Zeke Faux’s Bloomberg article, “Indexed Annuities Obscure Fees as Sellers Earn Trip to Disney,” focuses on the undisclosed fees and perks that incentivize agents to gloss over negatives like substantial surrender charges that penalize purchasers who might need to sell the product to meet an unexpected expense.
Indexed annuity contracts provide for surrender charges if a policy is canceled or money in excess of 10% is withdrawn during a set period that ranges from 3 years to 16 years. While insurers counter that most contracts do permit 10 percent penalty-free withdrawals annually, owners may incur a 10 percent charge from the Internal Revenue Service if distributions are made before age 59 1/2 because the earnings are tax-deferred.
In addition to the potential surrender charge, indexed annuities come with fees and expenses that are generally much higher than mutual funds. The article provides a damning quote from Kent Smetters, a professor of insurance at the University of Pennsylvania’s prestigious Wharton School and former U.S. Treasury Department economic policy official: “These contracts have really high hidden fees,” “That’s why they’re terrible ideas for older people even though they’re peddled to them.”
While indexed annuities are pitched as providing downside protection with upside potential, experts say that, even at low current rates, CDs generally provides better returns and better safety. The reason for that is the series of “haircuts” indexed annuity investors receive. In an index annuity, the upside is typically limited by “performance caps” and is often further reduced by a “participation rate.” On top of those, the issuer makes a “market value adjustment,” a complex calculation that usually reduces the cash value of the account. If those do not sufficiently protect the insurance company, it can adjust these haircuts to more of a buzz cut annually.
Despite all of this, record sales abound, up 16 percent from a year earlier, according to the article. So why do people buy them? The answer is: the products are not so much bought as they are sold by a highly-motivated sales force.
The rewards of indexed annuities are substantial ? for the selling agents, that is. Insurance companies pay sales commissions as high as 12 percent. Firms have also been known to have sales contests with winners receiving valuable prizes and benefits, such as free trips to Disney World. And “unlike the fees on mutual funds, those costs aren’t disclosed.” The obvious reason why they are not disclosed is that potential investors might question whether the sales person really has their best interests at heart in recommending the product, and that would be bad for sales.
So, salespeople typically downplay the complexity of indexed annuities and their long lock-up periods, according to Barbara Roper, director of investor protection for the Consumer Federation of America. The contracts are “one of the most abusively sold products on the market today,” Roper was quoted as saying.
State regulators have sued or issued warnings about deceptive sales of indexed annuities. Last year, a federal jury found that Allianz Life Insurance Co. of North America, the nation’s top indexed annuity seller and a unit of Allianz Se, misrepresented one product by promising a 10% “bonus” to hundreds of thousands of buyers. The bonus was illusory and could not be cashed.
Some insurance companies have made a decision not to offer index annuities. Those companies include Met Life, Prudential, New York Life, and TIAA-CREF.
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