As stock market indices hit historic highs, one would think variable annuity owners are also riding the wave of euphoria. However, this isn't the case as complaints are gaining in relative volume and regulators are aware of a mounting crisis.
According to the Wall Street Journal's Matthias Rieker, in 2012, the variable annuity was the only class of security for which arbitration claims increased with 220 cases filed, based on data from the Financial Industry Regulatory Authority (Finra). Last year, through November, 165 cases were filed which represented a 20% decline from the same period 2012; however stock and mutual fund cases dropped at a faster rate.
Variable annuities are insurance contracts that guarantee a minimum payment; however the remaining amount of the income payment varies depending upon the performance of an underlying investment portfolio. The biggest criticisms of variable annuities are high annual fees and ridiculously high surrender fees which render the funds illiquid for at least a few years.
Regulators aware of problems
Finra, which regulates the brokerage industry and manages arbitration for customer disputes, said that it is aware of the issue. In 2013, Finra made it a priority to investigate variable annuity sales practice issues as among the “key investor protection and market integrity issues.” In a recent interview, Finra Chairman and CEO Richard Ketchum said, “Annuities continue to get more complex” and the risks in selling them to senior investors remain substantial.
Complexity is a huge issue with variable annuities. Last month I wrote “An impartial review of the Prudential Defined Income Variable Annuity.” The prospectus was a stunning 116 pages and I assure you that it wasn't written for the benefit of the potential buyer. These documents were written by lawyers for the issuing company's protection, not for clarity for the buyer; therefore they aren't in layman's terms and are very convoluted. Combine the complexity with questionable sales tactics and you have a recipe for unhappy consumers.
Many critics and lawyers suspect high commissions are leading to variable annuities being sold to the wrong customers. Commissions can be as high as 10% of the money invested! It is no surprise that this often leads to very hard selling tactics that attempt to scare or confuse investors. Finra released an Investor Alert “Variable Annuities: Beyond the Hard Sell” which highlighted many pitfalls:
The marketing efforts used by some variable annuity sellers deserve scrutinyâ€”especially when seniors are the targeted investors. Sales pitches for these products might attempt to scare or confuse investors. One scare tactic used with seniors is to claim that a variable annuity will protect them from lawsuits or seizures of their assets. Many such claims are not based on facts, but nevertheless help land a sale… you should be aware of their restrictive features, understand that substantial taxes and charges may apply if you withdraw your money early, and guard against fear-inducing sales tactics.
How to protect yourself
Annuities aren't all bad and may in fact have a place in your financial plan, but it is important to remember that annuities can have surrender periods of 10+ years and surrender fees that top 10%. Therefore if you are considering buying an annuity, it is important to take your time to understand exactly what you are buying and know it will meet your needs. I have dealt with too many clients that have come to me asking for help getting out of an annuity, and I canâ€™t help after the fact.
First, you should check your broker's record using BrokerCheck – don't ignore any red flags.
Secondly, here are some questions that you should ask the person selling you the annuity:
- What are the surrender charges if I need to withdraw money earlier than expected? How long is the surrender period?
- Will you be paid a commission or receive any type of compensation for selling the variable annuity? How much?
- What are the risks that my investment could decrease in value?
- What are all the fees and expenses? Do these include the underlying mutual fund fees?
If you are still feeling unsure then seek a second or even a third opinion. It also makes sense to call the insurance company directly if you don't feel like you're getting the full picture. If the answers don't match what the salesperson is telling you then you may be dealing with a dishonest or confused broker.