The proposition that the failure to recommend annuities causes investment advisors to run afoul of their fiduciary duty is a controversial one. It should not be. Recently, I made this assertion in an article that elicited both support and criticism from advisors. Comments, pro and con, illustrated the mental divide that exits between advisors who are open to guaranteed income annuities, versus those who are unwilling to embrace them.
David Blanchett recently stated that advisors who fail to recommend guaranteed income violate fiduciary duty. This was noteworthy because Blanchett is a one of the most prominent names in the field of retirement income planning. He is the author of ground-breaking research papers, an adjunct professor at the American College, and head of retirement research at PGIM DC Solutions. If you are a participant in the retirement income industry, at any level, you know Blanchett.
Blanchett’s comments about investment advisors and guaranteed income resonated with me. I have for years held a similar perspective. Up until 2007, I had a long and fruitful career in the annuity industry. This provided me a close-up view of how annuities frequently enhanced individuals’ financial security. That experience also exposed me to the manifold objections a.k.a. slurs that certain investment advisors have historically hurled at annuities.
Even today, a significant percentage of fiduciary advisors reflexively shun annuities. Why? I believe the reluctance to recommend annuities is due to perceptions of excessive costs, or inferior rate-of-return potential, or limited liquidity. To be sure, and while seen mostly in the past, these deficiencies have been a characteristic of a slice of annuity contracts. To continue to eschew annuities on this basis, however, overlooks the fact that it is easy to access annuities with unambiguously consumer-friendly features.
A segment of fiduciary advisors, those most aggressive in their anti-annuity stance, may not recognize the deep-rooted hypocrisy in their cost and liquidity-related criticisms. The most anti-consumer, irony-filled and shameful reason some fiduciary investors continue to shun annuities centers on their own commercial interests: the reluctance to commit “annuicide." The annuicide phenomenon became so pervasive that a word had to be concocted to describe the condition. Namely, the advisor’s loss of fee income due to shifting to an insurance company of a portion of the client’s otherwise fee-based investment assets. Over a lengthy career in annuity distribution, I saw up close how the annuicide rationalization had become deeply embedded in the minds of certain fiduciary advisors. Rarely was I able to overcome it.
There is no doubt that the annuity industry has sometimes been its own worst enemy. Questionable sales practices leading to high-profile regulatory actions clearly diminished the industry’s reputation. I have never hesitated to call out practices that I viewed as harmful to both consumers and the annuity industry. However, as questionable as certain annuity sales practices were shown to be, they were no less sins than anti-annuity advertising campaigns such as, “I Hate Annuities. And You Should Too!”
Over the course of my career, I’ve met a large number of fiduciary advisors. I am friends with many. I believe that every one of the advisors I know personally are truly dedicated to placing their clients’ interests above their own. What then prevents the majority of fiduciary advisors from embracing annuities? I believe what’s been missing is a client-segmentation framework that places the annuity in a logical, needs-based context within the “right” client’s overall investment strategy.
The 'Constrained Investor'
A shift in thinking centering on an alternative form of client segmentation makes it easy to understand that not all clients with the same amount of money, e.g., $3,000,000 in AUM, face the same needs and risks when they get to retirement. Some clients with $3,000,000 are “overfunded,” meaning that they have more investment assets than they need to generate sufficient income to fund their minimally desired lifestyle. Overfunded clients typically have no economic reason for owning an annuity.
By contrast, the financial picture of a “constrained investor” is typically significantly advanced by incorporating an annuity into his or her retirement income investing strategy. Why? There are several reasons. First, the volume of a constrained investor’s AUM although it may be substantial, is not high in relation to the amount of income the investor needs to generate. This established a second characteristic of the constrained investor. Namely, to generate adequate monthly income sufficient to support the individual’s minimally desirable lifestyle, constrained investors have an absolute reliance upon their savings. Third, constrained investors must be protected against risks that may reduce or eliminate their income, e.g., timing, inflation, longevity and confinement risks
Constrained investors are generally best served by making guaranteed income a component of their overall retirement investing strategy. This should not be controversial. In certain cases, the guaranteed income component need not be furnished by annuity at all. Social Security provides a lifetime, guaranteed annuity. A wise claiming strategy may allow for Social Security retirement benefits to cover the required amount of secure monthly income. Another non-annuity solution may be to access regular monthly income via a reverse mortgage. Nonetheless, annuities will play a key role in a considerable number of clients’ planning strategies.