Insurance companies market those stock market index linked annuity and frequently made the product sound like a gift from heaven:
1. when market goes up, you participate;
2. when market tanks, you do not lose.
Where is the catch?
Your account will either participate a fraction of full upward movement of the equity market, say 7% out of 10% gain, or the gain is capped at a fixed number. Effectively, you give up some upside in exchange for protection of the downside.
How does insurance company achieve those truncated payoffs? The answer is dervivatives. If you sell some upside call options, and then use the premium to buy some downside put option protections (a "collar" in option strategy), you can achieve this.
Furthermore, insurance companies typically charge you a rather expensive premium to perform those option transaction on your behalf. You cannot really see the fee. It is all part of the product pricing. There is nothing wrong with the strategy. If you like the strategy, you can do it yourself by buying SPY, and roll over put and call options yearly.
Two additional concerns,
1. The annuity products have typically lockup period. It will be expensive to terminate the contracts early. If you manage the rollover option strategy on your own, you can decide when to cash out.
2. An insurance company has its own credit risk. If we have another financial crisis, your insurance company might not be able to pay out what it promises. If you do the collar on your own, your contracts are with the option exchange.
Just my 2c.
