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In December 2014, my commentary focused on the risks of annuities and I urged my listeners not to give in to the hard sell of annuities without reading the fine print.
Annuity 101
Here’s a quick recap.
An annuity is a hybrid product that combines aspects of an insurance product and a mutual fund.
Here’s how most annuities are structured: When you buy an annuity, the underwriter subtracts certain fees and expenses and does some math to come up with a fixed amount he can pay you each year… say that works out to $5,000 that you will receive each year for the rest of your life, without any adjustments for inflation. But over the course of say 20 years, with inflation at about 3%, the purchasing power of $5,000 drops significantly… to the equivalent of about $2,000 – so your annuity income stream does not keep pace with inflation and loses purchasing power significantly over time.
There are different types of annuities, with the popular ones classified by an alphabet. Annuities with C shares and L shares generally offer investors the ability to withdraw their premium payments or exchange their contracts sooner or even immediately without paying a surrender charge. In the case of C shares, they generally have no surrender period during which an investor would have to pay a charge for such a withdrawal. But the investor generally pays higher ongoing fees for that early withdrawal benefit. And these products offer a rich compensation stream for broker-dealers and their affiliated financial advisers.
Riders, which come at an extra cost, are added to annuity contracts to blunt the market risk in the product’s underlying investments. They offer additional features, such as death benefits that protect income or withdrawals if the beneficiary lives longer than expected.
Most annuities also charge fairly high fees – from 3.5% to 5% each year… so if your annuity earns about 5% to 7% a year… after fees, you only end up with a net yield of 1.5% to 3.5% each year. And the rub is that most of these fees go towards paying generous broker commissions… which is why annuity salespersons sell you pretty hard, often locking-you into unrealistic expectations.
And should you choose to break an annuity, you’ll end up paying pretty hefty penalties. So, I had urged my listeners back then, if you’re considering annuities, research your options well – look into fees, commissions, payouts, inflation adjustments… and compare them to yields on simple or inflation-protected U.S. Treasury or high-quality corporate bonds that yield a bit more, don’t charge exorbitant fees and do not lock-in your money or have you pay hefty penalties on early termination.
Annuity Regulation and Industry Impact
Then, in February 2015, President Obama proposed strict regulations that limit hidden fees, “back-door payments” and conflicts-of-interest – in a bid to reduce investment fees, expenses and biased investment advice, such as when some advisers steer clients into funds that pay high kickbacks but do not deliver superior returns.
The proposed rule required financial advisers to act as “fiduciaries” for their clients and put clients’ interests ahead of their own compensation or company profits.
Regulatory pressure and negative coverage is beginning to have an impact on the less desirable aspects of the annuities industry.
And it seems, all this regulatory pressure and negative coverage is beginning to have an impact on the less desirable aspects of the annuities industry. As a recent article by Trevor Hunnicutt outlined in InvestmentNews.com, a leading purveyor of annuities – Voya Financial Advisors – has restricted sales of variable annuities for the second time in two months, under increased pressure from regulators questioning the suitability of these products for retirement savers.
Voya, which serves more than 2,000 registered representatives, said it no longer approved sales of a second type of variable-annuity contract if that contract includes add-ons that come at extra cost. The newest rule — covering a type of variable annuity known as a “C share” — comes on top of an identical restriction imposed in June that covered “L shares.
Voya has also mandated that its brokers give clients an analysis of each annuity’s cost in dollars and obtain client sign-offs on this information before selling the new annuity. The analysis, which compares those contracts’ cost against a comparable B share annuity, is produced by a third party, Morningstar Inc. – so they are injecting some respected third-party transparency into the process.
ANNUITY COSTS AND EXPENSES
Apparently, Voya decided to add a layer of transparency in response to pressure from the Securities and Exchange Commission; the Labor Department which oversees employer-sponsored retirement benefit plans that enjoy favorable tax treatment; and the Financial Industry Regulatory Authority or FINRA. These agencies have been examining whether investors understand the different costs and expenses associated with different share classes and whether certain annuities are suitable for investors who purchase them.
INCREASED REGULATORY ATTENTION
This increased regulatory attention on variable annuities is putting new pressure on the annuities business that generates $140 billion in sales annually for the insurance industry, money managers and brokers.
This, to me, is fantastic news… because while we all tend to be cynical and think we do not have a say in most matters, this news on annuities proves otherwise… that individuals should voice their concerns over unfair business practices… and while complaints may seem futile initially, we still have a democratic system where our collective voices will ultimately be heard… and changes made on our collective feedback.
