Many retirees have heard the pitch: Index annuities are a perfect blend
of stock performance and little risk. They offer returns that go up when
the market does and are guaranteed to never lose principal funds. Sounds
like a great deal, and many retirees bought into it, which caused the
relatively new industry to soar from $5.3 billion in sales to $29.9 billion
in just nine years (“Index annuities are a safety trap,”
Money Magazine, Jan. 17, 2011).
Despite their popularity, however, index annuities can mean big problems
for investors. They can be incredibly complex, and they often have lower
returns than investors expect. Additionally, they can feature high fees
and hidden expenses, especially if the investor cashes out of the annuity
before the contract period is over.
This last issue may be the most problematic. Recently, many investment
advisors have begun advising that their clients “swap” their
existing annuities for new ones, often before their existing contracts
are up. (For more information about “swaps,” see our
Nov. 2010 post.) This causes investors to suffer large surrender fees and/or early withdrawal
But, why would an advisor recommend a product or action to their client
that may not be in the client’s best interest? The answer may lie
in how advisors are paid for annuity sales.
In 2008, Illinois state regulators began investigating Senior Financial
Strategies of Champaign, which does business as Pinnacle Investment Advisors,
after the Illinois Securities Department received a complaint made by
some of Pinnacle’s clients who alleged negligence on the part of
the company (“Illinois Securities Department says clients incurred
steep withdrawal penalties,”
The News-Gazette, Sept. 27, 2010).
In its investigation, the regulators found at least 15 cases where Pinnacle’s
clients purchased equity-indexed annuities with funds that came from the
liquidation of other annuities. None of the previous annuities were held
long enough for the clients to escape steep early withdrawal penalties,
but that didn’t stop Pinnacle from advising their clients to make
the switch. According to
The News-Gazette article, Pinnacle sold 65 equity-indexed annuities to clients in just five
months and made $426,281 in commission fees. (To learn about the problems
associated with equity-indexed annuities, click
here.) That’s $85,256.20 per month and $6,558.17 per annuity.
"When you have a market incentive to sell, sell, sell, why would anyone
be surprised that there are all sorts of abuses?" said Birny Birnbaum,
a former consumer representative to the National Association of Insurance
Commissioners (NAIC), in the Jan. 17
Money Magazine article.
Why, indeed. We’re glad that state securities regulators are beginning
to address issues like this, but it’s equally important that investors
protect themselves, as well.
Remember: With any investment, if it sounds too good to be true, it probably is
– regardless of what the guy selling it says.