Annuity IQ

Banks are one of the leading sellers of annuities, both fixed annuities and variable, and have an extremely captive audience. For the most part bank investment programs have been very successful for them and we see an increasing amount of advertising suggesting you should let your bank be your trusted financial advisor. The question is should you let them be your trusted advisor?

First, let’s look at a history of banks.

As we all know banks make their money off of interest rate spreads. They loan money to you and you pay interest on the amount borrowed. In return the interest you pay will be credited to the depositors of the banking institution. I can guarantee you that will always pay more in interest than you earn as that is how the bank makes their profit.

Of course there are fees to, overdraft charges, monthly statement fees, returned check fees, internet banking (in some cases) fees and some banks even charge you to see a teller. Banks are designed to give you a safe place to deposit money so it will be there at a future date. They are also there to make money, hence all of the fees they charge you.

In the late 1980’s and early 1990’s banks noticed a trend, they were loosing deposits to investment firms like Merrill Lynch and others. After careful consideration and butting heads with the Glass Stiegel Act, and winning, they began to offer investment services to their banking clientele. This proved to be a very lucrative business for the pioneers in banking investment services.

Over the period of just a few short years many major and regional banks rolled out with investment services. This in turn helped the bank keep the depositors money one way or the other. What I mean is if the depositor kept their money with the bank the bank wins. If the depositor wanted to invest their money they could do it at their local bank branch and the bank wins by collecting a commission.

Banks, in the beginning, mainly sold fixed annuities and then branched out to mutual funds. They also only had one person who would be selling these investments, a registered representative within the local branch. After seeing how profitable this business was banks did what they are good at, hired bean counters to improve profitability.

This led to sales goals which then led to higher sales goals and before long it was sell and meet the goals or your fired. This puts the financial advisor in a difficult spot. Since you are judged on performance, how much commission dollars you brought in the door, you have to sell either a lot of low paying products or sell a little of higher paying products. This is where banks really started to concentrate on annuity sales, as they pay a higher commission than mutual funds. This also led to sales abuse of annuities and where annuities got their bad name from.

Then banks got a novel idea, if one advisor can sell X out of one branch why not license more people in that branch and we can then sell twice as much! This means they started to license customer service reps to sell annuities, only fixed annuities. This was probably the worst idea I have ever heard of, not that these people are bad people, but you are taking an untrained person and turning them into an investment advisor. Now, when you sit down to renew your CD you will not only be shown the current interest rates you will now have the privilege of someone trying to sell you a fixed annuity as well.

When you take uneducated advisors or someone who had no idea what an annuity was a month ago and try to turn them into a selling machine overnight there is going to be problems. Like unsuitable sales, customer complaints and no one really knows what they are selling and why they are selling it.

What they do know is that they will be collecting a commission if they sell something. I have to tell you that the bank really does a number to their commission. A fixed product usually pays about a 5% commission, but the customer service rep/financial advisor only gets about 1% or less of the sale. The bank then pockets the rest of the commission, talk about ripping people off! Especially, considering customer service reps do not make that much money to begin with.

Remember, this post is geared towards the bank, not the people in the bank itself.

Now, banks sell about 20% of all the annuities sold in America, that’s one fifth of the entire annuity market place. What kills me is the fact that they usually only offer a couple of Annuity products and do not give their advisors a wide variety of products to choose from. The bank will do this so they can get more money and marketing support from a smaller number of insurance companies in return for a promise of more business in the future.

I have worked with many bank based financial advisors in the past and there are some really good ones out there, but I have to say that there are a lot more not so smart bank advisors than good ones. This is in large part because banks pay their advisors a lower commission payout rate (this is the percentage the advisor will receive from their selling efforts, usually 30% of their gross commissions and the bank will keep 70% of what the advisor brings in) and high pressure they put on their advisors to produce. Most of the good advisors will go independent so they can run their own business and not have the pressure to produce, plus the payouts can be much higher as an independent advisor.

There is a high probability that your bank based advisor will not be there in a couple of years. As a matter of fact, banks have an extremely high turnover rate with their advisors. This leads to someone new coming in to manage your account. It is not uncommon for a long term client of bank investment programs to go through several advisors over the years. This can lead to bad advice or, even worse, neglect of your account.

With that being said, should you let your bank be your trusted financial advisor? I would say no way. All they want to do is increase their profit margins at your expense. They would rather have a good salesmen work for them who makes questionable decisions, but brings in big commission dollars, than a good ethical advisor who makes good decisions and cares about their clients, but produces less commission dollars.

If you are going to invest your money I would recommend steering clear of banks and go the more traditional route. Stick with either a brokerage firm or someone who is an independent advisor who is not told what they can sell. The only people who benefit from banks being your trusted financial advisor is your bank, not you.

When it comes to equity index annuities there has been both harsh criticism and praise from both camps, the critics and the EIA producers. I myself have even gotten in the middle of the argument as I have a tough time explaining them as a reasonable investment.

What make these products so difficult are the crediting methods. Different companies offer a wide variety of different crediting methods that seem reasonable to the naked eye, but as you dig they are not as reasonable as they might seem. What I find disturbing is most firms do not readily provide illustrations and if they do they show you an ‘assumed’ rate of return….assuming anything does make an ass out of you and me by the way.

When we assume conditions in the market, based on a steady interest rate or return, of course things look fantastic. After all, when we use assumed rates of return we are talking about an ideal world, not what really happens in the market. The market does not have a steady rate of return, it never has, and that is what bothers me the most when people refer to the market.

Everyone says the market ‘averages’ X return over the last 10 years. What they fail to tell you is the market went up 20% one year and then had negative 15% return the next year and you end up with an average return of 2.5% over two years. That rate of return does not look bad, compared to a negative 15%, but it is not showing you the drastic movement of the market. Using an average rate of return is important, but there needs to be full disclosure on how the average works, it would just make all of our lives easier and litigation attorney’s jobs harder.

Anyhow, back to EIA’s…

When the crediting method that seemed so good to the naked eye turns out to be not very good the following year what happens? The issuing company will then come out with a new fantastic new method no one has ever heard of before. They do this because the previous product usually fails to deliver what was promised, or assumed. Instead of illustrations and showing real market returns you get a story to tell your clients, with little regard to what will actually happen.

This is when I started to try to find some way to track equity index annuities and their performance over time using actual market returns. You would think that this would be EASY to find, but I can assure you it was not. Well, not until I found a website call eiatestdrive.com.

This is a broker only site that allows you to input today’s hot products specs and see how it would have performed over the last 50 years in the real world market. For example you can see how a monthly average product worked out, or how an annual cap with monthly averaging looks, or spreads and caps etc…all this using real life S&P 500 rates of return over the last 50 years.

So, here is what I did…

I went and imputed the data from a couple of the best selling EIA products in the market place and the results, well, were amazing. Most of today’s best selling products did not perform very well…at all.

All these examples are showing $100,000 investment over 50 years and unless otherwise noted 100% participation in the S&P 500. All caps and spreads remain constant throughout the 50 years as well, which we all know does not happen.

Case #1

$100,000 initial investment into the S&P 500 over the last 50 years grew to 6.1 million dollars. One of today’s better selling products offers a crediting method that is fairly common. It is a contract that offers monthly averaging with a monthly cap of 2.6%.

Theoretically, this contract COULD return in upwards of 30% on an annual basis, in an ideal world using simple math to calculate that potential return (12 x 2.6%). So how did it do? Not very good, over the last 50 years that monthly averaging with a 2.6% cap only grew to 1.6 million dollars.

Compare that to the 6.1 million the S&P 500 returned it is not very impressive. Now, some will argue that you suffered no loses over that time frame and you are correct, but monthly averaging compared to other crediting methods just did not do well in general.

I then upped the monthly cap to a huge number, which is very unlikely to ever reach, of 3.5%. Over the last 50 years this crediting method would have grown to 3.78 million dollars. This is better, but I am using an unreasonable monthly cap I just wanted to put the neigh sayers away right away.

Case #2

A contract that offers monthly averaging and an annual cap. 100% participation and an annual cap of 10% over the last 50 years your investment would be worth 1.45 million dollars. Compared to the S&P 500’s 6.1 million dollars it just does not stack up.

I then moved the annual cap up to 15% to see how it would perform and it was a mild improvement. Your investment would be worth 2.75 million dollars, but still far behind other methods.

Case #3

Bonus EIA….I do not even want to show you this, but I will. 10% bonus is paid to your investment, so in this case you will start with $110,000 instead of $100,000. I also picked the best option, 100% participation NO monthly averaging point-to-point annual reset, it has a 6% annual cap.

I did not like the 6% cap so I ran it at a 10% cap…Remember we started with $110,000, annual point-to-point, NO monthly averaging and the cap is at 6% currently…

Over the last 50 years your account value would have grown to 2.7 million dollars. Compared to the S&P 500 this did not perform and considering you started with more money and had no negative returns it just goes to show you that it does not work and should not be sold, period. This contract is 14 years before it is out of surrender charges and you have to annuitize the contract to realize the gains.

Case #4

I picked this because the web site actually says it has potential to return 31.2%. This contract offers a 12% bonus, YES 12%! 100% participation without any spreads or fees. The best option available is an annual point-to-point with NO monthly averaging and an 8% cap.

Remember, we started out with $112,000, not the regular $100,000. After 50 years the contract grew to 1.61 million dollars. Not very good and this is a 12 year contract as well. So much for the 31.2% potential.

Case #5

This was a crediting method I have actually never heard of before, it is called ‘threshold’. In a nut shell, you get 2.5% of a threshold return predetermined by the insurance carrier. The current threshold is 10%, this means on the first 10% rate of return the client only receives 2.5%, but they get 100% on everything over 10%. This product also does not have any caps, spreads or monthly averaging it is a straight point-to-point contract.

Over the last 50 years with a 10% threshold this contract would have grown to 5.1 million dollars. I was shocked to see that as this sounded like the poorest contract in the group, but it was only 1 million less than the naked S&P 500 and compared to the other products listed above it totally blew them away.

Since this product gave you 100% of the return on anything over 10% your returns were much higher. Shocking to say the least.

I will gladly tell you the names of the products and companies I ran the illustrations for if you email me at scottdemonte@annuityiq.com. If you wish to use this illustration software go to EIATestDrive.com and register for the site at PlatinumIM.com, remember this is a broker’s only web site. Let them and your friends know you saw this on Annuity IQ’s blog! Thanks for reading.

It has been fairly quiet on the variable annuity front as of lately and we have been very busy over here, so excuse the lack of postings. We are hard at work on updates and membership upgrades to enhance visitors experience with our site.

We are also hard at work on a new fixed annuity site that should be up and running in a few weeks. This is in response to numerous inquiries about fixed Annuity information. We are, however, only concentrating on a couple of fixed and equity index products. As you know we only like to deal with the best products in the market place and we have found them.

I will keep you posted.

On October 3rd Fidelity announced it is offering immediate annuities in conjunction with their 401 (k) programs. They have already signed up a couple of companies to offer this to their employees about to retire. Is this an about face from the no-load companies view on annuities?

We would have to say no. Fidelity, T. Rowe Price and Vanguard have long since offered annuity products, but it was not until recently that they started pushing them, hard. We will not and cannot take anything away from these companies as far as mutual fund offerings. They all offer some spectacular mutual funds, but when it comes to insurance products, specifically, annuities, people should be skeptical.

Why would we say that? Simple, really what options are they really giving you? The only options they are giving you are their own where they will, obviously, make money on them. This would or could translate into a not so good deal for the consumer. It is our opinion that their variable annuity products are below average in all aspects except for cost. We do not know enough about their immediate annuities to make a judgment on them.

Fidelity is trying and probably will capitalize on this new immediate annuity option they are offering. They are offering two companies to choose from, John Hancock and The Principal. These two companies offer fine products and they are probably going to be good, but who gets paid the commissions on these products?

All immediate annuities pay a commission, ranging from 1% to 5% on the dollars invested. Traditionally when an advisor sells the immediate annuity he or she will collect the commission, so when a company is selling you the product who is going to get paid? We are unsure as that was not discussed, but we assume if these products pay a commission either Fidelity or a Fidelity advisor will be compensated. That in itself is no big deal, but it has us a little concerned.

Our first concern is the limited offerings by Fidelity and the potential to make a fortune off of selling these immediate annuities. Even though Hancock and The Principal have solid products, they may not be the best in the market place. Our second concern is the consumer, are they being given other options? Do they know they can shop for immediate annuities?

With 1.3 trillion dollars managed by Fidelity, they are poised to make a killing if they get paid commissions and gather even a small percentage of the money they manage into immediate annuities. This is a big concern because this is a very captive market place that they dominate. Many consumers may be unaware that other options exist besides Fidelity products and will not take the time to shop around. Worse yet, they may not even know they can shop around for other products.

We are also concerned that many investors may not be aware that this immediate annuity decision is final and irrevocable. With such an important decision being made, what is Fidelity doing to make sure the consumer understands the product and the decision that is being made?

What troubles us even further is the fact that they are not offering some type of variable annuity with a living benefit option. Fidelity has always had a close relationship with Nationwide, which had underwritten their Fidelity Advisor variable annuity, so why are they not offering Nationwide’s variable product that offers living benefits?

A variable annuity with a living benefit can accomplish results similar to an immediate annuity, such as a minimum amount of income for-life. They can also provide upside potential if the stock market or sub-accounts perform well. An immediate Annuity does not offer the same potential and is, generally, locked in forever unless you pay more to get some type of COLA benefit.

We see this as a first step to get people to understand annuities better and we will accept this as a first step. We would, however, like to see a bigger step in the near future and to see variable annuities get the recognition they so desperately deserve. We will not hold out breathe though, but we will wait anxiously.

You may have heard about these no surrender variable annuity contracts and they may sound attractive. What’s not to like, tax deferral, a broker’s advice and it mutual funds, usually, from different top self mutual fund families. We say they are not the best products out there.

Here’s why:

The fee for a no surrender broker sold variable annuity is higher than a standard 7 or 8 year contract. Usually, the fee is .30% higher than traditional variable annuities. The fees are higher to compensate the company for the increase of liquidity and to pay out the broker/agent an upfront commission of, usually, 1% and a trailing commission of 1% paid annually to the broker.

Now, do not get us wrong, we do not care about the commission, but what we do care about is needlessly spending money on a contract that you plan on holding on to for the long term. The average “C” share or no-load broker sold variable annuity is about 1.70% a full .30% higher than the average 7 year counter part. If you add any living benefit then the cost can skyrocket by as much as 1%.

Our point is, why spend the money if you do not have to? The broker/agent can be compensated by the same amount as the “C” share annuity by using the traditional product with lower over all expenses. These products do fit a specific niche, but overall they make little sense. Especially, since you can find plenty of annuities that offer living benefits for a cost of about 2% or so, that includes sub-account fees to.

If you are buying a living benefit on these contracts then you are automatically thinking long term. Because of this you should consider a cheaper longer term or standard variable annuity contract. Of course, this is just our opinion and everyone’s situation is different so be sure to ask your financial advisor which annuity is best for your needs.