How to avoid hidden pitfalls in fixed-index annuities
CHANDLER, Ariz. — The marketing and selling of fixed-index annuities remind fee-only insurance advisor Scott Witt of a common saying: If you’re in a poker game and you can’t spot the sucker in the room, then it’s probably you.
“One thing I’ve learned over the years is that insurance companies and insurance agents love complexity,” Witt, the founder of Witt Actuarial Services, told a packed room of roughly 75 financial advisors on May 17 at the NAPFA spring conference.
“The more complicated something is, the more difficult it is for questions from the consumer and the advisor, and complexity and confusion in my experience are two of the best things that insurance agents and the insurance companies have going for them.”
Witt drew laughter with remarks like the poker-game jab and his opening joke that, unlike most information sessions about FIAs, he had no free dinner to offer the attendees. He did, however, serve up tips on how best to understand the products, avoid their pitfalls and best make use of them for clients.
Sales of FIAs declined last year for the first time since 2009, but they still reached $57.6 billion, or more than a quarter of total annuity sales, according to the LIMRA Secure Retirement Institute. The products guarantee principal while providing returns up to a participation rate or capped rate set by the issuer.
Annuity firms and researchers predict that sales of the products will rebound this year, on the strength of new offerings pitching income security to waves of retiring baby boomers. Advisors in attendance at the session, though, view FIAs with skepticism, citing high fees, long surrender periods and complexity.
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“I never recommend them,” says Delia Fernandez of Los Alamitos, California-based Fernandez Financial Advisory, where she says she’s trying to steer many teacher clients out of previously purchased ones.
“The difficulty I have is that a lot of these products are sold to them, and they don’t really understand them,” she continues. “They don’t want to lose money, so it seems like the best of both worlds.”
Bob Morrison of Greenwood Village, Colorado-based Downing Street Wealth Management agrees, noting the difficulty of reading and understanding offering prospectuses that run up to 300 pages long.
“I tend to stay away from them because of the cost structure,” he says. “They tend to have high internal costs, and it’s complicated to understand the internal costs.”
Witt, who spent 10 years in actuarial roles at Northwestern Mutual, gave out a few tricks of the trade.
To gain a rough sense of the “opaque” commission within an FIA, he says, compare the percentage of the first-year surrender penalty to the overall surrender period. He used an example of one product with a 9% upfront surrender penalty and a seven-year period, which he says carried a 7.5% commission.
He also advised against fixed-universal-life insurance policies, which he says often cap investment returns at a higher rate than FIAs but make up for it by overcharging on mortality expenses and other fees. Advisors should keep in mind, too, that issuers may reduce the cap on their FIAs.
Guaranteed income riders also don’t add much value for their extra expense when clients have already purchased downside protection, Witt says. Advisors should also disavow any clients from thinking of FIAs as a substitute for equities, but rather encourage them to treat the annuities as a proxy for other low-yielding product like bonds or a CD.
He outlined a scenario in which he says an FIA could potentially work for a client: a 65-year-old with adequate retirement savings who takes advantage of products that allow for withdrawals of up to 10% per year. A 3% or 4% yield on investment would make the product helpful for the client, he says.
“Indexed annuities, in general, are dramatically oversold and often poorly understood. I think unnecessary riders are often added. They are not a substitute for equities,” Witt said. “But I think they can make the most sense as an upgrade from cash.”
He always closes his presentations with a message of “buyer beware,” he added. Earlier in the talk, he had noted that advisors need not approach FIAs the same way that issuers and salespeople do.
“The focus is on the sale. It’s not focusing on how it’s going to be used and set up maybe 10, 20 years down the road,” Witt said. “But that doesn’t mean that you can’t use this to your advantage if you can find a situation that makes sense.”