When Louisville, Ky.-based Jefferson National Financial Corp. began marketing its Monument Advisor variable annuity to registered investment advisors in 2005 and 2006, “It truly was like selling ice to Eskimos,” says Mitch Caplan, Jefferson National’s CEO.
The frosty reception wasn’t too surprising considering that the high fees and commissions traditionally associated with variable annuities clash with RIA philosophy and can eat up most of the tax savings they generate. Their terms and conditions also tend to be very confusing.
But the company wasn’t peddling ordinary annuities. Gone are the up-front loads, mortality and expense fees (M&E), death benefits, complicated guarantees and surrender charges. Instead, Jefferson National charges policyholders a monthly flat insurance fee of $20 for its product, which it describes as the industry’s first and only flat-fee offering. What makes it an annuity is that contract-holders can annuitize, even if very few do.
The $240 annual fee translates into 10 basis points for Jefferson National’s average policy size of $240,000. In contrast, the industry’s average basic insurance fee (M&E plus administration) is 134 basis points, according to a December 2012 Morningstar survey of 1,925 variable annuities.
The tax-deferred vehicle also offers more investment choices. The Monument Advisor platform offers more than 390 underlying mutual funds, including 70 alternative investment funds, for investors to put in the tax-deferred variable annuity wrapper. That’s five to six times the industry’s average fund count.
“We’ve re-engineered how you think about and use a variable annuity,” says Laurence Greenberg, president of Jefferson National. “It’s all about tax deferral.”
According to research the company conducted, annuity holders can save 125 basis points using a tax-deferred vehicle instead of a taxable vehicle (assuming these investors are in the highest tax bracket, hold a portfolio of moderate risk and rebalance annually). The company encourages advisors to use the product for their clients’ most tax-inefficient investments.
Today, Jefferson National works with nearly 2,000 RIAs and fee-based advisors. Its sales rose to $410 million in 2012 from $268 million in 2011, and Caplan hopes to reach $700 million this year as the company continues to grow its advisor base and deepen relationships with existing advisors. The company also hopes to accelerate growth with the capital raised through an $83 million management buyout completed last year.
This year’s tax hike on high-income clients of RIAs is likely to spark interest in ways to minimize tax bills, Jefferson National executives reason. “The world is on our side,” says Caplan, noting that advisors are seeking ways to deliver sustainable, superior returns to clients anxious not just about higher tax rates but sharp market volatility as well. The U.S. Department of Labor’s fee disclosure rules are also prompting interest in low-cost, highly transparent products, he says.
One of Jefferson National’s earliest adopters was Denver Money Manager LLC, a Denver-based independent, fee-only financial advisory firm managing approximately $130 million in assets for 160 households. “We’ve been longtime detractors of variable annuities,” says Aaron Grey, the firm’s managing partner. “Expense is one of our biggest hot buttons.”
Still, Jefferson National’s flat-rate approach and the variety of its funds appealed to his firm, which needed another tax-deferred bucket for those clients who are maxing out on 401(k) and IRA contributions and want to save an additional $50,000 to $100,000 a year for retirement. “We’re basically buying tax deferrals for $20 per month instead of 1.3%,” says Grey. “For us, it’s an entirely different animal.”
Jefferson National makes money through this monthly fee and through the distribution fees paid by most of the fund families on its platform. For ultra-low-cost funds that don’t pay a distribution fee, the company charges policyholders transaction fees of $19.99 to $49.99. This includes funds from Dimensional Fund Advisors and the Vanguard Group—the ones Grey uses most. But since his firm doesn’t trade frequently, he says clients are often charged this fee just once a year.
Denver Money Manager uses the annuity with approximately 15% of the households it works with. “It’s a very useful tool to have in our toolbox,” says Grey. If a client owns a pricey traditional annuity, Grey’s firm transfers it to Monument Advisor through a Section 1035 exchange without triggering tax consequences.
He emphasizes that his firm focuses on getting clients’ asset allocations correct before determining where to place assets for tax efficiency. “You can’t let the tax tail wag the investment dog,” he says.
Tactical And Practical
Jefferson National has been expanding its tactical offerings, which aim to help portfolios better handle market volatility. Early this year, it partnered with King of Prussia, Pa.-based CMG Capital Management Group Inc. and Needham, Mass.-based Braver Capital Management to launch new suites of tactically managed model portfolios.
Given the global debt mess, low interest rates and low inflation, it is especially important for investors to be defensive and trade on different trends, says Steve Blumenthal, CMG’s founder and CEO. But because tactical strategies such as his trade often, they can trigger many short-term capital gains and render the investments highly tax-inefficient. It helps to place them inside the variable annuity wrapper. That allows the portfolios to grow tax deferred and allows investors to see the significant compounding on those gains, he says.
CMG advises and consults on $550 million of assets, and its clients are mostly advisors. Among its clients, 10% to 20% use Jefferson National’s variable annuity. Blumenthal says this is growing. “I think the lights are going on,” he says. “Advisors see it and get it.”
Dave D’Amico, the president and chief market strategist of Braver Capital Management and Braver Wealth Management LLC, agrees. “I couldn’t warm up to annuities in the past,” he says, but, “if advisors are not looking at annuities, they are not doing a complete job for their clients.”
Braver Capital works with about 50 advisors, including Braver Wealth Management, for whom it manages approximately $710 million in assets for 400 clients. Approximately $50 million of this is invested in variable annuities, 65% through Jefferson National, says D’Amico.
Last year, one of Braver Wealth Management’s clients sold a business for $10 million in after-tax proceeds. Braver Capital moved 25% of those assets into tactical strategies sheltered under the Monument Advisor annuity and 75% into traditional accounts with low turnover. “We put the tax headache under the Jefferson National platform,” says D’Amico.
Behind The Scenes
Caplan, Greenberg and David Lau, Jefferson National’s chief operating officer, share a long history.
In late 1989, in the thick of the savings and loan crisis, Caplan and other investors purchased a small bank in Northern Virginia. They re-engineered it into Telebank, the United States’ first branchless bank, and expanded nationally. The management team, including Greenberg and Lau, took the bank public and in 2000 sold it to E*Trade Financial Corp. The technology developed at Telebank helped E*Trade grow into a leading Internet bank and broker.
Caplan stayed at E*Trade and was the CEO from 2003 through 2007. When the economy collapsed, he was affiliated with a venture capital firm, and he brainstormed on how to help emerging high-net-worth individuals boost savings. His interest in reaching this market through the advisor distribution channel led him to Jefferson National, where Greenberg and Lau had already moved sometime after the Telebank-E*Trade deal.
The Telebank alumni wanted to reincarnate the traditional variable annuity company by targeting RIAs and fee-based advisors through low-cost, advanced technology. “They started Jefferson National [in its current form] on the thesis that there was opportunity in the insurance world to do very much what we had done in the banking world,” says Caplan.
Why RIAs and fee-based advisors? Caplan and the others recognized that consumers needed advice, and they liked the fact that these advisors shunned commissions and adopted fiduciary standards. “That was the same side of the table that we wanted to sit on,” says Caplan. It was also the fastest-growing distribution channel in financial services.
Jefferson National keeps its cost structure low by using an online-only business model that eliminates the expense of flying wholesalers all over the country. “Our Web site effectively becomes the storefront,” Caplan says. Basing operations in Louisville instead of a more expensive city also keeps operating costs lower.
The company plans to relaunch its Web site this year with more functions. The site’s current features include analytics, screeners, a tax deferral cost comparison calculator and a variable annuity comparison calculator that looks up the value of other companies’ products. Advisors can also create investment models and execute trades through the Web site.
Approximately 30% of Jefferson National’s advisors use a third-party investment manager to manage client assets—a number Lau says is on the rise. Advisors can work with their own asset manager or choose one that has a relationship with Jefferson National.
The number of fee-based variable annuity products has risen to 60 from 34 in late 2011, according to Morningstar. The Fidelity Personal Retirement Annuity held the largest share of fourth-quarter 2012 fee-based sales (53.5%), followed by Monument Advisor (12.9%) and Vanguard Variable Annuity (11.3%), says Frank O’Connor, a product manager of licensed data at Morningstar.
Braver Capital uses the Fidelity annuity for some fixed income needs, but D’Amico says some of the product’s trading restrictions are incompatible with his firm’s actively managed strategies. “We have great relationships with both firms [Fidelity and Jefferson National] and they both offer great options,” he says.
“Fidelity does not have a flat fee but offers very good value.” Fidelity’s annual fees are 25 basis points plus fund fees, according to the company’s Web site.
The Vanguard Variable Annuity also is seeing growing interest from advisors, says John Heywood, a principal with Vanguard’s Retail Investor Group. Over 15% of the annuity’s sales now come through advisors reaching out on behalf of clients, he notes. That contrasts with over 90% of Jefferson National’s sales that come through advisors. Greenberg says that some well-heeled retail investors manage to find them.
Both Fidelity and Vanguard also stress low costs. The annual expenses for Vanguard’s 17 portfolios range from 46 to 79 basis points, including 29 basis points for M&E and administration.
Linscomb & Williams, a fee-based advisory firm in Houston that works with about 1,300 families, uses the Vanguard annuity product for $40 million to $50 million of its approximately $2.1 billion in assets under management. The Vanguard product is the firm’s first choice because of its cost structure (there are no front-end or back-end fees) and its investment selection. “It doesn’t have hundreds of different buckets, but we can put together a well-diversified portfolio using their lineup,” says George Williams, senior vice president with Linscomb & Williams.
The firm primarily uses the annuity to do tax-free exchanges for clients who already have an annuity and to accommodate clients who are particularly concerned about exposure to lawsuit creditors. “Ninety-nine percent fall in one of the two categories,” says Harold Williams, president and CEO of Linscomb & Williams. “In Texas, an asset in an annuity enjoys creditor protection.” The same goes for Florida and several other heavily populated states.
Morningstar’s O’Connor notes that fee-based variable annuities remain a tiny part of the variable annuity market—making up just 2.4% of total assets at the end of 2012. “Sales of such products are historically anemic,” he says. But more products may be launched as investors fear future tax increases, as more advisors convert to fee models and as consumers demand more income guarantees on low-cost products, he says.
For its part, Jefferson National is focused on adding value. “I think it’s our job to make sure that the platform provides choice to the advisor to be able to manage in almost any macroeconomic scenario,” says Caplan.
“Clients don’t have the intestinal fortitude to watch their accounts go up and down,” says Lau. “Advisors have to manage not only portfolios but emotions.”