The sunny side of life: anemic interest rates and an uncertain stock market feed the growth of equity index annuities. (Life/Health: Annuities).

Equity index annuities experienced a breakout year in 2002 with sales powering ahead by more than 80% to nearly $12 billion. Sales in 2001 were about $6.5 billion, according to The Advantage Group, a tracking service based in St. Louis.

Stock-market uncertainty and low interest rates helped drive investors to the hybrid fixed product, said Jack Marnon, president and founder of the company. EIAs promise a minimum of preservation of capital, but if the contract's links to a stipulated index of the equity markets perform better, investors are credited with the higher return.

Marrion has consistently portrayed EIAs as a tax-deferred alternative to certificates of deposit rather than a play on the stock market, largely because insurers cannot offer the full potential return of an equity index. And sure enough, when CD rates fell last year, investors first turned to traditional fixed annuities. When those rates also fell, investors turned to EIAs in order to "buy the potential for higher returns," Marrion said.

With stock market indexes still below water over the past five years, investors who instead chose EIAs have probably been counting their blessings, but not all of them. Those who bought five-year end-point contracts linked to the S&P 500 Index (still the most common index used by far) "are basically sitting at zero" because the contract's gain is calculated only at the end of the contract, said Marrion. The few who bought high-water-mark products locked in the S&P index at 1,400 plus, about a 50% gain for the five years. Those who bought annual-reset designs, in which gains are credited to the contract at the end of each year, experienced annualized returns of 3% to 5%. Marrion said more than 75% of buyers over the past five years chose annual resets.

Since their introduction in the United States in 1995, about 19 of every 20 EIAs have been sold by insurance agents. That will likely change this year due to the entry of the American subsidiary of the Dutch insurance giant, ING. The company last year introduced a registered index annuity, meaning it cannot be sold as a fixed product, but rather as a security under the Securities and Exchange Commission. ING distributes through a network of broker-dealers, all of whom are more comfortable selling registered vehicles, Marrion said. "ING has pulled up a whole new market of broker-dealers, banks and boutiques that had never before touched the product," he said. As a result, the percentage of sales by annuity agents has dropped to 85% from 95% due to that one ING product, Marrion added.

Marrion also predicted that the years-long trend toward longer surrender periods will come to an end this year. Five years ago, most contracts were for about five years, but in the past two years, the vast majority have been for 10 years or more. Insurers switched to the longer terms and longer surrender periods so they could pay higher commissions. In return, insurers hoped the business would stay longer on their books. But in recent months, the product manufacturers have been introducing shorter surrender periods and lower commissions as a way to get costs down, said Marrion.

Insurers have also been resorting to more use of caps on the amount of interest they will credit. With interest rates low and the stock-options market volatile and expensive, insurers have chosen to impose caps--typically 12% a year--as a way to provide investors with a higher percentage of the index' return up to the cap.

Allianz Insurance Group was, by far, the top seller of index annuities last year with $3.42 billion. ING sold about $1 billion of its registered index product, but Marrion said he segregates registered-product sales from his industry totals. Industry sales last year, including ING, would have therefore totaled an estimated $13 billion, he said.

Equity Index Annuity Sales

Sales zoomed ahead by more than 80% in 2002, reaching nearly $12
billion, about $5.5 billion more than 2001 sales.

         $ Billions

1995       $0.40
1996       $1.50
1997       $3.02
1998       $4.13
1999       $5.16
2000       $5.37
2001       $6.50
2002 *    $12.00

* Estimate

Source: The Advantage Group

Note: Table made from bar graph