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.