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

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.

Noreen J. Parrett, Esq. wrote an excellent article in the Fall 2008 Federation of Regulatory Counsel Journal that uses facts from the settlement on June 16, 2008 between the Wisconsin Office of the Commissioner of insurance and Pennsylvania Life Insurance Company. I highly recommend that you read her entire article, but here is a brief outline:

a)    Penn Life was fined $925,000 for not properly supervising its agents

b)    The article cites many examples of obviously unsuitable sales made by Penn Life’s agents

c)    Penn Life was ordered to provide its agents with written standards, processes, and procedures as to what constitutes a suitable sale

d)    Agents are required to provide a written a disclosure to clients to assist in the consumer’s understanding of the product

e)    Agents are required to perform a client liquidity analysis

f)     Penn Life must hire a compliance department to review most annuity sales, and to call all applicants over the age of 70

g)    Penn Life must approve all lead cards, marketing material, and sales scripts / presentations

h)   Penn Life must provide uniform mandatory annuity product training, including a written test

Her main point: Even though most annuity carriers have implemented much of the above, regulations will continue to get more stringent until abuses stop completely.

For more information see an earlier article by Connie O’Connell and Noreen Parrett. 

In Sunday’s “60 Minutes” interview President Obama shot down the House’s proposed 90% tax bracket on bonuses from employees of companies who receive bail out money by saying,

“As a general proposition, you don’t want to be passing laws that are just targeting a handful of individuals. You want to pass laws that have some broad applicability … you certainly don’t want to use the tax code to punish people.”

Notice that he did not condemn the concept of a 90% tax bracket. Obama has proposed a tax increase that increases the current 35% top tax bracket to 39.6%. If President Obama follows Franklin Delano Roosevelt’s lead, these tax increases may be only the beginning of a new wave of income tax increases. In 1932, and again in 1936, when faced by budget deficits caused by the Great Depression, FDR increased the top tax bracket from 25% to 79% (Source: IRS Website).

When helping clients plan their future income, annuity producers should discuss the possible income tax effect of this income, and whether annuities can help reduce these taxes.  Annuities can help your clients in the following ways:

1)    Taxes on interest can be deferred to a time when the client is in a lower tax bracket

2)    SPIA (Single Premium Immediate Annuities) that are funded with non-qualified money can produce income that includes a tax-free return of principal

3)    Although all the income from Lifetime Income Riders is 100% taxable, even from non-qualified money, those who desire a guaranteed lifetime income can lock in a high, fixed interest rate for the rest of their life

If history repeats itself, and Congress raises taxes back to the 90% tax bracket for unearned income (meaning, non-wage income), annuities have the potential of causing your clients to pay massive future taxes. Explain to your clients the problem that they may have if they defer the taxes until they die, when all the accrued interest becomes payable in a lump sum. If they want to leave their heirs a tax-free lump sum at death they perhaps should purchase a life insurance product instead of an annuity.

The point is that “taxes” is a hot topic right now, and is the perfect door-opener to tell your story to your clients, prospective clients, and their income tax advisors.

• Married, Joint Return
  1. Tier 1: $32,000
  2. Tier 2: $44,000
• Single
  1. Tier 1: $25,000
  2. Tier 2: $34,000

If your client has defined benefit pension or other fixed income above Tier 2, they cannot avoid paying taxes on Social Security. If they have no non-qualified money, they usually cannot avoid paying taxes on Social Security without reducing their income. However, here is an example of a married couple who filed a joint tax return and used annuities to reduce their Social Security and ordinary income taxes (2007 tax rates):

Helping someone save over $7,000 on their taxes may look “too good to be true” but it is actually well within the ability of most annuity producers:

1. $500,000 safe assets generates $15,000 in taxable interest
   1. Use $65,000 to buy a 5-Year Single Premium Immediate Annuity to generate $14,000 income per year
   2. Put $385,000 in several deferred annuities to provide future income
   3. Leave $50,000 in a money market fund for emergencies
2. The $40,000 this couple is taking from their 401(k) is higher than the Required Minimum Distribution (RMD) — reduce it to $25,000

Smart agents will work with the client’s accountant to work the above numbers and to create the ideal product mix. The key is to get the taxable income as close to the Tier 1 income as possible. This has at least four advantages:

1. The accountant’s OK adds credibility to your sale
2. The accountant will earn extra fee income
3. If product suitability is ever an issue, you have the accountant as a friendly witness
4. The accountant has other clients that need your help — excellent referrals

In summary, this idea created a $65,000 SPIA sale, $385,000 in SPDA sales, and opened the door for an IRA rollover from the client’s 401(k).

Annuity salespeople who complain about the strict suitability laws that have emerged since 2006 have it dead wrong – suitability is your friend. The heart of the suitability law is stated in the opening paragraph of the law in your state. It will be similar to Utah’s updated suitability law effective on February 1, 2009:

“The purpose of this rule is to set forth standards and procedures for recommendations to consumers that result in a transaction involving annuity products so that the insurance needs and financial objectives of consumers at the time of the transaction are appropriately addressed.”

Which agents do not want the needs and financial objectives of their clients appropriately addressed? Unscrupulous agents. Agents who focus primarily on their own needs (commission), not the needs of their clients. These agents are the ones that fuel bad press for the annuity industry, and are the ones you want to set yourself a part from.

Here is how suitability laws work to your advantage. Show your prospective clients a copy of the law, and highlight the following words:

“insurance needs and financial objectives of consumers”

“insurance producer . . . shall make reasonable efforts to obtain information concerning:

“(a) the consumer’s financial status;

“(b) the consumer’s tax status;

“(c) the consumer’s investment objectives;”

“insurance producers shall maintain or be able to make available to the commissioner records of the information collected from the consumer and other information used in making the recommendations . . .”

Tell each prospect, “As you can see, state law requires me to ask you a lot of personal financial questions, write the answers down, and to make a reasonable effort to match my products to your needs before making a recommendation. I have to keep these records for a minimum of [in Utah, 3, in most states 5, and in one state, as long as the policy is in force] three years so that if you ever have any questions, I can support the recommendations that I have made. Are you comfortable enough with me to give me your confidential, personal information?”

With information about all the client’s assets, risk tolerance, life expectancy, income needs, tax concerns, you are armed with the information you need to address the client’s financial concerns with solutions from your annuity product arsenal. You will very likely find that this means selling more than one product, making more sales, having a higher closing ratio, getting more referrals, and staying out of trouble with clients and regulators.

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.