Crafting Annuity Confidence and Clarity Is Hard Work

Art by Hye Jin Chung

In response to an American Benefits Council (ABC) survey fielded last year, of the 93 large companies polled by the Council, only 13 (14%) indicated that their organization offers a lifetime income option as part of its defined contribution (DC) plan.

According to ABC, of the 76 organizations that do not, almost two-thirds might consider such an option in the future, but for these organizations the leading cause of hesitation was “potential fiduciary liability,” followed closely by “lack of demand from participants.”

The ABC analysis offers some additional detail about plan fiduciaries’ hesitancy to embrace annuities. Responding companies indicated they worry that a plan sponsor offering an annuity option must manage substantial administrative and compliance requirements; sponsors offering a plan annuity option assume fiduciary responsibly for selecting the annuity vendor; sponsors know that where annuity options are offered they are not widely utilized; their own employees have not asked for an annuity option; and sponsors know that if a retiring participant wants to annuitize some or all of their lump sum they can do so in an IRA.

Sheryl Moore, president and CEO of Moore Market Intelligence and Wink Inc., says such figures are discouraging, but they are also a source of opportunity for financial services professionals to speak to an unmet need for more sophisticated retirement income planning. Moore’s firm is known for providing competitive intelligence tools to life insurance and annuity home offices, distributors, sales professionals and consulting firms—giving her an independent, bird’s eye view of the evolving annuity marketplace.

Misperception Abounds

“In this role, I have spent a lot of time correcting false, negative and inaccurate articles written about annuities,” Moore explains. “I’ve seen articles in major newspapers with a dozen factual inaccuracies about annuities. That’s not uncommon.”

According to Moore, the traditional media’s negative perception of annuities is tied to a lack of quality sourcing and the inherent challenge of conveying information about complex financial instruments in short pieces of content.

“As you know, the way stocks and mutual funds are sold on Wall Street works is that the sales person is either paid a flat fee or is paid an annual amount based on the assets, based on the AUM,” Moore says. “Annuities are different. The key difference is that most annuities are sold by commission, and the vast majority of annuities are paid one single commission at the time the product is sold.”

According to Moore, members of the public and financial professionals look at this simple fact about how compensation is organized and draw the false conclusion that annuities as a whole are not consumer friendly.

“A lot of registered investment advisers and broker/dealers take the position that annuities aren’t consumer friendly because they pay a commission of maybe 5%, while a mutual fund only takes 1% of AUM annually,” Moore says. “Those in the know understand that this is a total apples-to-oranges comparison. In reality, if you hold that mutual fund for 10 or 20 years, you will end up paying a lot more in fees to the mutual fund company than you would have paid as part of the initial 5% commission.”

Moore says there have been some attempts by the annuity industry to get around this problem, for example by trying to popularize trail commissions, where the salesperson gets a lesser amount or even $0 up front, but then they get an annual payment based on the account value of the contract for the life of the contract.

“This may be a better approach, but communicating this kind of information gets very technical, and again the media doesn’t really focus on these things,” Moore explains. “Many reporters are happy to hear from the stock and mutual fund salesmen, who talk about annuities not being consumer friendly relative to the stocks and mutual funds they sell.”

Education is the Solution

Stepping back, Moore says she is very passionate about annuities, but she does not endorse any company or product. She sees her work as that of an educator, describing how annuities really work.

“We don’t care if people like annuities or not—we are here to help people make an informed decision,” Moore says.

Moore further observes that the financial services-focused media may be a bit better at talking about the nuances of the annuity marketplace—getting into the weeds about fixed annuities, indexed annuities and variable annuities. But in at least one way some insurance-focused publications have also contributed to the perception that annuities aren’t consumer friendly.  

“A lot of insurance industry trade magazines back in the day would advertise to agents that they could make double digit commissions on specific annuities,” Moore recalls. “Over time, these types of advertisements led to a lot of backlash about annuities all paying really high commissions and not being consumer friendly. In reality, there are more than 800 annuities on the market today and only a small handful of them have a double digit commission, and at my last check, sales of those products accounted for something like 0.01% of annuity sales per quarter.”

Nevertheless, people continue seeing this information about high commissions, both coming from providers and from the media. Moore adds that she understands peoples’ healthy skepticism, some of which has come from legitimate issues that have occurred in the annuity markets.

“My experience has always been that product development runs ahead of regulation,” Moore explains. “For example, when indexed annuities first came out in the mid-1990s, there wasn’t a great set of regulations that addressed them specifically. Indexed annuities were a square peg trying to fit into a round hole, and so we did see some unsuitable sales and we did see some class action lawsuits. We saw products with double digit surrender charges—all the issues you hear about.”

But the regulations have now caught up, Moore suggests. Surrender charges are limited, for example. It’s much harder to fit double digit commission into these products, and because of that, the suitability problems have largely gone away, Moore says.

A Maturing Marketplace

“Today I would consider the indexed annuity market to be a mature market,” Moore says. “It doesn’t deal with any issues that are dissimilar from the fixed annuity market. One exception is that indexed annuities are dealing with growing pains relative to the types of indexes that are used—and the illustrations that are used with those products. But otherwise, things are much more mature than people commonly talk about.”

Moore says it will be interesting to track the use of fixed annuities as the financial services industry’s debate about conflicts of interest and suitability continues to unfold.

“Until recently, there has been little motivation to have fee-based fixed annuities or indexed annuities because there frankly was not a big market for that,” Moore says. “But when the DOL proposed the fiduciary rule some years ago, some people started saying, I need a way to show that I’m recommending this annuity in the best interest of the client, not based on the commission. That led to more fee-based fixed annuities being developed. Unfortunately, now that the DOL rule has gone away, the product development in this area has really fallen off. The other headwind right now for these more fiduciary friendly annuity products is that the interest rate environment makes fixed annuities generally look less attractive right now, so there is just less fixed annuity product development effort going on today.”