The Practice Doctor is IN

Al Depman, CLU, ChFC, CMFC, BH

Adventures in Annuity Settlements

Over the past few months I have been interviewing plaintiffs who are part of a large class-action lawsuit. The company and the states involved, while recognizable, aren’t important. I’m part of a team of independent financial services consultants who were brought on to help these plaintiffs understand their options as part of the settlement. Each one, whose average age is 70, had purchased an annuity product. The crux of the lawsuit involves the improper sale of these annuities, particularly in how bonuses were offered to plaintiffs as a purchase incentive.

The sad fact is that there have been far too many of these lawsuits over the past 20 years. That’s why the names don’t really matter. The underlying issue remains that product pushers and their boiler room tactics represent the past while today’s clients want a relationship-based sale. Companies who continue to set commission and bonus structures favoring the product-pusher will be caught in regulatory crosshairs and become more vulnerable to individual and class-action lawsuits.

In all my interviews thus far, the plaintiffs signed all the compliance paperwork necessary but didn’t really understand what they had purchased. The commissions generated on the products in question were typically front-loaded with minimal trails, providing an incentive to “sell it now” and less incentive to keep it on the books over the long haul.

 Rose’s story is typical:

“The guy that sold me that annuity was nice enough,” she explains. “He came out to the house and told me he was working with people retired from the electric co-op.  My husband worked for them for many years and passed away two years ago. So I have his pension and Social Security for income, plus a little bit set aside for emergencies.”

This “little bit” was $76,000, non-qualified, in a large-cap mutual fund. Rose, who is 75, took the money out of the mutual fund and rolled it into the indexed annuity in 2004.

“The agent showed me that my mutual fund was not doing so well. Then he showed me his annuity that paid a 10% bonus and would never lose money no matter what the markets do. That sounded like a really good deal, so I signed up.”

It was a one-interview sale and took all of 90 minutes.

“I got the annuity in the mail and never heard from him again.  When this settlement letter showed up, I tried calling him but never got a response. I feel kind of foolish. But he seemed like a nice young man.”

The most frequently misunderstood elements of the annuity that got the State Attorney General’s attention were: engendering new backend sales charges, not disclosing where the bonus money actually went, the tax status of the funds, and how the whole indexing process worked.

When I questioned Rose on these four items, she recalled talking about them and “sort of understanding them at the time. But I couldn’t tell you about them now.” 

Nearly every plaintiff I’ve interviewed echoed Rose’s post-sale confusion. 

But each case has its unique elements. Rose’s son, Jim, who lives in Texas, eventually joined us on one of our conference calls to “make sure mom’s making the right decision.” He was the beneficiary and the three of us spent a good deal of time discussing her current situation. 

She was still living in the family home in a small town, where the neighbors looked out for each other. If she were to need ongoing care, the $76,000 was earmarked for the costs associated with nursing homes or in-home assistance.  Her income was fixed and didn’t allow for much self-funded traveling or entertainment. She still drove but tried to keep it to a minimum and only during daylight. She played bridge, was involved in community and church activities, and had a network of friends and relatives.

Was the indexed annuity the right product for all of her remaining nest egg? I would certainly question the appropriateness in Rose’s case. The pros and cons:

Pros:

• It could be tapped for some cash annually (up to half the premium paid);
• It could be converted to a steady income stream for life;
• It could be annuitized and paid to a nursing home for the rest of her life;
• There is a death benefit feature for Jim to use to pay final expenses (but in this particular policy, he must take it over 5 years to maximize the payout and would have to take a lesser amount as a lump sum);
• There is a minimum guaranteed return on most of the money at 2.5%.

Cons:

• There are still two years on the surrender charges if a larger amount is needed to be withdrawn (over the allowed free annual withdrawal);
• To take advantage of the bonus, Rose would need to annuitize the contract or die;
• The inner workings of how the indexing actually worked is quite complicated for the financially-unsophisticated Rose to understand.

Since I was acting as a one-time, impartial consultant to Rose, we reached a general understanding of all these issues for the time being, and the annuity seemed like something worth keeping after weighing all the pros and cons. However, the complexity of the product could not be ignored. It required that Rose and Jim have a go-to person to refresh their understanding of how the annuity worked at least once per year.  In other words, having a relationship with an advisor would be critical. When they need to make significant decisions, who would they turn to for their options? Since Rose and Jim did not have a financial advisor they could trust, and my role was temporary, should they keep the policy or accept the proposed buyout?  With the buyout, approximately $80,000, they could put it into something safe, like laddered CDs, to keep things simple and have the funds accessible.

Rose kept returning to a simple question, one that was important to her. She has a friend whose husband had recently suffered a stroke. As a result, he needs in-home care and their house needs to be made wheelchair-friendly. It has put a severe strain on their finances and relationship. So Rose asked, at regular intervals, “What if I have a stroke?”

My advice to Rose and Jim was to take the buyout, put the money somewhere safe and accessible.

What would you have suggested?

The majority of you reading this are relationship-oriented advisors. In a sense, I’m preaching to the choir, at least where your top clients are concerned. Yet, take a look at your book of business. Do you have “B” or “C”-level senior-aged clients with just a product or two who might be seduced by a product-pusher like our friend who rolled Rose’s funds?  If so, reach out to them by mail or phone.  Let them know you or someone on your team can be available to review their product or portfolio at least annually.

Do your part to disable the product-pushers. I’ve seen plenty of the frustration, confusion, anger, and lawsuits created in their wake. Your clients, even those with smaller assets, deserve better.

If you have the clout, consider lobbying product providers to take the emphasis off up-front commissions and to spread them out over time. The recurring nature of this compensation will help reward relationship-building over transactions. It’s your playing field. Consider helping level it.

Until next month,

The Doctor is OUT.

Al Depman , CLU, ChFC, CMFC, BH, a.k.a. “The Practice Doctor”, is mitchanthony.com’s Business Practice Consultant. He is the creator of “The Practice Management Assessment” tool and materials and has authored numerous articles in professional publications on practice management. Al combined his Liberal Arts studies with 10 years of management experience with McDonald’s Corporation to enter the financial services world 22 years ago. Since then, Al has evolved from an MDRT-level sales rep into a full-time consultant specializing in helping others engineer their business practices to the next level. Contact him at al@mitchanthony.com .

© 2008 Al Depman