Today’s post is from an article I wrote for ThinkAdvisor and is part of the posts we have offered about annuity products. The ThinkAdvisor platform is one of the largest financial media outlets serving the professional financial advisor community. I also think the content will help you if you are considering purchasing an annuity.
Annuity critics frequently state that annuity products are just not worth it. They say that the only ones making money from annuities are the salesperson and the issuing life insurance company. Certain critics further state that annuity buyers are the last ones to obtain value from the product they purchase. The critics go on to present the argument that creative individual financial advisors and money managers can develop better, more cost-effective solutions using available financial products to address consumer needs. I believe these critics miss the mark by a wide margin. They usually ignore the fact that annuities are an insurance product.
I don’t believe these critics fully comprehend what it takes to bring an annuity insurance product to market, attract buyers and support the selling and administrative process while at the same time complying with mandated reserving and solvency regulations. The critics offer financial product solutions created without the comprehensive operational, actuarial, investment, marketing and solvency regulation governing and supporting annuities. In this article, I hope to shed better light on how the value generated by annuity products is shared.
The Parties to the Annuity Contract
There are normally three parties to the individual annuity contract: (1) the annuity buyer, (2) the issuing life insurance company and (3) the selling agent or entity. Here is what each party seeks to obtain from the annuity policy:
The Consumer/Buyer
The buyer is purchasing the annuity contract to address financial needs such as accumulating assets on a tax-advantaged basis for the time when full-time work ceases, securing income options including guaranteed lifetime income or income for certain periods of time or obtaining protections offered by the annuity contract such as payment of long-term care expenses or ease of transfer to beneficiaries at their death.
Naturally, as part of the buying process, the annuity consumer seeks the highest amount of accumulation, policy liquidity and guaranteed income payments consistent with their risk profile and time horizons.
The Issuing Life Insurance Company
The issuing life insurance company needs to make a profit for issuing the annuity product to maintain its regulatory capital, meet shareholder or member return needs and to generate financial results needed to maintain its financial strength ratings. The profit needed takes into consideration the costs necessary to develop the product, financially support annuity guarantees, fund regulatory reserves and to cover all administrative and selling costs. It is incumbent on the life insurance company to become as efficient as possible in how it manufactures annuity products in order to be as competitive in the market to attract buyers for its products.
The Agent/Selling Entity
All annuity sales must be made by an appropriately licensed and compliant life insurance entity. Regardless of how the product is purchased (from a licensed individual insurance agent, an investment professional or direct from a website) these entities need revenue to cover their costs of operations, technology, marketing, advertising, selling and customer support for the annuity products they offer and to make a profit for their efforts. These costs include the significant expenditures to comply with regulations governing the solicitation, presentation and sale of annuity products.
Annuity Realities
Overall, the annuity contract has to absorb the cost of the needs and share the value created split between the issuing life insurance company, the selling entity and the consumer. Ultimately, the price offered to the consumer is a balance or sharing of value among the three parties.
In comparison to pure investment offerings without insurance guarantees, annuity products are heavily regulated by state and for certain products, federal regulators. Complying with these regulations, which cover product approval and development, pricing, reserving for guarantees, issuer solvency and sales practices, must be properly considered and funded by all the parties.
The key differentiator from investment products is that annuity products provide insurance guarantees versus the simple purchase of investments to create income. As a result, all parties to the annuity sales must pay for and consider the cost of insurance regulation in product pricing and sale. For example, if a life insurer offers income guarantees, they must back up them with regulatory mandated capital and reserves using only investments approved by regulators.
100 Cents in a Dollar
As you look at the value that annuity products generate, there is a limit to how much is available to meet the needs of each party. I call this the 100 Cents Paradigm. What this means is that behind every annuity product sold there is only so much value generated to cover the costs of manufacture, supporting regulatory capital and reserves, marketing and selling costs while at the same time providing competitive benefits to the consumer. Product pricing and competitiveness is a balancing act taking into consideration the needs of each party.
Summary
The annuity value pie needs to be shared among the three parties to the annuity contract on a fair and reasonable basis. Consumers want the guaranteed accumulation, protection benefits or lifetime income; selling or advice entities must have the commission or fee revenue they need to provide their services and address regulations; and, lastly, the issuing insurance company needs its share to be able to meet solvency, reserving and to support guarantees offered. What this means is that all parties are essential to the contract and have needs that must be met. Given the highly regulated nature of annuity products, there are only 100 cents in the annuity dollar to be shared by the parties.
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