Unbundling Annuities: Customers Speak And Computers Cringe
When Henry Ford applied mass production techniques to the fledgling automobile industry to make cars affordable to most workers, he was famous for saying his Model T came in any color the customer wanted, “as long as it’s black.” Ford was producing his cars the way that best fit the production techniques he had created. The customer could take or leave what he offered.
For a long time, the annuities industry operated on Henry Ford’s original precept. Everything necessary for the annuity was bundled together in one package and offered on a “take it or leave it” basis. And like Ford’s effort to increase efficiency in production, the annuity was bundled to fit the needs of the underwriting company.
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We all know what happened to the automobile industry. It wasn’t long before basic black gave way to a rainbow of colors. And the Model T was joined by so many other models and styles and variations with options and accessories and customization plans that it is hard to imagine a time when anyone thought that one size would fit all.
Times have changed for the annuities industry, too. Today’s consumers are much more financially savvy than their parents, or even their older siblings. These consumers demand choice, in their cars and in their investments. To be successful in the modern annuities market, a company must offer a product with the flexibility to meet a wide variety of needs.
These market pressures are what led to the current practice of “unbundling” annuities. In the old days, the M&E charges (reimbursements to insurance companies to cover the estimated “mortality and expense” risk) represented expenses associated with the “standard” and fully loaded annuity and were deducted during the calculation of the fund’s unit value. Since the customer only saw the end resultthe unit valuethey rarely appreciated the magnitude of the M&E deduction.
But as consumers pushed for more specialization, the industry has responded (and rightly so) by pulling these and other charges out of the package and selling them individually, much like options in a car.
However, the automobile and annuity analogy breaks down at this point. Once an automobile buyer signs on the dotted line, the deal is done. Even if the purchase is financed over time with monthly payments, the car buyer can’t go back and undo parts of the deal. You can’t decide 12 months into your 48-month commitment that you don’t really need 14 cup holders and have them removed to lower your payments.
But with an annuity, the customers can change their minds about the “options” they want. And the fear is that customer will do just that if they know how much each of the “unbundled” charges cost them each month.
The securities industry addresses this challenge in a creative way. The charges are “unbundled” at the time of sale, and then essentially “rebundled” for the purposes of billing, with charges rolled back into the annuity through a recalculation of the unit value of the fund.
In theory, this solves the problem. The customers choose up front what they want based on cost and suitability to personal needs, then never have to worry about it again. All they see is the unit value on their statements.
But the law of unintended consequences has kicked in. By recalculating the unit value for each and every customer, a system that was designed to work at the fund level is now working at the consumer level. Instead of recalculating the unit value for a hundred or so different funds each night, some system operators are faced with literally thousands of calculations each night.