Bank Investment Consultant
Equity-indexed annuities would seem a natural for the wave of retirees starting to enter the market.
The products let their owners capture some of the gains from a rising stock market without risking the invested capital, and while being guaranteed a minimum rate of return. But high fees and regulatory scrutiny have largely kept bank representatives away. Still, it is possible that an improved version of the equity-indexed annuity will bring banks into the business.
Typically the product accounts for only 4% to 6% of all indexed annuity sales in the United States. Almost all indexed annuities are sold by independent insurance agents. In a study by the recruiter Human Capital Resources Inc. in St. Petersburg, Fla., bank advisers reported that indexed annuities made up just 1.2% of their sales volume, on average, whereas variable annuities contributed 35.3% and fixed annuities 19%. About 45.5% of bank advisers said they sell no indexed annuities.
This shyness on banks' part is not surprising. "Banks shouldn't be selling indexed annuities," said Dave Cervone, an independent bank consultant in Boardman, Ohio. "It's a product with complex rules and high commissions that is really designed for a different distribution channel - independent agents."
Equity-indexed annuities have more moving parts than most variable annuities, with higher average commissions, 8% to 9% (sometimes more than 10%), compared with 2% to 3% for mutual funds and 5% to 10% for most variable contracts. They also include surrender periods as long as 15 years during which investors who want to withdraw funds risk paying penalties as high as 22%.
Moreover, indexed annuities have taken a lot of regulatory fire plus a fair amount of bad press from major consumer publications.
The National Association of Securities Dealers Inc. cracked down, issuing an investor alert in mid-2005 warning of the complex rules and potential pitfalls that could harm investors. The industry self-regulating body also advised broker-dealers that - despite the fact that indexed annuities are technically not securities - their sales should be treated as "private securities transactions" rather than as "outside business activities." This would hold them to NASD's stricter standards of suitability and disclosure.
And state insurance commissions, which regulate the bulk of annuities, are also on the case. For example, in July 2005 Massachusetts regulators forced Bank of America Corp. to let more than 800 people older than 78 who had complained about "high-pressure sales tactics" escape the penalty for early redemption of indexed annuities bought through the bank.
It is little wonder that "indexed annuities have gotten a bad rap at banks," said Kenneth Kehrer, a director of Limra International Inc.'s Kehrer-Limra, a Princeton, N.J., consultancy. "Even if bank reps wanted to offer a client an indexed annuity, many bank managers wouldn't allow it."
Fred Henry, the president and chief executive officer of Fimco Inc., a 25-year-old third-party marketer and distributor of annuity products in Mequon, Wis., agreed. "Banks tend to view their bank rep operations more as a client service than as an income generator," he said. "What they're really concerned with is building lifetime relationships with their clients." The last thing they want, he suggested, is to make customers feel they have been "ripped off" for an excessive commission.
Basically, equity-indexed annuities try to capture the market growth in indexes such as those of Standard & Poor's Corp., while guaranteeing a regular return. Most such annuities "reset" each year, in response to the options market, and they include a "cap" - which determines the percentage of any market gain the client can capture - a figure the issuer can change annually. Typically, the cap is raised in a bull market and lowered in a bear market.
Despite indexed products' drawbacks, some banks lured by the promise of higher returns in this rising market are showing interest.
Moreover, some insurers are offering improvements that make indexed annuities less complex, risky, and costly. Carriers offering the new products include Jackson National Life Insurance Co., a Lansing, Mich., subsidiary of Prudential PLC in London; Lincoln National Corp., ING Group NV, and Allstate Insurance Co.
"Bank reps are being educated about this product," Mr. Henry said. "What they're learning - and what they're explaining to clients - is that the annual reset, while it can change how much of a return the client gets in the next year, also locks in the gains of the prior year, so that the client doesn't have to worry about losing his principal - or the prior year's gains."
This is a big improvement on mutual funds, but it is unclear that it is better than variable annuities with minimum-return riders. Clearly, in a down market, mutual funds can leave an investor with a gaping hole in his or her retirement fund.
"Over the last several years, there has been a growth in new indexed annuity products that are more consumer-friendly," Mr. Kehrer said. "They don't have the high commissions of most indexed annuities, and they don't have the high surrender penalties." They also offer guarantees - for example 3% minimum returns during the surrender period, which is typically not more than five to seven years.
The secret to offering indexed annuities successfully through banks, Mr. Henry said, is making them simple enough for clients to understand.
"It should be a simple product," he said, "but as it is, there aren't many people focused on the need to make indexed annuities simpler and easier to understand." Insurance carriers would need an incentive to do the research and development needed to create such products, he said, because the actuarial work can be costly.
Mr. Cervone, the Ohio bank consultant, recognizing this "chicken and egg" dilemma, said his organization is devising a model for indexed annuities that is to be introduced late this year.
"Insurance companies, if left to their own devices, are masters of deception," he said, "because … [the equity-indexed annuity] gives the people who traditionally sell their products - the independent agents - a lot of flexibility."
The idea, then, "is to take a reasonable number of smaller carriers and relieve them of some of the up-front development costs by developing … [annuities] ourselves," he said. The new products would drop the bells and whistles common in indexed annuities so that investors can get a better idea of what they are buying. Commissions would be lower, 5% or 6%, and the surrender period would not exceed seven years.
Another feature of the new products, Mr. Cervone said, will be the ability to back-test them. "With standard indexed annuities, it has not been possible to tell a potential client what the performance would have been over prior years," he said. "With all the moving parts, you couldn't do an honest job of it, and that is a huge liability for a bank."
The simplified products, by contrast, would let a potential customer compare how an indexed annuity would have stacked up against a certificate of deposit or a mutual fund over time. This ability could give equity-indexed annuities an advantage of transparency over variable annuities.
"If you can show that the client would not have lost money in years that the stock index went down and that over time …[the annuity] would have outperformed a CD," Mr. Cervone said, "that's a product that is appropriate for a bank broker to be selling." Five to 15 midsize to large banks are planning to offer the product when it becomes available, he said.
The key to bringing indexed annuities into the bank rep's product portfolio seems to be simplicity. "The issuer may think it looks simple, and the bank rep may think it makes sense," Mr. Kehrer said, "but if the customers, who are generally not the most sophisticated of investors, don't think it's simple, it's not going to work."
