Annuity Criticisms Often Boil-Down to Control of Assets

Annuity criticisms are a dime-a-dozen. 

The majority of financial advisors seem to have some issue with annuities, consumer perception is generally terrible and the financial media often appears to provide a reflection and reinforcement of prevailing sentiment.

There is a case to be made for “control of assets” as the common denominator for both the consumer and financial advisor perspectives.

Control of assets basically refers to the fact that annuities involve handing over money to an insurance company. 

Unlike exchange-based products such as ETFs, mutual funds or individual stocks and bonds, an annuity contract requires a consumer to relinquish control of assets for some meaningful period of time in exchange for a promised return of that money (in various forms—depending on the type of annuity) at some point in the future. 

The fact that consumers are averse to handing over a portion of their otherwise liquid life savings to an insurance company is perfectly natural.  While these behavioral-based obstacles surrounding annuity adoption may not be entirely rational, they are very real and serve as a piece of what economists refer to as the annuity puzzle.

In the case of financial advisors, the control of assets analysis is not so clear-cut.

Some of the control of assets concern among financial advisors is legitimately related to client interests.  For any number of reasons—including costs, lack of liquidity and overall suitability—the decision to retain control of assets and avoid using an annuity may be right for a client.

However, it can be argued that some portion of financial advisor aversion to annuities is related to business models and compensation-related incentives.

The reality is that some financial advisors really care about control of assets and some could care less. 

Those who don’t care at all tend to be insurance agents and brokers who receive commission-based compensation from insurance companies for the sale of products.

Those who really care about retaining control of client assets are fee-based and fee-only financial advisors whose compensation is related to something referred to as assets under management or “AUM.” 

AUM-oriented financial advisors receive a fee that is based on the amount of client assets they control.  For example, assume that an advisor has 50 clients and that the average client account balance is $500,000.  The total AUM would be $25 million and the level of compensation might be 75 basis points (three quarters of one percent) of that $25 million, or $187,500 per year.

Annuities do not fit this AUM model so well as annuitized funds reduce the amount of fee generating assets and therefore compensation.

In addition, financial advisors will occasionally sell their “book of business” to another firm.  This can be very lucrative as the valuation is typically some multiple of trailing year(s) revenue.  Again, annuitized assets can complicate and detract from this trailing revenue figure, and therefore have a negative impact on the valuation of the business.

The bottom-line is that potential conflicts of interest are not confined to the “greedy insurance sales-folks” that are so often invoked by the financial media.

The control of assets issue should make financial services consumers equally if not more wary when their financial advisor never bothers to even mention the word annuity.