By Warren S. Hersch
On a subject that is near and dear to annuity producers–the compensation they receive on the sale of a product–more is not necessarily better. That’s because a higher payout will almost always result in less attractive benefits for the client.
Thus, a judicious balance has to be struck, sources tell Annuity Sales Buzz. There should be adequate payout for the producer’s labor plus features that are suitable to the client, given his or her financial objectives.
“There is a fundamental trade-off between how much an advisor is compensated and the benefits the client receives,” says Michael Kitces, a certified financial planner and director of research at Pinnacle Advisory Group, Columbia, Md.
In most cases, sources say, the surrender charge period–the period during which surrender charges will be subtracted from an annuity’s account value if funds are withdrawn from the product–will lengthen in tandem with progressively higher payouts. A fixed deferred annuity that comes with a surrender period of, say, 7 years and that pays the producer a 3% commission might be lengthened to 10 years if the commission were to be increased to 6%.
How else might increased compensation be to the client’s detriment? Christian Clark, an a producer at Successful Solutions, San Diego, Calif., says contracts with higher commission schedules may also include a market value adjustment if the client fails to annuitize the contract.
Another factor is the interest earned in the annuity, a key variable that could clinch or sink the sale. All else being equal, the greater the compensation paid to the producer, the lower the interest credited to the client’s account. This is frequently true, sources say, of products that offer a bonus in the form higher “teaser” rate during the initial year of the contract, with the rate then dipping to a standard rate in subsequent years.
“From a pricing perspective, the interest paid to the client is absolutely affected [by the commission payout],” says Kitces. “If the insurer receives a dollar from the client and immediately writes the agent a check for 10% of that amount, then the carrier only has 90% of that money to invest,” he adds. “To get its money back, it will pay out a reduced interest rate.”
What commission rate on fixed deferred annuities do producers think appropriate? Given currently low market rates, compensation ranging from 2% to 5% of the value of the contract is generally considered the norm.
Products that offer substantially higher rates, particularly those approaching double digits, should be viewed with suspicion, experts say.
“Should an independent marketing organization offer between 6% and 10% on the sale of a fixed product, I would have to question it and ask how they’re paying such a high commission,” says Clay Blanton, a chartered financial consultant and principal of Blanton Wealth Creation & Insurance Solutions, Fresno, Calif. Normally, such high-paying products will come with caveats and loopholes that are not to the client’s benefit.”
Kitces agrees, observing that he also would be “nervous” about promoting fixed deferred products offering payouts beyond the 3% to 5% range. “Advisors are entitled to get paid for their work,” he says. “But they’re not entitled to get paid so much that the client can’t earn a good return on what they’re investing.”
Using an extreme example, he notes that an annuity that pays out 0.5% in interest and that offers a commission of 7% would require the client to hold the contract 14 years to break even. By contrast, the cost of the contract that pays the agent 3% could be recouped after just one year if the annual interest yield is an equivalent percentage.
As to the impact of “levelizing” commissions–compensating the advisor in roughly equal amounts over a period of years, as opposed to a front-end or “heaped” payout immediately after the sale–sources question whether this structure would result in a more competitive and (for the client) attractive product. But they agree that such trailing commissions would encourage producers to provide better service to clients after the sale.
“If insurers created a level compensation scale such that the commission was commensurate with the surrender charge period, then the client would get the best service the agent or broker could provide,” says Clark. “This is critical to improving client satisfaction. It’s a win-win for company, broker and the client.
“If you get paid only heaped compensation, there is no incentive for me to support the client in the future,” adds Kitces. “On the flip side, it’s hard to grow a new business on levelized commissions. Plus, we don’t see this type of compensation structure as much on fixed annuities as we do on variable and equity-indexed products.”
Experts agree, too, that advisors should disclose in conversations with clients how generally they’re paid, be it commission-only, fee-plus commission or fee-only. But they should not have to indicate the precise amount or duration of compensation, unless prompted by the client.