AARP and AnnuitiesPosted by Badger Coach on May 28th, 2014
In a May 2014 AARP blog article entitled “Why Insurance and Investing Often Don’t Mix,” blogger Allan Roth explains that “the insurance industry makes additional money by combining investing and insurance.” He also states, “This insurance/investment combination sold to consumers is generally found in so-called permanent insurance offerings, which provide both insurance protection and cash value. These include policies known as whole life, universal life, variable annuities, and equity index annuities, now rebranded as fixed index annuities.”
There are several glaring inaccuracies in this article. They are as follows;
A) Traditional whole life insurance does not have an investment component. It has a savings component that earns interest at a rate set by the insurance company. It also pays dividends. These dividends are not guaranteed, and they are a return of the excess premium you paid plus profits, if any, you receive from the company. All cash value in this account is guaranteed to never lose value.
B) Universal life insurance does not have an investment component. It too has a savings component that earns interest at a rate set by the insurance company, which will fluctuate but never fall below a set rate. However, cash values in this account may lose value.
C) Fixed index annuities are not investment accounts. They are saving accounts that track a particular stock market index. A portion of the stock market gains are credited to the savings account. The interest earned is guaranteed to never be less than zero, even when the stock market declines in value. And, any interest earned can never be lost due to the stock market fluctuations. Cash values in this account can lose value if fees exceed credited earnings over a prolonged period of time, or if the annuity owner liquidates the entire account before the end of the surrender period.
The variable annuity that Roth mentions is the only product that combines insurance and investments. The others listed do not. And, of all the products listed, the variable annuity is the only product that places an investor’s money directly into the stock market. This means that variable annuities provide no guarantees on your investment.
In 2010, The District of Columbia U.S. Court of Appeals declared that fixed index annuities were not an investment product when they vacated a previous ruling by the Securities Exchange Commission (SEC Rule 151A) to regulate and declare them as an investment product. This rule was proposed by the investment industry in an attempt to direct potential investor funds away from insurance companies marketing fixed index annuities and towards themselves.
According to the Securities Exchange Commission Section 3(a)(8) of the SEC Act of 1933, in order for an annuity to be exempt from registering as a securities product, or for them regulate this product, it has to meet all three components of the following test;
- The State has primary supervision over the annuity;
- The annuity owner assumes no investment risk, as this risk is to be borne by the insurance company; and
- The annuity must be marketed as a savings vehicle and not an investment vehicle.
The court found that the design and marketing of the fixed index annuity meets these criteria and, therefore, is exempt from needing to be registered with the SEC.
Cost Benefit Analysis
I do agree with the AARP blogger when he says, “The role of investing is to grow wealth, while the role of insurance is to protect it. Mixing the two may lead to disappointment.” Unfortunately, this is especially true when it comes to variable annuities. This product is the poster child for combining investments and insurance. And when compared to fixed index annuities, the all-in expense can cost up to five times or more money to provide you with a guaranteed income stream throughout your retirement.
When contributing funds to a retirement account, insurance policy, annuity, or a bank CD, the words “savings” and “investing” are often used interchangeably by financial professionals and the general public. To help reduce the confusion between these two words, I define them as follows:
Investment: An offering that is accompanied by a prospectus, does not provide principal protection, and is regulated by the Securities Exchange Commission.
Savings: An offering that is not accompanied with a prospectus, and provides principal protection that is backed by the Federal Deposit Insurance Corporation or the claims-paying ability of an insurance company.
Conflict of Interest
AARP blogger Roth also takes issue with the compensation structure between the insurance company and the insurance agent, stating, “You also pay more fees than if you invested directly…If you use an insurance company, you pick-up two intermediaries—the insurance company and the agent.” He further says, “each of the two intermediaries profits from your money.” And yet, an AARP disclaimer located on the AARP Financial website reads that, “AARP Financial is a collection of financial related products, services and insurance programs available to AARP members. Neither AARP nor its affiliates is the insurer. AARP contracts with insurers to make coverage available to AARP members. Insurers and providers pay a royalty fee to AARP for use of AARP intellectual property. Amounts paid are used for the general purpose of AARP and its members.”
Additionally, AARP members need to know that some of these insurance companies are controlled by an internal broker-dealer. This means that the broker-dealer decides which types of insurance and investment products its representatives may sell. Broker/Dealers are registered with the Securities Exchange Commission. Financial salespeople of a broker-dealer sell investment-related products such as variable annuities, primarily on a commission basis. The total compensation received by the broker-dealer is far greater for selling variable annuities than the compensation received for selling fixed index annuities. For instance, in 2013, the total sales for fixed index annuities was $39.3 billion, according to LIMRA LOMA Secure Retirement Institute. If the average fee on this product is 0.95%, first-year fees on new deposits collected by the insurance company totaled approximately $373,350,000. On the other hand, according to LIMRA LOMA Secure Retirement Institute, total sales for variable annuities during the same year was $145.3 billion. If the average all-in expense on this product is 3.75%, first-year fees on new deposits collected by the investment company totaled approximately $5.4 billion. Therefore, it should come as no surprise that some of these broker-dealers forbid their financial salespeople from selling fixed index annuities. The fixed index annuity is “too complex” argument that Roth refers to, fails to pass the sniff test. The next time someone says fixed index annuities are too complex when compared to variable annuity, just ask them which product will protect your money. There is only one answer to that question, and its not the variable annuity.
AARP provides much needed financial information to its members. However, the information is only valuable when it is not misleading, slanted or inaccurate, which may cause many of its members to pay considerably more for financial products than is necessary. Additionally, before deciding on whether a fixed, fixed index annuity or variable annuity is right for you, remember that only the first two provide principal protection.
The opinions expressed are those of the author and is for educational purposes only, and not an offer to buy or sell securities. As always, please consult with a qualified legal, tax, investment or insurance professional before making any financial decision. Investing involves significant risk, even the loss of capital. Invest only what you can afford to lose. Guarantees provided by an insurance company are based on its claims paying ability.