I have watched for several years the interplay between regulators, compliance departments, insurance companies and NAVA (National Association for Variable Annuities). Basically, the regulatory side of our business is very skeptical about variable annuities and the products are under attack. NAVA, on the other hand, publishes articles and research supporting the use of variable annuity products. So, are they the greatest invention since sliced bread or are they a scourge that should be driven from the planet?
In my own practice, I make limited use of these products but believe they can be a viable product in meeting client needs. This year, I have had two clients inherit variable annuity accounts due to deaths in the family. Both clients profited from the death benefit, as the recent bear market had left the annuities' values underwater. One client received a return of original premium, and the other received a 5% annual step-up. I had sold the client the 5% annual ratchet policy, but had nothing to do with the other annuity. Needless to say, both clients were extremely happy that these investments were in an annuity product with a death benefit. I also have clients who are very happy with their living benefits riders within annuities. Throw in the advantages of tax deferment, and I believe there is an excellent case for these products being valuable to clients. There are clients for whom these products are a good fit and others who will not be interested in them.
However, I believe there is much work to do to take these products out of the regulators' crosshairs and make practitioners like myself proud to offer them. First and foremost, there needs to be a cut in the product expenses and the commissions that these products pay. Let's face it's these products are pushed by some because they pay higher commissions than mutual funds. Well, if the product is a viable choice for a client solution, why do companies need to entice sellers with extra compensation? Personally, I would feel better about selling an annuity if my compensation was exactly the same as it is for mutual funds. The extra compensation that is often offered makes me feel defensive and slimy, having to justify my motives to myself.
I don't want the extra commission, so please pass it on to my clients through decreased expenses and, therefore, better investment results. Insurance benefits that help clients are worth paying extra for, but not commission structures that entice unethical people to sell these products when they are not the best choice for a client. I believe that the evidence in our industry is clear that mutual fund commissions are high enough, allowing representatives to make an adequate living based on their current payouts. So, NAVA, how about pushing for members to compensate sellers in the exact same manner as mutual funds?
While we are at it, how about making the choices the same as A, B and C shares? Clients could more readily see how much they are paying for their insurance benefits, choosing either up-front or deferred charges. This would give us a level playing field, allowing advisors and clients to select the product that best meets their needs.
As to "bonus" annuities, since there is no free lunch these products probably don't really have much merit in adding value to a client. The probability of misuse as a sales incentive or outright deception (due to lack of full disclosure) most likely outweighs any benefits from these products. So let's get rid of them.
Now, one more idea to make variable annuities the quality products that they deserve to be. While there has been an explosion in the number of investment choices within annuities, there has not been an explosion of types of investment choices. These products need to have more noncorrelated assets in their offerings. Clients should be able to prosper in these investments regardless of market conditions. To do this, annuity products should add inverse investments, inflation-protected bonds, commodity-related funds and other low-correlation investments.
With these changes, I believe the variable annuity can be a viable product and a valuable solution for clients in the future. I believe these changes would remove these products from the crosshairs of regulatory bodies and compliance departments. Investment results would be slightly improved by lower expense ratios. There might be a few less sales, but that would be an outcome that would benefit clients everywhere.
Ted Schwartz, CFP, is a principal at Capstone Investment Financial Group Inc. in Colorado Springs, Colo.