Six Steps the Annuity Industry Should Take to Become a More Accepted Financial Planning Option by Scott Stolz, CFP, RICP (week 67)

For 43 years I’ve been an advocate of annuities and the annuity industry.   I own four different annuities – a variable annuity, two fixed indexed annuities (FIAs and a Registered Indexed Linked Annuity (RILA).  Yesterday’s Wall Street Journal article on FIAs put me in a sour mood (The Sleepy Insurance Product That Came to Power Private Credit’s Ascent - WSJ).  I can’t believe I’m still reading negative articles like this about annuities.  Clearly, I’ve just been spitting in the wind for the last 4 decades.  While the article is far from balanced, it’s also not inaccurate.  There are a lot of consumer-friendly indexed annuities in the marketplace that I would heartily recommend to clients.  Unfortunately, right beside these quality contracts are far too many high-commission and high-fee contracts that are often overly complex.  And sadly, in many cases, the same insurance company offers both the quality contracts as well as the ones that should not even exist. 

So, this is my Jerry McGuire moment.  I’m going to layout steps for the industry to take if it has any desire to stop seeing articles like today’s WSJ article:

1. Quit designing products with surrender charges longer than seven years.  Five years would be even better.  Yes, annuities are designed to be a long-term investment.  And yes, no one should buy an annuity if they don’t intend to own it for ten years or more.  But things change.  Investors need flexibility.  No one should have to wait a decade or longer to be entitled to all of their money.  The reality is that most annuities with a surrender charge of ten years are more exist only to allow the insurance company to pay more commission.  Which brings us to suggestion #2.
2. Limit commissions to no more than 5%.  Anyone that won’t sell an annuity because it “only” pays a commission of 5% is not selling the annuity because it’s in the client’s best interests.  The WSJ article indicates that “insurers say the higher commissions reflect the complexity of the products, which require greater explanation.”  That’s absurd.  If that were the case, then the products with the most options and features would pay the highest commissions. 
3. Quit designing annuities with different commissions, fees and surrender charges based on the distribution channel offering the product!!!  Any annuity company that offers fixed and indexed annuities in both the broker/dealer/bank channel as well as the independent insurance agent channel will offer different versions of basically the same product in the two channels.  Why?  Because to compete in the later channel you need higher commission products.  The size of the commission is often a key factor in determining if an independent agent is going to recommend annuity A or annuity B.  In contrast, the broker/dealers and banks have much more control over their annuity product platform.  And since they are much more highly regulated, they limit that platform to the most consumer-friendly products.  In addition, in order to reduce potential conflicts of interest, these firms also typically levelize the commissions across their various annuity types.
4. This one is for the regulators – Change the annuity suitability model regulation #275 to include cash and non-cash compensation as a material conflict of interest.  Currently, this rule specifically excludes commissions from the definition of a “material conflict of interest”.  Not only are commissions a material conflict of interest, I would argue that they are the most material conflict of interest.  Commissions is the very definition of a conflict of interest.  Until this is changed, insurance companies will be hard pressed to implement suggestion #3 above.
5. Quit illustrating possible annuity returns based on backtested index data that has no chance of being anywhere near reality.  The article claims that educational material for an indexed annuity from Delaware Life illustrates a $100,000 premium tied to a stock and crypto index growing to $2.7 million in 21 years.  Obviously, such an index would not have a 21-year track record, so Delaware Life had to use backtested returns to generate the illustration.  I verified that this annuity does indeed offer such an index.  I’m not sure why a product designed for safety first needs an index based on crypto, but what do I know?  To get that type of growth, the annuity would have to average 16.99% per year.  If that was even remotely possible, no one would ever need any investment other than that annuity. 
6. Quit combining features that conflict with each other and really only layer on additional costs.  The article highlighted a professor that bought a $40,000 indexed annuity from Aviva (now owned by Athene) when she was in her 50’s.  At the end of her 12-year surrender charge period (which should not exist) she had averaged only 3.7%.  This sub-par return was partly due to the fact that she added both an enhanced death benefit and a guaranteed lifetime income benefit.  These additional features cost her about 2% per year.  She never used either benefit.  I’m hard pressed to understand how someone in their 50’s needs an enhanced death benefit.  And how much lifetime income will $40,000 provide?  But adding both to the contract?  Did the client need lifetime income, or did they want to create an estate?  Odds are at the age it was purchased, she didn’t know.  If not, then the solution is not to add both options at a cost of 2% per year.  The solution is to not add either option.  But, if a policyholder does elect to pay for additional options such as an enhanced death benefit, I believe the insurance company has some responsibility to make sure those options are effectively utilized by the policyholder.

The annuity companies will argue that offering multiple commission options, surrender charge schedules, index crediting options, and optional riders is all about choice.  And they are not wrong.  But history has shown that as the number of choices increases, so does the number of unsuitable product recommendations.  Therefore, the industry can continue with the status quo and continue to live with the poor reputation annuities have had for decades, or it can finally decide to offer only the most consumer-friendly products, features, and pricing.