A review and analysis of Equity Indexed Annuities, which have become incredibly popular among insurance agents in the last few years (because no securities license is needed to sell them).

After outlining various types of Equity Indexed Annuity [EIA] contracts, the article discusses reasons why both direct contract comparisons and ex ante performance estimates are difficult. It then explores three types of performance evaluation metrics: (1) option payoffs; (2) historical payoffs; and (3) simulation-based payoffs. Using the lower and upper bound dollar payoffs set by the EIA’s contract provisions, the article quantifies the likelihood that a contract owner either benefits from the downside protection or regrets the cap on the upside payoff. The probability of regret is explored over a spectrum of investment portfolio alternatives that might appeal to both conservative and aggressive investors. This discussion suggests that EIAs should be evaluated in both ‘dollar-wealth’ space and ‘utility-of-wealth’ space. It concludes by noting that the utility theory underlying classical economics cannot explain the popularity of EIAs among retail investors.

This article was co-written by Patrick Collins, Huy Lam, and Josh Stampfli.