 30, 2006; F02

To the insurance industry, equity-indexed annuities are a Goldilocks product: not too risky and not too safe. They are long-term investments that safeguard principal, guarantee a minimum rate of return and also offer investors some upside if the stock market does well.

To critics, these annuities are unnecessarily complicated, high-fee investments that line the pockets of insurance professionals at the expense of investors who don't understand what they are buying.

"They are the biggest fraud on earth," said Craig McCann, a consultant and former Securities and Exchange Commission economist. He calculates that virtually all investors would get better returns with equal safety by putting 60 percent of their money in U.S. Treasury bonds and the rest in a stock-index mutual fund.

But Gary Hughes, executive vice president of the American Council of Life Insurers, disagrees. "With the baby boomers retiring without much in terms of secure income, this is the kind of product they should be considering," he said.

No matter what your perspective, one thing is clear. Equity-indexed annuities have become incredibly popular in recent years, as investors have sought safe alternatives to the stock market and low-paying certificates of deposit.

These annuities are structured as insurance products, so they grow on a tax-deferred basis, guarantee a minimum rate of return and have a lock-up period in which the money can't be removed unless you pay a penalty. What makes them different from an ordinary fixed annuity is that there's a potential upside -- investors also receive a share of the return of the Standard & Poor's 500-stock index.

Sales have risen every year since their introduction in late 1995 and have nearly doubled since 2003, to $27.2 billion, according Advantage Compendium, a research firm that studies the industry. While still small potatoes compared with the $9 trillion mutual fund industry, equity-indexed annuities have begun to draw attention from securities and insurance regulators as well as consumer advocates.

They are concerned for two main reasons. Indexed annuities charge higher commissions than most stock and bond investments -- on average nearly 7 percent of the investment and as high as 13 percent in one extreme case. The lock-up periods are often quite long -- on average 10 years, and as much as 18 years -- which can be problematic for investors who suddenly need their money.

The securities regulators also worry that investors don't know that they aren't getting the same level of regulatory protection they do when they buy mutual funds and variable annuities. Unlike brokers who sell securities products, in most states, the agents who sell indexed annuities do not have to certify that the products are "suitable" for their customers.

On Friday, securities and insurance regulators will gather with industry representatives and consumer advocates at the National Press Club for a roundtable on the issue and try to come up with more uniform rules.

"We see very different levels of investor protection on products that look, to investors, to be very similar. We think of this as an effort to level the playing field," said Robert Glauber, chairman of NASD, the securities industry regulator that is co-sponsoring the gathering with the Minnesota Department of Commerce. One-third of all indexed annuities are sold by Minnesota-based Allianz Life Insurance of North America.

Insurance industry officials say they think much of the concern about equity-indexed annuities is misplaced. Although the product often has the name "equity" in the title and its return is linked to the stock market, it's not a true securities product because buyers are guaranteed the return of their principal plus a minimum level of interest, they say. Therefore, they argue, these annuities should be viewed and regulated as insurance, where the seller, not the buyer, absorbs most of the risk and is compensated for it.

"It's got more [return] with a floor [on losses] and it costs something for the insurance company to do that," said Barbara Lautzenheiser, an actuarial consultant who does work for both the insurance industry and regulators.

Some industry advocates say much of the fuss about equity-indexed annuities is being driven by brokers worried about competition. Many annuity buyers fund their purchases by taking money out of the stock market.

"It's a natural shift in the risk tolerance of the population. People are seeking guarantees, and the securities industry [is] losing revenue," said Michael Ebmeier, chairman of the National Association for Fixed Annuities. He argues that broker-dealers want the products regulated by the NASD so that the broker dealers can then demand that their employees sell only approved products and pay a cut to the dealer.

Consumer advocates and regulators meanwhile worry that agents are not doing a good job of explaining the lock-up period and the consequences of tax-deferred growth. Unlike mutual funds, which distribute gains annually, annuity owners don't pay taxes on their gains until the they start to take money out. That allows years of tax-free growth -- a major upside -- but the gains are ultimately taxed as ordinary income rather than at the lower capital-gains rate.

The National Association of Insurance Commissioners, which regulates the indexed annuities, has for several years been urging states to require agents to do a suitability analysis for customers over age 65, and in March it amended its model insurance statute to require suitability analyses for indexed-annuity customers of any age.

But only 15 states have adopted any kind of suitability requirements at all, said Roland Panneton, senior counsel for the National Association of Insurance and Financial Advisors.

"Annuity products can be absolutely appropriate for some and not appropriate for others," said North Dakota Insurance Commissioner Jim Poolman, who chairs the NAIC's life insurance committee and will be participating in Friday's meeting. "Insurance regulators are trying to figure out what we can do to get our arms around the issue."

Poolman warned, however, that consumers are still going to have to protect themselves by doing their homework. "Ask what it costs [in penalties] to get out of a product and keep asking until you sufficiently understand it," he said. "Clearly, people should ask what are the downsides of the product and keep asking until [they] get a straight answer."