An Interview with Wharton Professor David Babbel - Part One

This is the first part of an interview with Wharton Professor David Babbel.

Professor Babbel led the fixed indexed annuity study that is discussed in several previous posts on Annuity Digest.  These posts can be accessed by clicking here.

Part 2 of this interview will be posted later this week.  Annuity Digest would like to thank Professor Babbel for spending time with us for the interview.

 

Annuity Digest: If you had a friend who knew very little about annuities or investing, how would you communicate the gist of this study and its results to that person?  In other words, the study was presumably developed for an industry and academic audience.  What would you want or expect a consumer audience to take from the study?  Is there a sort of distilled message that could be drawn from the study for a consumer audience?

Professor Babbel: The genesis of the study is as follows.  There has been a lot of misinformation in the popular press regarding FIAs. The vast majority of newspaper and magazine accounts vilify FIAs based on the results of alleged academic studies. The in-depth studies we conducted took over two years to complete and involved six Ph.D. financial economists and a pair of very well known senior actuaries.  Our studies show that the products of at least some of the companies in this field are viable – indeed, rather attractive products. Our findings regarding actual products show that since their inception in 1995, they have performed quite well – in fact, some have performed better than many alternative investment classes (corporate and government bonds, equity funds, money markets) in any combination.

Annuity Digest: What was the catalyst for the study?  What drove your curiosity?  Was it the seeming disconnect between conventional financial media coverage of FIAs and what you thought might exist from a performance standpoint?

Professor Babbel: FIAs hit the market like a storm and soon become one of the most popular insurance products. I had done several studies on deferred annuities prior to the arrival of FIAs in 1995, and had a natural curiosity to study the structure, behavior and performance of these new varieties.

Annuity DigestAsset decumulation is front and center for a number of reasons—including demographics, social security/public policy, the financial crisis, etc. What role can professionals in academia play in changing the manner in which consumers are informed about annuity products and in overcoming some of the misperceptions and behavioral hurdles that exist in the industry?

Professor Babbel: On the one hand, you have sales people and insurance marketing efforts to describe FIAs in a favorable light. On the other hand you have class action attorneys who do what they can to vilify FIAs. State regulatory bodies, appropriately, do not typically take a stand, one way or the other, except with regard to whether the products comply with regulations and whether the sponsoring companies meet solvency requirements. The Federal Government and FINRA have never regulated these products and currently have no expertise to comment, credibly, about the merits or defects in these products. Academicians generally “do not have a dog in this fight” and can look at the products dispassionately. They are not seeking to sell any products, nor expand their regulatory empires. Their studies are peer reviewed by disinterested experts. Therefore, the studies done in academia should not be fraught with bias one way or the other. Typically, academicians take years to study products such as these, and one can see the literature meandering back and forth as greater understanding and more intelligent and appropriate analytical tools are employed to study the instruments. The main problems with academic studies are that they typically take a long time to get published, many of the best ones are not readable by a lay audience, and it typically takes an academician with expertise to sort through the varying methodologies and findings to make sense of them.

Annuity Digest: Asset decumulation and the annuity industry typically involve products that are heavily intermediated and sold rather than bought.  How might investment professional use the information in your study to better serve their clients, and how might consumers use the information to better inform/prepare themselves for a very important decision and purchase?

Professor Babbel: Our studies do not make predictions about how well FIAs will perform in the future. Rather, they undertake a rigorous analysis of the products and the alleged defects in the products. They found in the products that were examined in depth, they operated the way they were designed to operate and over the period of their existence, performed well.

Annuity Digest: Has the industry—either trade groups or marketing/wholesale organizations—approached you about the study?  If not, why do you believe this might be the case?

Professor Babbel: Yes, but I have thought it best not to write and publish a sponsored study on FIAs because of the litigation surrounding the issue. Rather, from time to time I have presented our findings in academic conferences and will ultimately publish something on the subject when I find time. Recently, some other academic articles have been written that largely corroborate our studies, and with an expanded purview and alternative methodology.

Annuity Digest: Why, in your opinion, has the FIA industry not jumped on this PR and marketing opportunity?  It seems that either trade groups or asset managers within other asset classes would, to say the least, leverage a report like this from a marketing and PR standpoint?

Professor Babbel: I do not undertake research to help market any company’s specific products, nor do I endorse a product of a particular company publicly. I do, however, look at a genre of products, including average features and average pricing, and comment on the entire genre. For example, I may research whole life insurance contracts, participating and nonparticipating, and comment on their pricing and performance, but I won’t comment publicly on a particular company’s product.

Key Phrases Manual: 

Comments

Professor Babbel says "I do not undertake research to help market any company’s specific products, nor do I endorse a product of a particular company publicly."
But according to The Wall Street Journal the Babbel study was financed by New York Life, a major seller of annuities. I am totally unimpressed by the research of Babbel and the other "experts." It is shoddy and incomplete and biased toward annuities.
No way you can tell me that an annuity -- with its high commissions, fees, marketing costs, and expenses -- can beat a simple investment in one or two no-load, low-fee mutual funds. There also is no way to compare an annuity to alternative investments because the sucker who buys an annuity loses all the "investment" left in it.

The Babbel study referenced in the recent Wall Street Journal article is a completely different study...

Hilarious--the guy is not even referencing the correct study with his rant.

Also, wasn't the whole point of the study (which is as transparent as day) to objectively and professionally (the guy is a Professor at Wharton after all) compare fixed indexed annuity performance to a set alternative investments :)

If you would only do a little homework, you would know that New York Life does not sell FIAs. Actually, they push the hell out of Variable Annuities. So if they financed Babbel's study, they did it out of good faith and altruism. Another concept you are ignoring is the risk of your no-load funds. Where in your program does the No-load fund guarantee the principal, guarantee profits are taken and locked in with no taxes every year, and guarantee the owner has lifetime income. No-loads have one distinct attractive feature: they have no sales fees. So for that benefit, you give up the safety and strategy of an FIA? You are shortsighted, Steve. Let's also remember how your fee advisor gets paid (I know because I am one). He charges 1.5% per year, right? In 15 years, he has successfully milked the client of 23% of his retirement portfolio. Yes, it's true. An annuity commission is between 1% and 7% based on the term. That's a far cry from 23%. Now we know why RIAs and brokers don't like them.

Careful! Your ignorance is showing. Not to mention your bias. Fixed index annuities have no fees or commissions that come out of the investors' funds. In addition, your statement, "There also is no way to compare an annuity to alternative investments because the sucker who buys an annuity loses all the "investment" left in it" is patently absurd. It's easy to compare and amount of money in an annuity with what the same money would have done in "one or two no-load, low-fee mutual funds" over the same period of time.

Pick the funds. I will compare my fixed index annuities with you any day.

Your rant is like so many I read from people who either know nothing of which they speak, or the Wall Street mavens who have be stealing their clients' money for so long they feel entitled to continue to prey upon unwary investors and become bitter at any alternative that comes along.

Finally, while New York Life does sell annuities, they specialize primarily in variable annuities which are a completely different animal from what Professor Babbel's study focuses on. In that case you are correct; the marketing costs, fees and commissions are completely out of hand and you would be hard-pressed to find any index annuity broker hawking variable annuities...so maybe your rant is base solely on ignorance after all.

Could someone list the FIAs Prof Babbel used in his studies, please? How can I get a ranking of FIA products in the markets i.e Consumer Reports like ranking with various aspects evaluated? The planner I am talking to may only want to promote the product he knows. He may or may not be aware of other products, which could be better.

Could Mr. Stephen Kelley list the FIAs he likes and their performance, please?

I am not entirely certain, but have a feeling that the FIAs used in the study were not published as part of study.

Maybe someone else can provide more definitive feedback.