Surrender charges are the single most cited factor in annuity complaints. Many — too many — agents gloss over these in their sales presentations. That’s not only dishonest, it’s just plain dumb! An annuity buyer who becomes aware, only after the sale, of the impact of surrender charges is likely to feel cheated and may file a complaint. But when a prospective buyer is told not just how and when these charges will be imposed, but why they exist in the first place, he or she will often happily consent to these charges.
Here’s how I explain them:
Mr. Prospect, we’ve talked about these surrender charges which will cost you money if you take money from this annuity in the first few years, but not why those charges exist. Let me explain.
Insurance companies know that when they issue a deferred annuity contract — or a life insurance policy, for that matter — it will take time before it can recoup the initial costs of putting that policy on the books. These so-called “acquisition costs,” including the company’s regular overhead costs (salaries, operating expenses, agent commissions, etc.), always exceed the first year’s premium. The company will literally lose money if the policy is not kept in force for long enough to see the insurer’s investment return for investing the premiums equal those acquisition costs.
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There are three things the insurer can do to make sure it doesn’t lose money. It can impose an initial sales charge — say 6 percent — and credit your contract only with 94 percent of your premium and credit interest only on that 94 percent. Does that strike you as something you’d like to buy?
The answer, in my experience, is always no.
OK, I thought so. The second thing the insurer can do is pay you less interest that it could afford or impose annual fees. How’s that sound to you?
Again, the answer is always, “No. I don’t like that.”
Right. The third thing the insurer can do is to recognize that it only loses money when some buyers cash in the product early, and that it can simply impose on those buyers — and only those buyers — an early surrender charge, which will not be imposed on those buyers who do not cash in early. How’s that sound? Does that strike you as a fairer arrangement?