Index Annuities are Hot Selling Insurance Products – Should You Buy?
Indexed Annuities are Hot-Selling Insurance Products – Should You Buy?
By J.R. Robinson, Financial Planner, August 2023
I will not force you to read to the end of this article to glean where I stand on one of the hottest selling products in the investment and insurance world. To be as clear and unambiguous as possible, the answer to the question posed in the title is – NO!!! Not a soft “no,” but rather a hard “NO” with three exclamation points for emphasis. Financial Planning Hawaii clients will not hear me recommend index annuities (IAs).
I do not like them in the same way the fellow in Dr. Suess’s class children’s rhyme did not like Green Eggs and Ham. However, unlike him will not eventually succumb to peer pressure from the insurance industry. I will not like them here or there I will not like them anywhere. Not now. Not ever.
YOU DO NOT LIKE THEM SO YOU SAY, BUT WHY THEN ARE THEY “HOT” ANYWAY?
Don’t worry, I am not going to keep the Dr. Suess schtick going for the rest of this essay. In the wording of this article’s title, I was deliberate in referring to them has “hot-selling” instead of “popular” because, in my opinion, the reason they are “hot” is that the product design and jargon used to market them make them eminently pitch-able to insurance agents and other commission-based sellers of insurance-based financial products.
I do not believe they are “popular” because I do not see unbridled demand for them in the same way that consumers were scrambling to by Series I savings bonds in 2021 and 2022. Instead, I believe consumers are buying them because they are being sold on the seductive marketing song that the insurance companies and their salesmen are singing.
The crux of index annuities' success in the marketplace is that their product design fosters the perception that they offer consumers a way to participate in the upside of stock market returns without having to endure bear market returns. Wealth without risk is always an effective lure when fishing for consumers’ money.
Similarly, the use of the term “index” in the product title enhances the appeal by creating a subliminal association with index fund investing. Over the past few decades, the investing public has become increasingly aware of the overwhelming academic research support for the concept of investing in passively managed, ultra-low-cost index mutual funds and ETFs. Index funds and ETFs are truly “popular” because they attract trillions of dollars of consumers’ investment dollars without the need for investment salespeople.
Another subtle element of IA design that bothers me is that they exist beyond the reach of the two securities regulatory authorities – the Financial Industry Regulatory Authority (FINRA) and the Securities Exchange Commission (SEC). IAs are technically fixed insurance products and not securities. As insurance products, IAs are regulated by NAIC the national association of insurance commissioners. In NAIC’s regulatory realm, opaque commissions are the norm and are not required to be disclosed to consumers. Similarly, insurance product sales fall outside of the “Best Interest” and fiduciary standards of care that are respectively applied by FINRA and the SEC to financial advisors within their jurisdictions.
To summarize why I have such a dim view of index annuities in another carefully chosen word, I do not like them because I believe they are investment “gimmicks.”
WHAT ARE THE DESIGN FEATURES THAT CAUSE YOU TO LOATHE INDEX ANNUITIES?
Product Complexity - The common consumer belief that the return on the money they invest in IAs is directly tied to stock market returns is a gross misperception. In fact, I will take this one step further by asserting that the perception some consumers may have that IAs the opportunity for full participation in bull market returns is a myth.
Instead, these contracts typically calculate returns that, while they may be derived from various stock market indices, are typically well below actual upmarket returns while clawing back gains during prolonged down markets. Additionally, subtle features such as long surrender periods, required annuitization, and/or certain withdrawal restrictions all add to product complexity. These formulas are often so complex that they are rarely understood by consumers or even by the salespeople who are schlepping them.
Opaque Commissions – While the vast majority of are sold by agents who are compensated via opaque commissions, in my experience, the commissions paid on IAs seem to be higher than the norm. I have an informal guideline that has served me well over time in helping determine which investment products may be suitable for portfolio construction – If I receive a continuous stream of spam in my inbox from companies encouraging me to distribute a product because of the high commissions they pay, the is not a fit for Financial Planning Hawaii clients.
Note: A common rebuttal to the opaque commissions issue that is often advanced by some of my industry peers is that there are a growing number of index annuities that are sold without commissions by investment advisers who charge asset-based fees and even by some fee-only financial planners. My response is that changing the sales structure does not make the product design chassis any less abstruse.
Overly Optimistic Projected Return Assumptions – Over the years I have had a number of fee-only financial planning clients ask me to review index annuity contracts they purchased several years earlier. In nearly every case, the investors were disappointed in the returns since they were far lower than the illustrations they were provided and because they were aware of the stock market’s relatively strong performance over the time they had invested. Most did not understand that they were not investing in index funds. In a number of instances, the return was in the 3-4% annualized range, which was actually reasonable if the annuity had been pitched as an alternative to low-yielding bonds at the time of sale…but the illustrations they were given at the point of sale suggested they would earn equity-like returns. Often these illustrations were used with a “stock market returns without downside risk” pitch to lure the consumers to transfer long-term IRA and rollover money out of stock mutual funds and into the annuity contracts.
The Bait and Switch Dog & Pony Show
For as much disdain as I have toward insurance companies that sell IAs, their marketing prowess and promotional expertise are undeniably elite. As Exhibit A, over the past few decades, I have noticed that academic researchers who write papers supporting the theoretical underpinnings of annuity and insurance product design concepts have a funny way of turning up as speakers at insurance and brokerage sales conferences. In some instances, they even end up on insurance company/industry payrolls. What better way to boost IA sales than by giving them academic credibility/legitimacy? It’s genius, really and it has been enormously successful.
Two examples of prolific, outspoken academic researchers who have, in my opinion, gone over to the Darkside are David Blanchett, PhD and Michael Finke, PhD, both of whom, in addition to their “day jobs” serve as adjunct professors at the American College of Financial Services (formerly known as the American College of Life Underwriters), a private, insurance industry-backed “university” that confers no accredited undergraduate degrees, but has long served as the preferred preparatory program for insurance agents seeking to earn the Certified Financial Planner (CFP) designation. The college’s board and trustees are comprised primarily of insurance industry executives. As such, the College serves a valuable public relations role in the proselytization of insurance products and gives its faculty a loud megaphone for reaching the financial planning community. Professors Finke and Blanchett have both published numerous papers on the merits of insurance and annuity products including indexed products. Both also promote their insurance-friendly views in commentaries and interviews and have achieved near-rock-star status in the financial planning community. Examples of their research and commentaries include the following:
Professor Blanchett recently left his position as Director of Retirement Research with Morningstar to become Director of product development at Prudential Global Investment Management (PGIM), a division of Prudential Financial. Prudential is a leading seller of annuity products including IAs. Michael Finke is a tenured professor in the Personal Financial Planning Department at Texas Tech. Although he is not employed directly by an insurance company per se, aside from his position with the American College, Finke discloses on his LinkedIn profile that his academic research sponsors include Northwestern Mutual, TIAA, New York Life, AIG, Pacific Life, Prudential, and MetLife. He is also a founding Fellow of the Washington D.C.-based lobbying and PR organization, the Alliance for Lifetime Income. The stated purpose of this insurance-industry-backed non-profit is “educating and empowering consumers with simple, transparent and easy-to-understand information they need to make good financial decisions when purchasing an annuity.” More visibly, a Google search of his name on YouTube finds scores of videos of Professor Finke preaching the gospel of annuity products for insurance companies such as Northwestern Mutal Life and bloggers/salesmen such as “Stan the Annuity Man.” . As an unabashed annuity zealot, in a February 2021 interview, Finke went so far as to chide financial advisors like me who eschew annuity products. In his own words, “There is a tremendous disconnect between academics and practitioners and when it comes to annuities. We [academics] all know that annuities are the best tool to safely fund a retirement. Advisers must consider this tool if they are to do their job properly.”
Of course, the question readers may justifiably ask is, “If the academic research supports Finke and Blanchett’s enthusiastic endorsement, who is a lowly financial planner in Hawaii to challenge such esteemed authority?” First, while it is true that academic researchers have long suggested that consumers would do well to have a greater portion of their retirement income coming from guaranteed sources (e.g., social security and pensions) to hedge against longevity risk, Finke’s assertion that all academics “know that annuities are the best tool to safely fund a retirement” is pure hyperbole. A review of the academic literature beyond what is produced for the consumption of the financial planning community finds that consumers are not necessarily underestimating longevity risk nor are they irrational in their reticence to embrace to embrace annuities. A reluctance to make an irrevocable decision to transfer wealth from heirs to an insurance company and the existence of financial safety nets such as home equity and social welfare programs (e.g., Medicaid) are two commonly cited rationales for consumers to reject Finke’s universal proclamation of the superiority of annuities. Other research has shown that consumers value the earlier years of retirement more than the years at the end of life. There is also a growing body of published research suggesting that there may be other effective strategies to manage longevity risk that do not involve transferring wealth to insurance companies.
At the same time, what is entirely lacking from Finke’s eminently conflicted position as a paid researcher for the insurance industry is any acknowledgment that the insurance companies sponsoring his research have a profit motive that may move product design away from the theoretical fair pricing discussed in his research papers. In plain English, an annuity purchased from a private insurance company is not the same as a pension annuity or social security.
Hyperbolic rhetoric aside, my greater gripe with Blanchett’s and Finke’s research is that it serves as the empirical sleight of hand that enables insurance companies to dupe consumers into buying their products. While Blanchett, Finke, and other academic researchers make a compelling mathematical case for risk-pooling as a tool to hedge longevity risk, what is lost on the public is that the products they are buying often bear scant resemblance to the theoretical models described in the research papers.
Simply put, in my opinion, academic research credibility is at the heart of the insurance industry’s clever, sophisticated, and decidedly deceptive bait-and-switch scheme to sell annuity products…and it has been incredibly successful. I believe it is the primary reason why index annuity and insurance sales have exploded over the past decade. One of the highest honors for insurance agents is the so-called “Million Dollar Round Table” which recognizes agents who sell a million dollars per year in insurance premiums. If there was ever a “Billion Dollar Round Table,” Professors Blanchett and Finke would be the inaugural recipients.
WHY I WOULD RATHER BE A CURMUDGEON THAN A LEMMING
Perhaps my jaded view of the insurance industry - shaped by 30+ years of financial planning for individual consumers – has made me blind to the financial magic of indexed annuities. On the other hand, Blanchett, to his credit, frequently acknowledges the individual complexity of the products and suggests that financial advisors should take the time to understand the mathematical intricacies of each contract/policy before selling them to clients.
For my part, I confess that I do not have the mathematical muscle to separate the IA wheat from the chaff. From my grassroots planner-client perspective, if I have to be an actuary and a contract law attorney to discern whether these products are appropriate for my clients, they will not be on the Financial Planning Hawaii menu. Just because other advisors may place their faith (and their clients’ money) in the academic credibility argument doesn’t mean I have to. As I hope I have also articulated in this missive, I am decidedly not okay with the misleading manner in which many these products are marketed and sold to consumers. I am a financial planner, not a salesman. To me, indexed insurance products are dirty business and I want no part of it.
What to Know About Indexed Annuities – Lower Risk has a High Price (Morningstar, 2/17/2021)
Don’t Buy an Indexed-Universal Life Policy Until You Read This (Advisor Perspectives, 8/23/2023)
What Insurance Agents Don’t Tell You About Indexed Universal Life (IUL) (Advisor Perspectives, 8/14/23)