Those of us who have heard the word “annuity” before have likely also heard some colorful adjectives used to describe these products and their distribution; depictions like “complex,” “expensive” and the ever cringeworthy “no obligation free steak dinner” tend to come to mind.
In some cases, these descriptions prove disturbingly true. In others, the prevalence of either poor product design or of deceptive practices by product salespeople has been sensationalized. Sadly, this has caused many fiduciary advisors to shy away from a key asset class that provides lifetime income—many times, simply for fear of association with this ugliness. More can be done by representatives of the fiduciary advice, annuity and technology industries working together both to overcome these perceptions and to better integrate annuities into the holistic planning solutions that fee-based advisors use. In so doing, we could together help more Americans access the psychological benefits that protected lifetime income can afford.
Annuities, far from being inherently bad, are insurance constructs that have been in existence since at least the early A.D. 200s, when Roman jurist Ulpian purportedly invented the first annuity mortality tables. Sometimes accurately, and sometimes not, annuities today are regularly discussed in the mainstream media. That is an enviable degree of consumer attention being paid to what literally amounts to a financial instrument category name. (Can any readers imagine a fired-up and/or reasoned argument that calls into question the merits of another entire well-known financial investment category, like mutual funds or bonds?)
The feature that all annuities do inherently have in common is income stream protection. From there, annuities come in many different varieties; fixed versus variable, “income now” versus “income later,” single versus recurring deposits, and institutional versus retail are some oft-used distinctions between annuity types. But the germane distinction between annuity types is between those that are explicitly priced to include within them costs associated with distribution, versus advisory class annuities, which do not compensate distributors from within the product’s pricing (but on which a fiduciary advisor may choose to charge advice-based fees.) It is not the annuity product container itself, but rather the historical method by which product distributors are compensated, that typically inspires negative consumer impressions of annuities.
This distinction in compensation methodology between compensation earned in exchange for selling a financial product and compensation earned by virtue of providing ongoing financial advice to a consumer has many implications for consumers, for financial professionals and for regulators. One byproduct of these differences is that the product sets that have historically been used to deliver solutions to consumers working with a sales professional differ substantively from the financial products that have tended to be used by fee-based advisors. In the first environment, products that have higher upfront costs, more set-and-forget embedded features and lower ongoing costs thrive. In the second, the opposite is true.
Historically, most life insurance and annuities were sold by career agents, and it was worthwhile for insurance companies to make significant investments in cultivating the expertise of the sales professionals representing them, both because they represented the company’s values, and because they communicated to end purchasers the unique attributes of that insurer’s products. Those insurance companies that continue to maintain career sales forces in the United States invest significant home office resources in developing a consistent nationwide training infrastructure, so that the agents that represent its products do so with a well-practiced, well-vetted and potentially unified voice. This captive distribution model is the paradigm from which embedded life insurance and annuity sales charges originally derived; the distribution charges embedded in these insurance products were used not only to cover the costs of insurance companies’ investments in training their sales forces but also to pay the agent. It is false to assume, as the mainstream media often does, that career insurance agents are trained to just make product sales at all costs. It is accurate instead to assume that career insurance agents are trained in how to identify, and how to connect with, the types of consumers who might find the agent’s products valuable. In the past, it was considered worthwhile for U.S. insurers to make these investments in the human capital development of their sales forces, and in this environment, agents of one company competed with agents of other companies on product attributes as well as on pricing.
Fast forward to the modern environment, where few insurers continue to invest in career agency, and accordingly, few insurance products are sold by the above-described process. According to a recent McKinsey report, the average age of a licensed insurance agent in the United States is now 59. There does not exist an infrastructure to support educating young people to become independent insurance agents, and with our nation’s youth exiting college with high debt levels, a commission-based starting career may not make good financial sense for most graduates. It is thus entirely unclear in our brave new world if/how future financial professionals may come to develop insurance-specific expertise, but I will leave this series of concerns for a future article.
To the prior point, sales charges embedded within annuity products evolved in the insurance space not only due to the complexity and time it takes to explain a risk transfer investment but also to recoup the cost associated with employing and training a sales force. This sales infrastructure is costly to embed in a product; however, it is important to keep in mind that investment advice can also sum to a material amount for a consumer. Most holistic advisors know that in an era when clients seek portfolio income optimization from savings that comparing these two options can be critical to meeting a fiduciary standard.
No-load annuities, as opposed to commissionable annuities, serve as financial instruments on which fee-based advisors can advise clients. Distribution of this product type will prove entirely different from how distribution of commissionable annuities works. No-load annuities are now new entrants in a relatively staid industry. It is only within the past few years, inspired perhaps in part by the now-vacated Department of Labor fiduciary rule, that a panoply of annuity issuers began in earnest to market no-load deferred annuities. These annuity product introductions now make it theoretically possible for fee-only advisors to introduce, and charge fees for advice upon, investment solutions that include no-load annuities for their clients. That’s good news for those of us who think annuities are overall beneficial for society, because an ever-increasing proportion of Americans are choosing to work with fiduciary advisors. More product development that enables these advisors to introduce protected lifetime income solutions then is, ceteris paribus, a good thing. More education is also a good thing, with the recently evolved Alliance for Lifetime Income taking a pivotal role in educating both consumers and advisors on the benefits that protected lifetime income can afford Americans.
No-load annuity product development represents a step in the right direction toward enabling fiduciary advisors to weave together an investing framework that includes protected lifetime income. It is, however, not enough. The next step is to build the necessary bridges that best connect fiduciary advisors with insurance-based solutions.
Having access to sophisticated models, I can analytically compare the performance of a portfolio including annuities that contain embedded sales charges to the performance of portfolios that include no-load annuities on which an advisory fee is charged, and I can know that it is not inherently the case that the portfolio including one product type always outperforms the portfolio containing the other product type. There is no product panacea that can solve America’s well-documented retirement undersaving challenge. What I am convinced of though is that to help mitigate the effects of America’s undersaving challenge, annuities can provide not only a source of guaranteed income, but also help fiduciary advisors better manage the clients' other investments that provide greater liquidity. As with most investment decisions, this is an “and,” not an “or” decision.
Among the technical issues on my radar for the integration between annuity providers and the fiduciary advice space include:
- Technology integration between investment and insurance systems
- Independently substantiated income valuation methods
- Asset to income translation on aggregated client statements (brokerage statements that include annuity income, not just asset, values)
- Clear regulatory guidance on if/when/how/in what context it can be appropriate for advisors to bill on income streams/income bases
- Additional annuity product innovation
There have been good reasons historically why annuities have not been systematically incorporated into fiduciary solutions. But if enough dedicated people and companies work hard to change the status quo, those reasons won’t need to continue to be true, and in the future, all clients of all types of financial professionals can get access to the protected lifetime income that only annuities can provide.