In view of the retirement income needs of baby boomers, continued growth in retail sales of structured products–structured notes, exchange traded notes and other structured investments–appears to be bright.
But challenges will test this industry before it reaches its full potential.
One type of structured product, the equity index annuity, provides some insight into both the challenges and the opportunities. Following is a review of how EIAs came about, flourished, and then came under fire. The EIA industry, like other segments of the structured products industry, needs to respond to its challenges in a compelling manner in order to regain its momentum.
Looking very much like a vanilla structured note, the first EIA debuted in 1995. It offered upside potential based on 95% participation in growth of the S&P 500 over its 5-year contract term, plus downside protection via minimum guaranteed interest crediting equal to original investment compounded at 3%. At a minimum, the EIA owners were guaranteed 121% of original investment after 5 years.
Guess what? Those purchasing these EIAs in 1995 did very well, just about tripling their money.
The product structure teaches a few things: it was easy to understand, fairly transparent, and uncomplicated; it offered a pristine value proposition of protection plus growth potential (critical for those age 60+ in or near retirement); it assured delivery of 121% gain after 5 years, even if substantial growth in the S&P 500 did not occur; and its liquidity was generous. The deferred sales charge of 5% graded down to zero after 5 years, and the EIA paid 4% commission to producers. A win-win-win for everyone.
If this type of EIA had endured, the current upheaval in the EIA industry would likely have been avoided, and EIA sales would probably have risen to many 10s of billions of dollars.
But by year 2000, the EIA industry had changed. Copycat products had debuted, but with complexity, higher fees and loads, reduced liquidity, extended surrender charge durations, daily, weekly or monthly averaging of index values, and juiced up compensation to attract annuity producers. Later, even more novel “features” showed up such as 2-tiered interest crediting and “bonuses” on invested premium.
Before long, an EIA could be sold that provided a 10% bonus on original investment, on top of the 3% minimum interest rate guarantee, and another 10% paid in commission to the agent. That amounted to 23% out the door in year one.
How could insurers possibly make money this way while investing most of the premium in bonds paying 6%? The answer was gimmickry. The penalty period for early surrender had been effectively made permanent. The policyowner couldn’t really liquidate without using systematic withdrawals over a minimum of 5 years, subject to withdrawal penalty.
Long story short: the unthinkable happened. That is, EIAs came to be seen by many observers as unsuitable for seniors with retirement income needs–the very clients for whom EIAs were originally designed.
By 2005, the Financial Industry Regulatory Authority viewed the EIA environment as so misleading, predatory and reckless that FINRA issued Notice 05-50, to force its broker-dealer members to assume suitability review for EIA sales by their own reps. This happened despite FINRA’s lack of jurisdictional oversight over fixed annuity products.
In the following years, class action lawsuits proliferated; articles in the major media warned seniors to “avoid a costly mistake” with EIAs; and Dateline NBC television even did a hidden camera sting to catch insurance agents selling EIAs to seniors. Then, just a few weeks ago, the Securities and Exchange Commission proposed a rule categorizing indexed annuities as securities.
As the annuity industry takes stock of its challenges, it should recognize that the EIA business is badly broken, and that other segments of the annuity business have suffered from collateral damage. The annuity industry’s greatest sales opportunity ever, boomer retirement, is now threatened, and this is something to which its allied industry, the structured product industry, is paying close attention.
Some lessons for both industries:
–The key to success in delivering EIA and other structured products to retail customers may not be found in product features.
Rather, it rests with supplying customers with an emotion–the feeling of confidence in their advisors and the products and retirement solutions their advisors recommend. The best way to create such confidence is through education and good communication. Here is an easy formula to pull it together: clarity + comfort + compelling = confidence.
–Advisors need tools that help them communicate, educate and have meaningful conversations with clients.
In particular, advisors need tools like streaming videos that draw clients into the conversation digitally. Such tools can help explain the advantages of structured products in an unimpeachably compliant, timely and convenient manner; facilitate mass advisor and investor education, up-selling and cross-selling; help customers see that the words “derivatives” or “structured” aren’t scary; and help solve advisor prospecting woes.
For a long time, the annuity industry has lacked such video capabilities. Not so the critics of annuity products–a point made abundantly clear when the SEC showed excerpts from Dateline NBC’s televised segment on annuity sales practices. The video was used to show some of the problems its new proposal aims to curb.
If the industry embraces video technology, it will be able to join the battle in a key place where it is being played out. The industry will also be able to be more proactive about educating buyers and conveying the value of its products in the preferred medium of many baby boomers.
As the EIA experience has shown, relying upon difficult to understand disclosure documents and complex features offers little practical benefit.
–Offer well-designed, easy-to-understand, and timely structured products, conveyed compliantly, passionately, and within a clear compelling context.
This will not only spur sales success; it will also serve boomers in an honorable manner throughout the most financially challenging period of their lives.
The soon-to-begin battle to defeat the SEC’s proposal on EIAs provides the annuity industry an opportunity to take a fresh look at how it delivers education and creates confidence in its products. In a battle that may rise all the way to the U.S. Supreme Court, it’s ironic that the amount of television the Justices watch may really matter.