In what is going to be a 6 week series I intend to do on the use of variable annuity contracts and structured settlement annuities, I'm going to address several key points that I feel trial lawyers, personal injury victims and settlement professionals need to know about these powerful new contracts and why they are a very viable alternative to structured annuities in many instances, and why I expect to use them more and more for long term accumulation and income needs for personal injury cases. Among the key topics will be discussions on the following:
1. In many cases we have low income, or moderate income clients to whom the tax benefit of a section 104, section 130 qualified structured annuity is almost irrelevant, and who are rightfully focused on maximum cash flow monthly, not on net after tax cash flow. Variable annuities now provide superior net cash flow in many cases. Too often structured settlement professionals over sell the tax free payments of a structure, and fail to look at other taxable annuity contracts that can actually offer higher monthly cash flow to the client in many situations. The fact is that variable annuity contracts offered today by the likes of AXA, SunAmerica, Lincoln, American Skandia, etc, provide guaranteed net income of 5% to 6%, or in some cases even higher based on the age of the annuitant. While the income is taxable when paid out, the principal returned is always tax free, and the net monthly check to a low to moderate income tax payor each month is more relevant to them then a tax benefit that saves them little to nothing in taxes in the real world. We need to realize that to the vast majority of our current clients, and potential clients, maximum cash flow is of primary concern, not tax benefits.
2. The risk to the client, and to some degree the advisor, of selling a fixed rate, irrevocable annuity in a historically low interest rate market such as we have now is huge, as it locks a client into a permanent long term rate that economic and market history suggests is about half of the yield on equities on a historical basis. There is no way to sugar coat this, but the facts are that if structures yield only 4.5% to 5% on your typical long term annuity at the moment, and stock mutual funds have averaged over 10% for most long term measuring periods, you are very hard pressed to make a case that this is a rational purchase for the long term annuitant. It makes no difference if it's tax free when you can potentially get twice the yield on an alternative investment. There must be some means to keep them tied to the market or other investment yields or you run the risk of putting your client permanently behind competing investment products. The settlement industry's failure to develop an equity index or equity linked product that captured the imagination of plaintiffs, and wasn't horribly expensive or complex, has been a failure. The Met Life equity product is sold by no one that I know of, and it was almost impossible to get compliance people to approve it. The Mass Mutual trust/annuity product was just getting started when MML pulled the plug on their Settlement Solutions division so we don't know how that would have fared in the long run. The fact is that the new variable annuity products offered outside the structured settlement channel have both guaranteed minimum rates of accumulation and payout, PLUS, the ability to get the higher yield offered by investing in bond, stock, real estate equity accounts. The client gets zero down side risk, with almost complete upside market participation, eliminating the major negative of the fixed rate contract, that being the inability to keep up with markets.
3. With variable annuity contracts you retain account liquidity for emergencies, while still having annuitization and income, and not creating a situation where a client has to factor at considerable cost to get their money. The biggest benefit of a structure, it's fixed nature and the inability of clients to easily cash it in, has become over the years, the products Achilles heel, with factoring companies overwhelming annuitants with offers to cash in and take huge paper losses on their periodic payments. The structured settlement industry needs to let go of the myth that the structure is a product that prevents spendthrift or reckless use of the funds, it doesn't. Anyone can, and many do, factor their payments and cash them in at substantial cost, as a result of not being able to manage their money or other financial pressures. What the settlement broker or advisor needs to do is first do a better job of programming the clients needs at the time of settlement and not shoveling all the money into a structure, but looking at secure alternatives such as variable annuity contracts that allow for access to their funds with little or no penalty in the event their situation changes. History has shown us people will cash in, so why have we created a scenario where cashing in costs them 20% of their present value when viable options are right in front of us?
4. By using a variable annuity contract to fund long term income needs for a structured settlement or court settlement client we get away from the "sell it and forget it" mentality that is pervasive in our business. Clients need and want ongoing advice, assistance and guidance from a qualified professional and the variable annuity by it's nature requires the broker or representative to do annual updates, reviews, etc. Again, one of the major drawbacks of structured settlement annuity contracts is once they are sold, the broker disappears and the client is left to manage their finances or program with little or no access to on going advice or guidance. Are we really doing our job as brokers, planners or representatives by selling a one time solution and then disappearing for all but the most essential policy service on the contract? We all know one of the reasons for this is that the compensation on a structured settlement to the broker is entirely front end loaded with no trail or servicing compensation what so ever. People generally do what they are incentivized to do, and in this case, with the traditional settlement annuity product, it is sell as much as you can at time of settlement and then pass the service, and problems, on to the life markets back office. Variable annuity contracts offer a variety of compensation models for the broker or representative, with a range from all the commission up front, to one that is a level life time annual commission based on the assets under management. If we are ever going to evolve to a more professional and advisory capacity, our compensation model needs to incentivize the advisor to provide ongoing reviews and to be tied to the long term success of the client. These new products do that.
5. These are not the wretched "indexed annuity" contracts sold by insurance agents for the last ten years, looking to offer equity performance in an old school Single Premium Deferred Annuity wrapper. These are brand new, innovative, somewhat complicated variable annuity contracts that blend the best features of fixed guarantee products and equity based investments. The typical structured settlement broker or agent can't sell these because of the fact that very few settlement professionals are licensed as registered representatives or affiliated with a broker dealer. To offer these products, the planner or broker MUST be a registered representative of a NASD firm, and any illustration or sale material to an attorney or plaintiff must be accompanied by a prospectus and other required sales and disclosure material. This is not a simple product but one that requires a bit more salemanship and education on the part of the advisor to offer and explain it, and therefore it is not a simple take it or leave it type sale. There are a lot of unique features and benefits that the client must be aware of and the advisor has to really read and study on each companies offerings to competently explain the benefits and drawbacks of using these annuities.
Next week I will start a foundational series of blog posts on what the new contracts are, how the guaranteed accumulation and payout's work, what companies I recommend, what features are unique to particular companies, as well as the drawback's and costs of these annuities. To know where they will fit in the world of settlements and retirement planning you have to first know what makes them unique. I have no doubt that in my practice that these contracts will begin to have a greater and greater amount of utility and that trial lawyers and plaintiffs will find them increasingly attractive and I think by the end of this series you'll agree with me that we are about to witness a sea change in what kind of annuities are used to fund the future needs of personal injury victims.