NASAA 2010 Investment Adviser Training Variable & Equity Indexed Annuities Chad Hartwick State of...

NASAA 2010 Investment Adviser Training

Variable & Equity Variable & Equity Indexed AnnuitiesIndexed Annuities

Chad HartwickChad Hartwick

State of MichiganState of Michigan


These views are my own views These views are my own views and not necessarily those of and not necessarily those of

NASAA or the State of NASAA or the State of MichiganMichigan


Annuities in GeneralAnnuities in General

Parties involvedParties involved Insurance CompanyInsurance Company Contract OwnerContract Owner Annuitant / InsuredAnnuitant / Insured BeneficiaryBeneficiary

Contract between the owner (usually the Contract between the owner (usually the annuitant) and the insurance company.annuitant) and the insurance company.

Primary aim is to help protect individuals Primary aim is to help protect individuals from outliving their expected income.from outliving their expected income.


Annuities in GeneralAnnuities in General

Two Phases – Accumulation, Two Phases – Accumulation, AnnuitizationAnnuitization

Annuities provide a guaranteed Annuities provide a guaranteed periodic income for a designated period periodic income for a designated period of time or the life of the annuitant.of time or the life of the annuitant.

Annuities are commonly accumulated Annuities are commonly accumulated on a tax deferred basis.on a tax deferred basis. Single PremiumSingle Premium DeferredDeferred


Annuities – Fees & ChargesAnnuities – Fees & Charges

Mortality and Expense (M&E) – Mortality and Expense (M&E) – Insurance coverageInsurance coverage

Surrender ChargesSurrender Charges Optional rider/benefit feesOptional rider/benefit fees Sub-account expenses (Variable)Sub-account expenses (Variable) AdministrativeAdministrative


Annuity - TypesAnnuity - Types

Fixed – pays a current interest rate Fixed – pays a current interest rate based upon the performance of the based upon the performance of the insurer with a guaranteed minimum.insurer with a guaranteed minimum.

Indexed – pays an in interest rate Indexed – pays an in interest rate linkedlinked to the performance generally to the performance generally of an equity index, with of an equity index, with limitationslimitations. . Guaranteed minimum.Guaranteed minimum.

Variable – Allows the owner to invest Variable – Allows the owner to invest in sub-accounts. (mutual funds)in sub-accounts. (mutual funds)


Variable AnnuitiesVariable Annuities

VAs are hybrid securities products issued VAs are hybrid securities products issued by insurance companies.by insurance companies.

They bundle mutual fund like accounts They bundle mutual fund like accounts with insurance-type components. Often with insurance-type components. Often referred as a mutual fund inside an referred as a mutual fund inside an insurance wrapper.insurance wrapper.

They are deemed retirement planning They are deemed retirement planning tools and are treated accordingly from a tools and are treated accordingly from a tax perspective.tax perspective.

Complex and evolving.Complex and evolving.


VAs cont - RegulatorsVAs cont - Regulators

Product (company, contract, Product (company, contract, prospectus)prospectus) State Insurance DepartmentState Insurance Department Securities Exchange CommissionSecurities Exchange Commission

Sale (advertising, agents, suitability)Sale (advertising, agents, suitability) State Insurance DepartmentState Insurance Department Securities Exchange CommissionSecurities Exchange Commission FINRAFINRA State Securities Department (THIS IS YOU)State Securities Department (THIS IS YOU)


VAs cont – MF vs VAVAs cont – MF vs VA

Three differences between Mutual Three differences between Mutual Fund and Variable Annuities – The Fund and Variable Annuities – The insurance wrapper.insurance wrapper. PaymentsPayments Tax – deferralTax – deferral Guaranteed death benefitGuaranteed death benefit


VAs cont – paymentsVAs cont – payments

Usually several types to choose fromUsually several types to choose from IrreversibleIrreversible Rarely used, approx 1% of deferred Rarely used, approx 1% of deferred

variable annuities are annuitized.variable annuities are annuitized.


VAs cont – Tax DeferralVAs cont – Tax Deferral

Earnings grow tax deferredEarnings grow tax deferred Earnings that are withdrawn are taxed Earnings that are withdrawn are taxed

as ordinary income not capital gains.as ordinary income not capital gains. Withdrawing $$ prior to 59 ½ may Withdrawing $$ prior to 59 ½ may

mean IRS penalties (10%), interest is mean IRS penalties (10%), interest is withdrawn first and are fully taxable.withdrawn first and are fully taxable.

Over 60% of VA sales are already Over 60% of VA sales are already QualifiedQualified


VAs cont – Death BenefitVAs cont – Death Benefit

Principal protection at death of Principal protection at death of ownerowner

Can provide insurance to the Can provide insurance to the uninsurableuninsurable

Actual benefit may not be “large” Actual benefit may not be “large” relative to cost (i.e. expensive relative to cost (i.e. expensive insurance)insurance)

Benefit to the beneficiary!!!!!!!!!Benefit to the beneficiary!!!!!!!!!


VAs – Investment SelectionsVAs – Investment Selections

Sub – accounts (clone funds)Sub – accounts (clone funds) Offer wide range of choices including Offer wide range of choices including

multiple fund familiesmultiple fund families Ability to move from one fund to Ability to move from one fund to

another w/o commissions, taxes, or another w/o commissions, taxes, or loadsloads

Usually will have some fixed and Usually will have some fixed and money market funds as wellmoney market funds as well


VAs – fees & expensesVAs – fees & expenses

M&E – 1.25%M&E – 1.25% Administrative fee - $30Administrative fee - $30 Mutual fund fees – 1%Mutual fund fees – 1% Surrender fees – 8 years 8%Surrender fees – 8 years 8% Optional rider/benefit feesOptional rider/benefit fees Bonus AnnuityBonus Annuity

Higher M&EHigher M&E Higher Surrender feeHigher Surrender fee


VAs cont – Riders & BenefitsVAs cont – Riders & Benefits

Long term careLong term care Guaranteed minimum withdrawalGuaranteed minimum withdrawal Guaranteed minimum incomeGuaranteed minimum income Principal protectionPrincipal protection Enhanced death benefitEnhanced death benefit May have a waiting period / age May have a waiting period / age

limitslimits Cost $$$$$$Cost $$$$$$


VAs cont - SuitabilityVAs cont - Suitability

3 Phases3 Phases Suitability of the productSuitability of the product

PayoutPayout Tax DeferralTax Deferral Death BenefitDeath Benefit

Suitability of the sub-accountsSuitability of the sub-accounts To aggressiveTo aggressive Not aggressive enoughNot aggressive enough

Suitability of the riders/benefitsSuitability of the riders/benefits


VAs cont – Suitability rulesVAs cont – Suitability rulesFINRA Rule 2310 – Recommendations to Customers (Suitability) (a) In recommending to a customer the purchase, sale or exchange

of any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such customer as to his other security holdings and as to his financial situation and needs.

(b) Prior to the execution of a transaction recommended to a non-institutional customer, other than transactions with customers where investments are limited to money market mutual funds, a member shall make reasonable efforts to obtain information concerning:

(1) the customer's financial status; (2) the customer's tax status; (3) the customer's investment objectives; and (4) such other information used or considered to be reasonable by

such member or registered representative in making recommendations to the customer.

(c) For purposes of this Rule, the term "non-institutional customer" shall mean a customer that does not qualify as an "institutional account" under Rule 3110(c)(4).


VAs cont – Suitability rulesVAs cont – Suitability rules

FINRA rule 2330 – Members FINRA rule 2330 – Members Responsibilities Regarding Deferred Responsibilities Regarding Deferred Variable AnnuitiesVariable Annuities More specific suitability requirements on More specific suitability requirements on

deferred VA transactionsdeferred VA transactions Principal review and approvalPrincipal review and approval Supervisory proceduresSupervisory procedures Training for agents and principalsTraining for agents and principals Notable exceptionsNotable exceptions

NASD Notice Members 96-86, 99-35NASD Notice Members 96-86, 99-35


VAs cont – Inappropriate salesVAs cont – Inappropriate sales

Recommending a purchase for somebody Recommending a purchase for somebody with few liquid assets, or short term need with few liquid assets, or short term need for funds (not liquid products)for funds (not liquid products)

Overly aggressive sub-account choicesOverly aggressive sub-account choices 1035s – surrender charges1035s – surrender charges 1035s – loss in death benefits - stripping1035s – loss in death benefits - stripping Riders that will not reasonably benefit the Riders that will not reasonably benefit the

customercustomer No economic benefitNo economic benefit High commissions, 5-6%, no breakpointsHigh commissions, 5-6%, no breakpoints


VAs cont – Managed VAsVAs cont – Managed VAs

Are you kidding me??????Are you kidding me?????? Some VAs are structured for thisSome VAs are structured for this May be very expensive with the May be very expensive with the

added management feeadded management fee Are they automatically rebalancing?Are they automatically rebalancing? What are they managing?What are they managing?


VAs cont - SupervisionVAs cont - Supervision

Firm’s ResponsibilitiesFirm’s Responsibilities Establish standards of conduct it expects Establish standards of conduct it expects

from its registered representativesfrom its registered representatives Disseminate and enforce these Disseminate and enforce these

standards relating to suitabilitystandards relating to suitability Provide ongoing sales practice and Provide ongoing sales practice and

product knowledge training for its product knowledge training for its registered representativesregistered representatives

Establish policies and procedures Establish policies and procedures regarding sales practices and regarding sales practices and investment productsinvestment products


VAs cont - SupervisionVAs cont - Supervision

Firm’s ResponsibilitiesFirm’s Responsibilities Develop and enforce suitability standards to be Develop and enforce suitability standards to be

used in the investment processused in the investment process Monitor and supervise the sales activities of its Monitor and supervise the sales activities of its

registered representatives through the use of registered representatives through the use of management, oversight and exception reportsmanagement, oversight and exception reports

Conduct the appropriate follow-up with the Conduct the appropriate follow-up with the representativerepresentative

If necessary, correct any transactions that are If necessary, correct any transactions that are determined to be unsuitable for the customerdetermined to be unsuitable for the customer


Equity Indexed AnnuitiesEquity Indexed Annuities

A fixed (what?????) annuity product A fixed (what?????) annuity product that allows investors to participate in that allows investors to participate in market like returns.market like returns.

They offer a minimum guaranteed They offer a minimum guaranteed return. Typically this guarantee is return. Typically this guarantee is based on 90% of premium and based on 90% of premium and interest rate is typically 3%.interest rate is typically 3%. May be credited at the end of the May be credited at the end of the

surrender period.surrender period.


EIAs cont – RegulationEIAs cont – Regulation

Not a security – 1933 Act exceptionNot a security – 1933 Act exception Rule 151 – Safe HarborRule 151 – Safe Harbor

Annuity is issued by an insurer subject to supervision Annuity is issued by an insurer subject to supervision of State Insurance Commissionersof State Insurance Commissioners

Insurer assumes the investment risk under the Insurer assumes the investment risk under the contractcontract

Contract is not marketed primarily as an investmentContract is not marketed primarily as an investment

Not sold by prospectusNot sold by prospectus Less demanding sales practice than Less demanding sales practice than

variable annuitiesvariable annuities Some companies are registering themSome companies are registering them


EIAs cont - CharacteristicsEIAs cont - Characteristics

Commission rates are typically from 7-13%Commission rates are typically from 7-13% Surrender periods are typically in the 10 Surrender periods are typically in the 10

year range but may go as high as 18 year range but may go as high as 18 years.years.

Various indexes may be used, the S&P 500 Various indexes may be used, the S&P 500 is the most popular.is the most popular.

Guarantees are secured by purchasing of Guarantees are secured by purchasing of bonds by the insurance company.bonds by the insurance company.

Equity returns are typically paid by Equity returns are typically paid by purchasing options.purchasing options.


EIAs cont - VariablesEIAs cont - Variables

Crediting MethodsCrediting Methods Participation RatesParticipation Rates Spread / Margin / Asset FeeSpread / Margin / Asset Fee CapsCaps Flexibility in AllocationsFlexibility in Allocations


EIAs cont – Crediting MethodsEIAs cont – Crediting Methods

Annual Reset (Ratchet) – Looks to the Annual Reset (Ratchet) – Looks to the change in the index from the beginning of change in the index from the beginning of the year to the end. All losses are ignored.the year to the end. All losses are ignored.

High Water Mark – Asses the index value High Water Mark – Asses the index value at various points in the year and compares at various points in the year and compares to the start of the term.to the start of the term.

Point-to-Point – Compares the index value Point-to-Point – Compares the index value two distinct points.two distinct points.

Do not get the benefit of dividendsDo not get the benefit of dividends..


EIAs cont – Participation RatesEIAs cont – Participation Rates

Determines how much of an index Determines how much of an index gain will be credited to the annuity gain will be credited to the annuity contract.contract.

Example – 80% Participation RateExample – 80% Participation Rate 10% gain in the index means a 8% 10% gain in the index means a 8%

credit to the contract.credit to the contract.


EIAs cont – Spread/Margin/Asset EIAs cont – Spread/Margin/Asset Fee Fee

May be used instead of or in addition May be used instead of or in addition to a participation rate.to a participation rate.

A percentage that will be subtracted A percentage that will be subtracted from the gain in the index.from the gain in the index.

Example – 3.5% SpreadExample – 3.5% Spread 10% gain in the index means a 6.5% 10% gain in the index means a 6.5%

credit to the contract.credit to the contract.


EIAs cont – CapsEIAs cont – Caps

Return credited to the contract is Return credited to the contract is capped with an upper limit.capped with an upper limit.

Usually stated as a %.Usually stated as a %. Example – 8% CapExample – 8% Cap

10% gain in the index means a 8% 10% gain in the index means a 8% credit to the contract.credit to the contract.


EIAs cont – CreditingEIAs cont – Crediting

Some insurance company’s are Some insurance company’s are allowed to change participation allowed to change participation rates, cap rates, and rates, cap rates, and spreads/asset/margin fees. spreads/asset/margin fees. (OUCH!!!)(OUCH!!!)

Stated in the contract if allowed.Stated in the contract if allowed.


EIAs cont - AllocationsEIAs cont - Allocations

Many EIAs offer several index options Many EIAs offer several index options to choose from in addition to a true to choose from in addition to a true “fixed” option.“fixed” option.

Investors can determine how much Investors can determine how much of each premium dollar goes into of each premium dollar goes into each index choice.each index choice.


EIAs cont – Where does it go?EIAs cont – Where does it go?

Premium breakdown of $1 with a Premium breakdown of $1 with a 90% participation rate90% participation rate $0.09 Expenses – agent expenses, $0.09 Expenses – agent expenses,

insurer expenses and profitsinsurer expenses and profits $0.63 Guarantee$0.63 Guarantee $0.28 Available for options$0.28 Available for options

*** Information and example from NAFA’s Index Annuity Parts – Section 3*** Information and example from NAFA’s Index Annuity Parts – Section 3


EIAs cont – SupervisionEIAs cont – Supervision

Not much, since they are not securitiesNot much, since they are not securities FINRA Notice to Members 05-50FINRA Notice to Members 05-50

Raises concerns about associated persons Raises concerns about associated persons selling EIAsselling EIAs

“…“…. The status of any particular EIA under . The status of any particular EIA under the safe harbor (or under Section 3(a)(8)) the safe harbor (or under Section 3(a)(8)) will depend on the facts and will depend on the facts and circumstances”circumstances”

FINRA Rule 3030 (Outside Business Act)FINRA Rule 3030 (Outside Business Act) FINRA Rule 3040 (Private Securities Trans)FINRA Rule 3040 (Private Securities Trans)


EIAs cont – MarketingEIAs cont – Marketing

““Free Lunch” seminarsFree Lunch” seminars Registered Representatives and Broker-Registered Representatives and Broker-

Dealers have to be carefulDealers have to be careful Insurance company vs selling agentInsurance company vs selling agent

Difficult to explain product w/o discussing Difficult to explain product w/o discussing investmentsinvestments

Variations of a themeVariations of a theme ““Get market returns with no chance to lose $$Get market returns with no chance to lose $$

$”$” Often sold by insurance agents that do not Often sold by insurance agents that do not

have a security license.have a security license.


Thank you!Thank you!

Have a nice day Have a nice day

NASAA 2010 Investment Adviser Training Variable & Equity Indexed Annuities Chad Hartwick State of...

Documents

Transcript of NASAA 2010 Investment Adviser Training Variable & Equity Indexed Annuities Chad Hartwick State of...