Annuity Illustrations
Annuity Marketing, Sales Ideas, Suitability, and Issues by Michael J. Prestwich

You may have heard that SEC Rule 151(a) will be dead if the Finance Reform Bill is signed by President Obama. This is because the Conference Committee bill passed by the joint House-Senate conferees on June 25, 2010 included language proposed by Senator Tom Harkin (D-IA) to leave fixed indexed annuities under state supervision. The Finance Reform Bill also will make the 2010 NAIC Suitability in Annuity Transactions Model Regulation the law in all 50 states.

The fight against fixed indexed annuities is far from being over, however.  Here are several articles that appeared in response to the Harkin Amendment:

·         Jane Bryant Quinn on CBS Money Watch wrote, Congress Sells Out Seniors: No SEC Regulation for Indexed Annuities (Be sure to read Sheryl J. Moore’s 32-point response to this article)

·         FINRA, the Financial Industry Regulatory Authority, posted an Investor Alert about indexed annuities

·         Senator Daniel Akaka (D-HI) said in hearings for S.A. 3920, “Deceptive sales practices have been found to be used in these products. An individual in Hawaii pushed equity index annuities to collect high commissions at the expense of senior investors. Those investors least able to effectively evaluate financial products need these federal protections, without question. And they’ve been suffering.” (see full article)

·         Kevin Keller, president of the Certified Financial Planner Board of Standards, said, “These are products that are ripe for abuse among the elderly. It’s important for consumers, especially the elderly, to have the protection of the SEC.” (see full article)

·         Barbara Roper, director of investor protection at the Consumer Federation of America, in her letter to Congress wrote, “If adopted, this amendment would open a gaping hole in investor protections without any assurance that the insurance regulation relied on in its place is adequate or effective.” (see full article)

·         Denise Voigt Crawford, the Texas Securities Commissioner and president of the North American Securities Administrators Association said in her letter to Congress, “It’s a hybrid product, so the questions in play here go beyond just equity-indexed annuities themselves and raise issues concerning who is going to regulate these hybrid instruments on a going forward basis.” (see letter to Congress)

The list of consumer groups and financial professionals who are against indexed annuities is endless.  What is their beef?  Here is a summary of the issues that I have found after reading numerous articles and following indexed annuities almost from their inception:

·         Deceptive and/or high pressure sales practices

·         High commissions

·         High / long surrender charges

·         Lack of disclosure

Most annuity producers and companies who market indexed annuities, especially those who are members of the National Association for Fixed Annuities (NAFA), have already adopted marketing methods and procedures that deal with the above concerns.  Passage of the provisions of the 2010 NAIC Suitability in Annuity Transactions Model Regulation opens producers and companies to fines, discipline, and civil action if they cannot prove that they adhered to these higher suitability standards.

In short, assuming the final provisions of the Finance Reform Bill remain intact and the law is signed by President Obama, those involved with the development, distribution, administration, and purchase of fixed indexed annuities finally won after a long fight.  This win comes with a price, however.  All the players in the fixed indexed annuity industry must strictly follow the provisions of the 2010 NAIC Suitability in Annuity Transactions Model Regulation or the enemies of indexed annuity products will continue their attack with more ferocity than ever before.

A Wall Street Journal article published on
March 26, 2010 quotes Senate Banking Committe Chairman, Christopher Dodd, as saying, “It is my hope that shortly after our return on the second week of April that we will come to the floor of the U.S. Senate to debate, hopefully a full-throated debate, about how we reform the financial services sector of our nation.”

If this bill passes, the stronger, tighter, NAIC Suitability in Annuity Transactions Model Regulation passed on March 28, 2010 may become immediately effective in all 50 states.

Here is a quote from page 966 of the Senate’s Restoring American Financial Stability Act of 2010:   …adopted rules with respect to fiduciary or suitability requirements in the sale of annuities that meet or exceed the minimum requirements established by the Suitability in Annuity Transactions Model Regulation of the National Association of Insurance Commissioners (or any successor thereto);

Page 1427 from the House’s Wall Street Reform and Consumer Protection Act of 2009 that passed on December 17, 2009 states: “SUITABILITY AND SUPERVISION RULES FOR ANNUITY PRODUCTS. A State shall have adopted rules that govern suitability requirements in the sale of annuities which shall meet or exceed the minimum requirements established by the National Association of Insurance Commissioners Suitability in Annuity Transactions Model Regulation in effect on the date of the enactment of this Act, or any successor thereto.”

Does this mean that insurance companies and annuity producers may have to be ready for these new laws by June first? Probably not, but they will almost certainly be in effect in most states this year. 

Mark, age 39, reported on CNBC’s “On the Money” program that he invested $175,000 into Equity Indexed Annuities over the past five years and the value today is over $225,000. He has friends telling him to surrender the annuity for the $200,000 “put it into the market.” Mark asks the panel if this is a good idea. Off camera Mark must have told the panel that the surrender period ends in May, which explains why two of the panelists suggest that he wait a few more months to review this product.

See http://www.youtube.com/watch?v=iOyXfcB9r6s

Here are some highlights:

“It’s a ludicrous penalty (obviously understands that annuities have a 10% tax penalty prior to age 59 1/2) – you shouldn’t get out now. This is an Equity Indexed Annuity. That means that your principal is protected – you are going to get $225,000 out of this annuity.”

(By getting out) “You are looking at product picking . . . this product here, this timing here . . . you really need to sit down and work out a plan to decide what you are trying to accomplish over time . . . what is this money for?”

“You started with $175,000 and now have $225,000 now? I wish I had a product that had grown from $175,000 to $225,000 in the past five years, that’s not bad.

“Don’t try to time it [the market] we saw what happened today . . . if you put all your money in one day, you could lock in your losses.”

“This is a 5.15 – I figured it out – a 5.15% rate of return for the past five years. You should patting yourself on the back – actually thanking that person that sold you the equity indexed annuity – stick with it!”

It is refreshing to see a few positive statements made by the press and about fixed indexed annuities.

The take home message for agents: sell the product that is best for the client as Mark’s agent obviously did. Five years ago, when Mark was age 34, he must have been looking for a safe place to put $175,000, for the long term, that had tax deferral, and the potential to earn an interest rate higher than most other safe-money accounts.

I spoke yesterday with an agent who had just made a substantial annuity sale. I asked him which product he sold. I then asked him how he disclosed the fact that this Fixed Indexed Annuity product is designed primarily for income, the index growth only applies to the annuitization value, not the accumulation value, and that the cash surrender value of this product after 10 years would probably be less than the original premium.  He was shocked, and couldn’t believe his ears. He said that this particular product is one of the most heavily promoted and highest sold in the industry. Among other things, I told him to read the fine print in the six page disclosure.

I believe that there is a relationship between the number of complaints a company has, and the quality of the agent training, disclosures, and illustrations a company produces. Do you agree?  Jack Marrion’s Index Annuity website just released a list of companies that sell Indexed Annuities and listed them in order of the least number of complaints to the highest: 2007 Index Annuity Complaints

The company with the highest number of complains receives 20 times the number as the company with the lowest. Comment if you believe there is a correlation between the number of complaints and the quality of training, products, disclosures, calculators, illustrations, and other agent’s services that a company provides. Do the companies listed provide a calculator that discloses the guaranteed minimum surrender value, for example?  I know, for example, that the company listed at the top, Great American Financial Resources, provides an Indexed Annuity Illustration system that discloses everything – formulas, surrender values, guaranteed minimum surrender values, cost of income riders, hypothetical values both current and guaranteed.

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There are important lessons to be learned by those who sell financial products from yesterday’s FINRA News Release announcing that Morgan Stanley is ordered to pay over $7 Million in fines and restitution to clients. Here are the main points:

a)    Representatives made recommendations based on unrealistically high projections

b)    Morgan Stanley did not properly supervise their field force

People lost their jobs, the firm got bad press, and must pay a hefty fine. Why? Representatives promised more than they could reasonably deliver.

Each day I talk to agents who market fixed indexed annuities on the phone. Some want to illustrate their products at 6%, or even 8% interest.  They don’t understand that these rates are virtually impossible to achieve when the caps for indexed annuity products range from 6.50% to 9.40%. See the Index Annuity Product Comparison spreadsheet that I developed to help educate these agents.

The above FINRA News Release is a reminder that customers only complain when they feel like they have been hurt financially or when their expectations have not been realized.  If you sell Fixed Indexed Annuities I offer the following suggestions:

a)    Always show the guaranteed values, and put your emphasis there

b)    Always explain the tax benefits that annuities may offer

c)    Sell at least two annuities – one with a six year or shorter surrender charge so that your customer will have adequate liquidity if their situation changes in the future or if they have an emergency

d)    When discussing the potential values, explain that the primary purpose of Indexed Annuities is to prevent loss, not to create large gains

e)    When illustrating a hypothetical interest rate for Indexed Annuities, use a maximum of 5%, but half the cap rate is good rule of thumb.

Some agents disagree strongly with the above opinion. Examine the Index Annuity Product Comparison spreadsheet closely and you will see that I am right.

Remember annuities provide strong, after-tax values. Here is an illustration that compares a $100,000 Jumbo CD earning 3.73% interest with two index annuities, one illustrated as earning a 1.00% return and the other illustrated at a 3.00% return.

The main point: Be conservative with your promises and projections. This will keep you out of trouble, and if your products exceed your client’s expectations, you will have happy clients.

Yesterday an agent asked me to compare three similar fixed indexed annuity products, each with an annual point-to-point interest crediting method, but with the following differences:

·         Surrender Charge durations of 7, 10, and 14 years

·         Bonus Rates of 0%, 5%, and 11%

·         Current Participation Rates of 8.90%, 7.80% and 7.80%

Often products with a premium bonus show higher values after 15 years, but if your client needs their money in 5 to 10 years, most of these products carry sizable surrender penalties. Since this particular insurance company pays an additional 1.10% interest rate on the non-bonus product, it is difficult to determine if the bonus products actually will deliver the highest values to the customer.

This spreadsheet compares the year-by-year surrender value of the above three products using hypothetical changes in the value of the index.  If you sell similar products, I encourage you to customize this spreadsheet to help your clients decide which product, or blend of products, best fits their needs.

I will let you decide which is the best income plan for a hypothetical sixty year-old man in a 25% tax bracket who wants the highest lifetime income from $100,000 starting in five years:

Plan A: Certificates of Deposit

$100,000 at 4% interest, less 25% taxes, grows to $115,927 in 5 years. He lives off the interest, $4,637, pays $1,159 taxes, and enjoys a non-guaranteed lifetime after-tax income of $3,478.

Plan B: Indexed Annuity With Income Rider

The $100,000 grows free of taxes for five years then provides $7,040 guaranteed lifetime income at age 65. He pays $1,760 each year in income taxes and enjoys a $5,280 guaranteed lifetime income. (See slide 23 in the PowerPoint training seminar designed by the insurance company for licensed agents.)

Plan C: “Laddered” or “Split” Annuity

$100,000 is divided into three annuities that grow free of taxes for five years:

1.    $24,862 - Five Year Guaranteed Rate Annuity at 4.90%

2.    $23,587 - Ten Year Guaranteed Rate Annuity at 5.00%

3.    $51,550 - The same Indexed Annuity as Plan B above

This plan qualifies for the exclusion ratio so most of the income is tax-free. At age 65, this plan guarantees $7,020 annually, $6,508 after-tax, for five years; at age 70, it guarantees $8,541 annually, $7,584 after-tax, for five years, and finally, at age 75, it generates a $10,793 guaranteed lifetime income ($2,698 taxes, $8,095 after-tax).

So which plan is better after 15 years?

Plan A: $34,780 “maybe” after-tax income; $100,000 likely remaining in account

Plan B: $52,800 guaranteed after-tax income; $61,869 guaranteed amount in indexed account (guaranteed values calculation detail)

Plan C:  $70,460 guaranteed after-tax income; $70,676 guaranteed amount in indexed account (see last page of split annuity illustration for details)

Plan C has double the income of the CD and also outshines Plan B. Plan C, the three product plan, gives the client more flexibility, more access to his money, higher guaranteed income, and better tax advantages.

The agent also benefits; a higher, guaranteed, after-tax income is easier to sell. Shorter surrender charges make this concept easier to defend as a suitable sale. The commission is less in the first year, but since there is a built-in new commission every five years, the 15 year total commission is actually higher.

After 30 years, when the client is age 90:

Plan A: $86,950 “maybe” after-tax income; $100,000 likely remaining in account

Plan B: $132,000 guaranteed after-tax income; $0 guaranteed amount in indexed account (guaranteed values calculation detail)

Plan C:  $191,885 guaranteed after-tax income; $0 guaranteed amount in indexed account (see how income riders work)

It is important to mention that the indexed annuity may perform above its guaranteed interest rate and that the client may have a positive balance in his indexed account at age 90.

Most agents tell me that they derive 95% of their income from Fixed Indexed Annuities. Most agents believe indexed annuity products are generally the best for the client, but I doubt that this is true 95% of the time. There may be some agents who sell indexed annuities because they pay a higher commission than traditional annuities; or do they?

Who makes more money:

Agent A who sells an indexed annuity, makes a one-time $100,000 sale, and earns $8,000, or

Agent B who sells a five year guarantee product and earns a 3% commission every five years? Here is his commission assuming a 4.50% continuous interest rate:

·         Year 1, commission on $100,000 = 3,000

·         Year 5, commission on $119,252 = 3,739

·         Year 10, commission on $148,610 =  4,659

·         Year 15, commission on $185,194 = 5,806

Agent B’s total commissions over 15 years is  – $17,203 — more than double that of Agent A’s!

Other considerations:

·         Which product is easier to explain and sell?

·         Which product is easier for the client to understand?

·         Which product has a shorter surrender charge?

·         Which product is easier to defend when client suitability is challenged?

I have nothing against Fixed Indexed Annuities. In fact, they are wonderful products when the client understands the product and does not need to touch their money for ten or more years. In many situations a blend of different traditional and indexed products works best.

Successful agents find the best annuity products for their clients and let commissions take care of themselves.

An agent in Tucson just emailed the following ad that appears the local paper by an Arizona Super-lawyer. One of her clients answered the ad, the law firm filed a lawsuit, the insurance company is investigating, and the agent faces a $78,000 commission charge-back for an indexed annuity sale made in January 2008.

The irony of this situation is that the indexed annuity was funded with stocks that would have lost about 40% of their value in the 11 months from January 2008 to December 2008 had the client kept them. The agent gathered a lot of information about the client’s financial situation. At the time of the sale the agent, the client, and the insurance company deemed this sale suitable.

I have several questions for the readers of this blog:

·         If you are an insurance agent, has something similar happened to you? Please share your experience on this blog.

·         Do insurance companies fight to keep annuity business on the books, or do they nearly always settle when confronted by these law firms?

·         In these situations, what documentation do insurance companies ask agents to provide about the nature of the sale and why it was deemed suitable?

·         Do clients often lose heart when indexed annuity products declare a zero percent interest rate in the first year?

·         This product had a 10% interest rate bonus – does this help or hurt a sale, since bonus products have much higher and surrender charges than non-bonus products?

·         This product had about an 8% commission – does this help or hurt when an insurance company has to defend a sale?

·         This was a one-product, one-company sale for nearly $1,000,000 – does it help or hurt to put all your money in one product if you have to defend a sale?

Please share your experiences and comments.

Seniors have heard the “high rate of return” story for fifty or more years. Most of them have been burned by this tale at one time or another and they are tired of hearing about it. Today most seniors are interested in four things:

1)    Safety

2)    Guarantees

3)    Tax Advantages

4)    Income

Why would they be interested in hearing about growth when millions of people just lost their shirt to this story?

It took 18 years for the market to recover from the 1929 crash – how many seniors can wait that long?

Obama promised to raise taxes on those who earn $50,000 or more – why not use this as a door-opener?

Forget accumulation values – focus on Income, Guarantees, Tax Advantages and Safety!

Closely examine a sample Flexible Income Stream illustration from ImagiSOFT.

Did you know that in most states that agents can lose their insurance license if they sell using illustrations that do not give the guaranteed values the same emphasis as the illustrated or hypothetical values? This illustration does just that – and I recommend that you spend the majority of your time talking about the guaranteed values and mention the illustrated values in passing, rather than the other way around.

If I were presenting to the 65 year-old John J. Smith, I would ask him this question, “Which would you rather have, an annual $9,000 after-tax income per year, guaranteed for only 5 years (his current certificates of deposit)    - or -    $11,700 after-tax income guaranteed for the next five years, guaranteed to increase to $14,200 for the next five years, guaranteed to increase in year 10 to $17,200? (See the second to the last page of the previously mentioned illustration.)  In short, which would you rather have, $135,000 of “maybe income” or $216,000 of guaranteed income over the next 15 years?

The last page shows the “Grow Back Account,” a fixed indexed annuity, illustrated at 5% interest, which may bring the account back to $303,000 after 15 years. Again, I recommend that you emphasize the guaranteed value of $189,500.  If the Guaranteed Lifetime Income Rider is elected, starting at age 80, this account will generate $33,765 each year for the rest of John J. Smith’s life.

In summary, why is this income strategy a suitable, high-quality sale?

·         John J. Smith is currently using $300,000 CDs for income to generate an income of $12,000 per year

·         This income is fully taxable. In his current 25% tax bracket, he must pay $3,000 per year

·         His primary goal is safe, dependable income

·         The interest rate is guaranteed at 4.00% for five years, and thereafter, renewal rates are uncertain

·         He is in good health with a family history of long life

·         Annuities lock-in a safe, dependable, predictable, guaranteed, income for 15 years

·         Annuities provide this income 90% tax-free

·         This annuity strategy guarantees an income increase every 5 years

·         After 15 years, the last component of this strategy guarantees $33,765 annual lifetime income. This is nearly three times the current income generated by the certificates of deposit – with an extremely high degree of safety

·         If John’s future goals change, this strategy offers three different surrender charge schedules – one as short as five years long

Focus on Income, Guarantees, Tax Advantages and Safety, and I guarantee you and our annuity customers will have a prosperous 2009!

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