Steve Savant puts his industry advocate hat on and vents his displeasure at what he views as the unfair propaganda of the securities industry against annuities in the public domain.
Editor’s Note: The opinions expressed here are those of the author, Steve Savant, and not necessarily those of Insurance Selling magazine.
I’ve been waiting in the wings for years for some carrier, any carrier to stand up to the mutual fund and ETF industry to set the record straight on annuities in the public domain, but to no avail.
Their silence isn’t golden; it’s just plain yellow. It’s the neutral zone of cowardice and by default collaboration. I can’t understand for the life of me why annuity manufacturers have capitulated to Wall Street. It amounts to surrendering your faculties to the street tactics of a billion-dollar bully bent on the destruction of the annuity industry.
Their articles, blogs and press releases spew such misinformation, omissions of material fact and outright lies about annuities that the consumer constantly recoils at the very mention of the word. They bludgeon annuity manufacturers and their purveyors with the sledgehammer of the financial press and mainstream media who redistributes their fake news like holy writ. They characterize the insurance industry as the red-light district of the financial community, whoring our wares with our so-called extraordinary compensation for our services. It’s nothing more than a shaming technique. I’m tired of it. And I’m mad as hell and I’m not going to take any more!
Just a quick note: This is certainly not a treatise on annuities vs. mutual funds and ETFs. There are many Rhodes Scholars in our industry, more academic than I; as there are also nationally recognized product experts with greater understanding than I. But even as David felt compelled to face down Goliath with a great degree of trepidation, I come into the marketplace with a bit of apprehension and my humble slingshot.
Annuity commissions vs. fund fees
The security industry lets loose their attack dogs to howl in self-righteous disgust over the exorbitant compensation paid up and down the food chain of annuity sales distribution. It doesn’t matter whether the distribution channel is direct or through intermediaries, it’s too rich. They say annuity sales are driven by the avarice of insurance agents, as if insurance agents are the lowest form of vermicular life and need to be cut out of the apple before getting their piece of the pie.
Characterization like that can be for anyone in any industry. There have always been bad apples in every business. There are product lines out on the street that appear to benefit the manufacturer and not the consumer. I hate those annuities and in general terms you can eighty-six the vast majority of annuities, mutual funds and EFTs on the lack of real benefits alone. They’re a waste of shelf space. They should just succumb to a Darwinist end based on the survival of the fittest and reduce the annuity industry’s huge product inventory down to a remnant.
But is the performance of those annuity contracts that would be left standing really affected by commissions? With the exception of variable annuities, the compensation model for fixed rate annuities, lifetime SPIAs, DIA and most indexed annuities are less costly to the consumer than most mutual funds and ETFs over the same holding periods. And if you add an annual RIA fee, you only exacerbate my point.
Fixed interest rate annuities and lifetime SPIAs and DIAs are spread products. The cost of distribution – i.e. commissions – have already been priced into the final guaranteed interest rate or income payout rate. But to hear annuity detractors in the press tell it, annuity compensation is a big-ticket item, way too lavish to be part of a good, consumer-centric product.
But when an advisor is involved the compensation of mutual funds, ongoing trailer fees can be 50 to 100 basis points a year. Most RIAs charge an additional 100 basis points to that for portfolio management, resulting in compensation charges between 150 to 200 basis points. This is far more lucrative for the advisor than for an insurance agent selling lifetime annuities like SPIAs and DIAs. Far more rewarding than commissions paid for fixed interest rate annuities. Pricier than most indexed annuities.
Even RIAs who use no-load funds are still charging their annual fee over the lifetime of the consumer in retirement. But even 1% in fees per year, every year can accumulate to some big money over 30 years of retirement and erode real rates of return.
While in contrast, lifetime annuity payouts don’t debit the retiree’s income one damn penny. Again, and that makes sense because guaranteed fixed interest rate annuities are a spread product, so it doesn’t contain a compensation charge or some servicing fee. The compensation complaint against annuities by the securities industry and fund manufacturers is, for the most part, a red herring. But what is a legitimate complaint? All the expense loads in financial products. Amazing, some of these fees, charges and other debit classifications directly paid by the consumer are not disclosed in mutual fund and ETFs.
Another quick note: In my retail practice I sold mutual funds. In my 401(k) I purchased mutual funds. I still maintain mutual funds in my portfolio to offset inflation and to capture a little growth along the way. But I also bought guaranteed lifetime annuities to supplement my Social Security benefits to cover my guaranteed essential budget items and discretionary spending in retirement. So, I use mutual funds as well as annuities in my retirement plan.
The compensation complaint against annuities by the securities industry and fund manufacturers is, for the most part, a red herring
All those points add up
In February 2012, the U.S. Department of Labor published guidelines for ERISA retirement plans to disclose expenses and fees under 408(b)(2). This was an eye-opener for everyone involved in the sale of mutual funds and ETFs in qualified plans. But most advisors were asleep at the wheel when the regulation went operational.
It was curious to me to discover qualified plan administration and custodial care charging on average around 25 to 29 basis points depending upon the assets under management. That seemed reasonable to me. But the biggest revelation came from the disclosures of the cost of funds themselves. For most security licensed representatives and RIAs, the fund’s prospectus was the only discussion point for internal expense loads addressed with a potential buyer. The average fund expense load cited in the prospectus is generally around 90 basis points and most RIAs were charging an additional 100 basis points. Resulting in a traditional talking point that funds and management cost to consumer are little less than 2%.
But then an economic epiphany occurred when some (not all) qualified plan administrators included the transaction costs listed in the fund’s statement of additional information. For whatever reason the document is not required as a delivery item to the fund owner by the advisor. In fact, most advisors are unaware of these extra charges.
The average cost cited in the statement of additional information (SAI) is around 144 basis points. The SAI costs are comprised of brokerage commissions, market impact costs and the transaction spread cost. I was floored! But the bloodletting didn’t stop there. An additional expense called cash drag – money held in cash equivalents for liquidity – costs around 83 basis points. So, on qualified fund costs with the advisor fee could be around 4.46% annually. Non-qualified funds around 4.17%. Don’t believe me? Read senior wealth manager Ty A. Bernicke, CFP’s article in Forbes.[i]
This doesn’t include non-qualified funds subject to taxation on gains, which averages around 100 basis points, increasing the non-qualified costs to 5.17%. I only mention this because of the tax deferral and the exclusions ratio of deferred and lifetime annuities.
A final quick reminder: This article isn’t a white paper. It’s just me venting my displeasure at the unfair propaganda of the securities industry against annuities in the public domain.
Uncertain rate of return
Consider the internal rate of return (IRR) of 3% for a lifetime income SPIA based on the contract owner’s life expectancy. The beta risk is zero. The only risk to the annuity contract owner is the insurance company itself. But that can be said of all financial product manufacturers. Could a mutual fund or ETF manufacturer go belly up? Yes.
If I apply the average cost of a mutual fund to the 3% IRR in a qualified plan the nominal rate needs to be 7.46% return. As the rate of return increases, there usually is a corresponding increase in the beta risk. And 7.46% is not a slam-dunk return year in and year out for even the best portfolio manager. You’d need a portfolio prodigy or some anal-retentive analytic living in Nerdvana for such an achievement. That person doesn’t exist. And of course, the punctuation that mutual funds and ETFs don’t guarantee returns.
In the lost decade (2001-2010), the S&P 500 Index experienced 4 years of double-digit losses. Seniors who began taking their retirement distributions in 2001 had three straight years of double-digit compounded losses in a row. The losses experienced by retirees during the 2008 market meltdown were so severe that some retirees never recovered back to par on their portfolios until 2015. Indeed, the S&P 500 Index wasn’t profitable in that 10-year period. And to think that this period in time couldn’t happen again is delusional. This is just another example of the sequence of returns risk, i.e. it’s not just the years of loss, it’s the years of recovery. How can seniors plan their budgets for essential spending when their income isn’t guaranteed?
Looking for a fair shake
Annuities are not the end all for all financial scenarios. But in retirement planning I just can’t see how you can omit them, just on the basis of better interest rates than banks and the guaranteed lifetime income.
The financial press and their mainstream media co-conspirators use annuities as a pejorative to incite consumer fear against insurance companies. When I bring up the lost decade, I’m accused of fear mongering. Who’s really the bogeyman here? But it’s not just the security and fund industries that use negative ad campaigns against annuities; it’s the axis of evil comprised of a debt guru, a FICO psycho and a portfolio manager fishing for assets by denigrating annuities. It’s truly amazing that any annuities are sold at all under these circumstances and in this environment of misinformation.
One last observation: It often appears that the authors of these articles are journalistic rookies who have had to do research on the subject or have interviewed an anti-annuity source. Years ago, one such author was so incompetent that I contacted her to set the record straight. I was a gentleman. I used diplomacy. I was thoroughly “P.C.” She emphasized several times that she graduated from the Walter Cronkite School of Journalism. I told her I didn’t care if she was Walter Cronkite’s daughter, the information she laid out was chock full of errors, severe bias and lacked any kind of financial underpinning to her piece.
All I want is a fair hearing with math and science underscoring the foundation of economic discussion; to be a fair arbiter, laying out both the compensations, expense loads and historical IRR. The scales of truth that weigh public opinion always have someone’s thumb on it. I’m not looking for a columnist to frame the argument. I’m simply seeking adequate light to review the facts for myself – or in this case for the consumer – so they can make an educated call.
[i] “The Real Cost of Owning A Mutual Fund” by Ty A. Bernicke, https://www.forbes.com/2011/04/04/real-cost-mutual-fund-taxes-fees-retirement-bernicke.html#5d306cfd3244
Steve Savant is a syndicated financial columnist, talk show host and popular platform speaker. Steve is a nationally recognized videographer, content creator and co-contributor to Advisys, Insmark and LifeSpecs. Steve’s videos and content are distributed to over 280 media outlets and 200,000 Twitter users. To contact him visit www.lifesizesolutions.com, email email@example.com or call (520) 261-4599.