L-Share/ Short Surrender Annuities: Not Impressed

“There are some scumbags in this business and they deserve to be prosecuted out.”  – Joseph Jordan, former advisor and current consultant

Mr. Jordan’s comments couldn’t be more relevant — or true – than they are right now.

Some insurance companies in their never-ending quest to find new victims (I mean, clients) often resort to very clever deceptive practices that often go undetected by the client.  Not everyone can do an expose a la John Oliver whereby he eviscerated John Hancock’s convoluted 401k proposal.

A big drawback to selling an annuity is the surrender period. This means purchasers of these products often have to pay between 8-10% of their principal if they decide to withdraw more than 10% of their contract in the first seven years.

This is a sliding scale. As the years pass, the penalty decreases. Unscrupulous salespeople often gloss over this interesting tidbit in their eagerness to close a sale and collect their generous commissions. Wham bam, thank you, Ma’am! So sorry we forgot to mention this minor detail.

Being penalized to access your funds should an emergency arise is not exactly a fringe benefit for a client.

Don’t worry, the guys with the pocket protectors have come up with an ingenious solution. They created a new product with a much more tolerable three-year surrender period. Perfect!

Now a client can get those same protected benefits with the addition of potential high stock market returns.  Introducing the L-share/Short Surrender Annuity, this is the new and improved version of their logic-defying model.

What can go wrong here? Plenty!  The first warning sign is these products pay salespeople higher commissions than the seven-year surrender fee versions. This is always a bad sign. High payouts are needed to sell bad products. This iron law of finance never fails.

In addition, the annual mortality, expense, and administration (MEA) fee is about 40% higher in the L-shares than the standard seven- year product! This means this product is deceptively sold on its liquidity benefits. The exorbitant price of this new feature is often not fully disclosed.

This increased annual expense more than offsets the possible loss of an extra four years of possible surrender fees for the insurer.  Here is an example of this from AnnuityFYI:

With an L-share Annuity, You Will Pay a Higher Mortality, Expense and Administration (MEA) Fee & Likely Get a Lower Return

Let’s take a hypothetical, but typical, scenario:

• $100,000 investment
• Assumed growth rate of 10% over 10 years, after sub-account fees (but not including MEA fees)
• You have the choice of:
  • Variable Annuity ABC Standard — a seven-year surrender product with a 1.15% MEA fee. This is the MEA fee for the typical seven-year surrender variable annuity recommended through Annuity FYI (without a bonus). Typical surrender schedule: 7%,7%, 6%, 5%, 4%, 3%, 2%, 0%
  •  Variable Annuity ABC L-share — the exact same product with a three-year surrender and a 1.65% MEA (this is the average industry MEA fee on an L-share at the time of this writing). You are paying a premium in terms of MEA fees for the privilege of having a surrender period that is 3-4 years less than the less expensive, standard product. Typical surrender schedule: 8%, 7%, 6%, 5%, 0%.
  •  With the seven-year product, after 10 years your account value will be $233,499 (10% growth, less 1.15% MEA fees). With the three-year product, after 10 years your account value will be $222,992 (10% growth less 1.65% MEA fees). Because of the higher MEA fees on the L-share, your account value would be $10,507 less (4.50% less) than the seven-year surrender product, which is otherwise exactly the same!

Stuff like this is starting to get more of FINRA’s attention. Met Life was recently fined $25 million for their annuity shenanigans. In the words of James Day, FINRA Associate Vice President, “Annuities are at the sweet spot of complex products marketed to retirees and people about to retire.”

L-shares fall right into this category. The situation is a criminal investigation waiting to happen. On top of the above-stated math, there is another disturbing issue concerning this product. Why is the salesperson marketing an equity-based product to a client who expresses a concern that they might need their funds in 3-4 years?

Any competent advisor knows that, at a bare minimum, an investment of five years is required if capital is to be exposed to the volatility of the equity markets. Investors with time frames less than that should not have the money invested at all.

The only good thing about most annuity products are they will keep many individuals employed at both FINRA and the SEC for years to come. This is a small solace to the numerous victims of annuity malfeasance.

To sum up things in the words of T.V. host Suzie Orman:

Imaginary Caller: “Should I take $100,000 from my IRA and buy an L-share/Short Surrender Annuity to take advantage of the lower surrender fees?

Orman: “Permission Denied!!”