A popular insurance industry myth begins with an injured worker’s disability claim for an accident he said was the result of “poor planning.” Asked by the company to provide more detail, the man said he was working alone at the top of an 80-foot radio tower. Nearing the completion of his task, he realized he’d brought 300 pounds of tools up with him over the course of several trips. Rather than carry the tools down by hand, he decided to lower them by using a pulley and barrel attached to the top of the tower. He loaded the tools into the barrel and then went back to the ground to untie the rope.

Weighing only 155 pounds, the surprise of suddenly being lifted off the ground caused the man to forget to let go of the rope. He proceeded up the side of the tower at a rather rapid rate of speed. He met the barrel coming down, which explained his fractured skull and broken collarbone. Unfortunately, due to the seesaw action of the rudimentary pulley system and hundreds of pounds of equipment flying through the air, this was only the beginning of the man’s injuries.

While cartoonish urban legends make for an entertaining read, inaccurate and irresponsible financial myths can do lasting damage to a client’s fiscal security. Annuities appear to be particularly vulnerable to incorrect information, especially when it comes to their place in a senior’s portfolio.

“One of the biggest myths we deal with has to do with bonus products,” says Tony Bahu, CEO of AnnuityMD.com, an informational Web site for annuity consumers. “People think there are no tradeoffs and they get all this extra money upfront. But there will be consequences. If the money is received upfront, one way or another they’ll give it back over the life of the contract. Clients come in and say a particular annuity is better because it gives a great upfront bonus. But that’s simply not the case.”

Not surprisingly, in addition to bonus products, Bahu fields a high number of questions about equity-indexed annuities, and he says advisors and clients are often mistaken about the nature of their risk and return. He’s found a number of articles that describe EIAs as having more risk-and-return potential than a fixed product, and less risk-and-return potential than a variable product.

“This is plain wrong,” he says. “An EIA is a fixed product and has the exact same amount of risk. This means that as long as the company remains solvent and the client holds the contract to maturity, he won’t lose money. In fact, the minimum guarantees mean that if it is held to maturity, it will be guaranteed to make some amount of money.”

Bahu explains that EIAs are not home-run hitters and are designed to perform about 1 percent or 2 percent better than a traditional fixed annuity. Under most circumstances, he says, they will not beat a normal market over time.

“It’s not for investors who want all upside,” he says. “It’s for the risk-averse investor who wants a fixed annuity to perform better than the fixed markets. The client won’t knock it out of the park, but they also won’t lose money. I’ve heard advisors get this wrong on both sides.”

Variable interest
Fixed annuities (and their EIA variations) provoke heated debate and criticism, but they are far outpaced by variable products. Some of the criticism is warranted, especially in the area of appropriate use. But the financial media’s zeal to discredit the product as a viable planning tool has led to misinformation and outright distortions.

One preferred tactic is to negatively compare the performance and fee structure of a variable annuity with that of a stand-alone mutual fund. But Mark Mackey, CEO of the National Association for Variable Annuities, discounts what he sees as an apples-to-oranges comparison, and says an annuity is much more than a simple investment product and has a number of useful insurance features.

“When comparing VA fees with a stand-alone mutual fund, of course there will be an additional fee to pay for any sort of insurance features,” he explains. “But I think people will be surprised that annuities are not all that much more. People assume the price difference between the two is the mergers-and-expense fee from the sub-account, but that’s not the case. In many instances the management fees are actually lower because of the arrangements the companies have with various managers.”

Bahu agrees and says some companies have done a good job of introducing low-fee products. But he cautions that with any variable product, the advisor and client have to be sure they’re getting the intended benefits.

“Some of these products do, in fact, have high fees,” he adds. “We ask people upfront why they want to be in a variable annuity, in order to make sure the product is understood. If they say tax advantages, these advantages should more than cover any fees.”

As for performance, Mackey notes that most of the annuity-to-mutual-fund comparisons compare a VA to an index fund. They assume the purchaser of the fund is going to employ a buy-and-hold strategy. They don’t realize that the average mutual-fund holder turns over an entire portfolio every four years, and they pay taxes on any gains.

By contrast, an annuity is a long-term investment vehicle. The built-in surrender charges and penalties for early withdrawal provide for a measure of forced discipline, which is a necessary component in retirement planning for a majority of Americans. And when used properly, Mackey says, a five-year or seven-year sales charge will never come into play.

“In relation to the tax-advantage issue, people say that variable annuities do not belong in qualified plans,” Mackey says. “But they’re perfectly appropriate in qualified plans because of the insurance benefits. Annuities were specifically created for the qualified market and Congress has legitimized the strategy.”

Mackey lists the death benefit as the final criticism he and his organization hear. People often wonder about the odds of actually using it. For Mackey, this shows a fundamental lack of understanding of insurance.

“If someone purchases homeowner’s insurance and never has a house fire, do they somehow feel cheated?” he asks. “The whole point is not to use insurance. Some $3 billion over and above the contract value has been paid out in death benefits – something happened and the family was made whole. For these reasons a deferred annuity is appropriate to serve the senior market, and an immediate annuity is absolutely appropriate.”