Thursday, March 28, 2024

The FYI On LTC, AOBs, COBs And EOBs

My title is tongue in cheek of course but there is truth to it. There are a lot of acronyms and terminology that can make one’s head spin. So, I wanted to write a quick article discussing the meaning of some of these things, differentiate between a few areas of the long term care business, and also explain correct terminology.

I believe that the long term care opportunity for you, the financial professional, is too large to ignore. So, if you are not really familiar with the long term care space, this article may shed a little light on the topic.

Stand Alone LTCI
Although the stand-alone long term care insurance marketplace has gone through some significant “de-risking,” these policies are still superior to what they were when first offered as they are loaded with various features that did not exist previously. For instance, when first offered in the late 70s by the handful of carriers that offered it, LTCI only covered expenses associated with nursing home/skilled nursing facilities. This is in contrast to the policies today that also offer coverage for in-home care, adult day care, and assisted living facilities.

The old label of “nursing home insurance” is no longer appropriate. As a matter of fact, based on many studies as well as my experience at long term care carriers, anywhere from 50 to 75 percent of first time long term care claims are for in-home care versus nursing home and assisted living facilities. These numbers are important because they demonstrate the flaw in the notion that long term care insurance is “nursing home insurance.” It is important to discuss with clients that LTCI is insurance that can actually allow you to stay out of the nursing home and allow you to have more options than if you were otherwise on Medicaid.

To discuss some features of these products, some traditional LTCI policies today have return of premium options that address the “use it or lose it” concern that many consumers have had about LTCI. One can choose among a handful of benefit periods and also a handful of inflation options. One can also choose a shared care feature that allows you to use your spouse’s benefit pool if yours depletes. The list of features goes on…

What about the huge premium increases that have happened over the last couple of decades? I believe that, with updated interest and lapse assumptions on new offers, the prices will be more stable than they have been in decades. No longer are carriers estimating overly optimistic long term interest rates along with six percent lapse assumptions! (Note: For carriers, an aggressive lapse assumption can be dangerous and overly rosy because that means they are assuming they will not have to pay claims on those policies that lapse. Consumers have held on to their long term care policies and carriers have reflected this in their new lapse assumptions.)

Combination/Hybrid Products
Combination products are an alternative to the traditional LTCI we just discussed. Because many people discuss “combination products,” “acceleration products,” and “linked benefit products” as if these terms are synonymous, I would like to spend some time differentiating the terminology as these terms are not synonymous.

Combination/hybrid products are the broad category of products that can be on a life insurance chassis or an annuity chassis. Thus, a combination/hybrid product is an annuity or life insurance policy that has some form of long term care benefit, usually in the form of a rider. These products can be life insurance with accelerated death benefit riders, annuities with long term care riders, or they can be true linked benefit products that we will discuss in a bit.

With what has happened in the stand-alone LTCI marketplace, today around 90 percent (Milliman 2021 Long Term Care Insurance Survey) of the long term care marketplace is combination products versus stand-alone LTCI. Clearly the flexibility of these combo products is very appealing to financial professionals and consumers. Combo products will only continue to grow in popularity.

Below are two subcategories that make up the larger combo products/hybrid products category:

  • Acceleration of Death Benefit Products. (Note: the AOB is technically a rider added on to the base policy.)
  • Linked Benefit Products

Accelerated Death Benefit Type Products
This is a subcategory of the broader combination product/hybrid world. These are usually life insurance-based products where the death benefit (and no more than the death benefit) can be accelerated for the purposes of a long term care event or a chronic illness.

When I present this product/rider I like to point out that the life insurance of the old days typically had one “trigger” in order to access the death benefit—death. However, today’s products many times have a chronic illness rider or long term care rider that allows for the acceleration of the death benefit. These AOB riders are the mechanism that allows the insured to get enjoyment out of the product during their lifetimes rather than having to die. Again, the two prominent rider types offered within this category are chronic illness riders and long term care riders. Again, AOB riders will generally allow for just the death benefit to be paid out for long term care, nothing more. What if you want more of a long term care pool? That is where linked benefits might come in.

Linked Benefit Products
Linked benefit products are the second subcategory of the broader combination product/hybrid world. What separates a linked benefit product from just a normal life policy with the death benefit being available for acceleration? It is the COB rider (continuation of benefits) or EOB rider (extension of benefits). With just an AOB rider (acceleration of the death benefit) that we previously discussed, the maximum amount that is accessible is the death benefit, period! However, when you add a COB/EOB to a product that also has an AOB, you get access to multiples of the death benefit when it comes to long term care. A lot of acronyms, so allow me to give you an example.

Example: John bought a linked benefit life insurance policy for a single premium of $100,000. The death benefit on this life policy is $200,000. Should he need long term care, the acceleration of benefits rider allows him to access all of this death benefit. What if he continues to need care even after his death benefit is depleted? Well, fortunately, because this is a linked benefit product, he has a COB/EOB rider that allows for an additional two times (example) his death benefit, or an additional $400,000 in the long term care pool. That COB/AOB that piggybacks on the base product and the AOB is what makes a linked benefit product a linked benefit product. Once his AOB is depleted, the COB/EOB can kick in. What if he died before depleting all of his death benefit? The remaining death benefit will go to a beneficiary.

(Note: One of my favorite products is actually a linked benefit annuity product that triples the clients premium for purposes of long term care, with relatively minimal underwriting. The client gets access to their annuity accumulation value if they need long term care, plus they have a COB/EOB that is an additional two times their accumulation value!)

New Annuity Caps Better Than Renewal Caps. Do I Replace?

Carriers have better pricing horsepower for annuities than they have had in over a decade. By “pricing horsepower” what I am referring to is interest rates. We all know that the 10-year Treasury Bond yield has increased substantially over the last couple of years. However, a better benchmark to pay attention to for what carriers largely invest in is corporate bonds. Carriers like the additional yield that corporate bonds provide over Treasury Bonds, while maintaining “investment grade” quality. Hence, my favorite benchmark, the Moodys Baa Corporate Bond yield.

Chart 1 shows the interest rates–minus the carriers’ spread–can be viewed as the call option budget for indexed annuities, which ultimately determines the caps and participation rates. Clearly, at the time of this writing with the rate being 5.59 percent, the carriers are able to purchase caps and participation rates that are very high, at least relative to recent history.

For many agents, these rising rates and the rising rates’ impact on annuities is new territory. Because of this, I have recently had conversations with agents about the disconnect between the caps/par-rates on new policies versus renewal caps/par-rates on existing policies.

For example: I recently saw a renewal statement on a client’s policy where the renewal participation rate was 185 percent. Although that seems very high, what was the participation rate on new policies for new clients that want to purchase that same annuity today? Almost 300 percent! Naturally, this disconnect has generated questions from the agents. Let’s discuss a couple.

First, is the carrier trying to “rip off” our clients that are in the old policies?

No. Allow me to explain.

Annuity caps are based on “new money rates” that the carrier is able to invest their dollars in at the time the annuity was issued. And to simplify, the cap on the annuity will remain somewhat tied to those original rates, although there will be some ebbing and flowing as interest rates adjust and also as call option costs ebb and flow. With existing annuities, you see relatively low deviation among the caps/par-rates at issue versus caps/par-rates on renewal. The important thing to note with annuity/new money pricing is, when prevailing interest rates increase, annuity caps on new issues are very quick to respond—like what we have seen over the last year. The downside here is, as interest rates have increased and new issues are looking great, the renewal rates on seemingly identical older policies are not keeping up! Why is this? Because, remember, new money pricing “kind of” anchors the annuity pricing to the original bond rate from when the policy was originally purchased X years ago.

Annuity/New Money Pricing is in contrast to “Portfolio Pricing” that carriers often use with life insurance. With portfolio pricing, the blended rate of the insurance carriers general account (or large “tranches” within the general account) is what determines the cap/par rates on IUL, whether those IULs are new IULs or renewal IULs. Over time, that multi-billion-dollar chunk of investments will slowly go up and down with prevailing interest rates. The overall interest rate of the general account is very slow to respond because the carrier’s general accounts are so large. Those general accounts always have bonds that come to maturity and are being replaced, but only a relatively small chunk at a time.

Furthermore, with the life insurance general account pricing, the carriers are generally able to keep new issue caps/par-rates in lockstep with the renewal cap rates on existing policies, at least for the same generation of product. (Note, it is a common practice for carriers to launch new generations of products where the carriers can more easily disconnect the renewal-caps/par-rates from the new-issue cap/par-rates, but that is a conversation for another day.)

The positive side to “Portfolio Pricing” that most life carriers use is when interest rates are rapidly decreasing. When this happens, there is a significant lag in the amount of time it takes for that giant portfolio to get watered down by the lower rates. For instance, for the longest time we saw IUL caps on new IUL policies hold “relatively” stable while the annuity caps on new issues plummeted because of dropping interest rates. Now the inverse is happening with annuities. Rates are spiking up and new-issue annuity caps are as well. But agents are left wondering why the annuity renewal caps are not increasing as well. It all has to do with the “New Money” pricing that annuities use. So, the answer is , the carriers are generally not playing games by purposely keeping renewal caps low relative to new issues.

Now, with what I just said about annuities, many agents are wondering if it would make sense to “surrender” old annuities to get the better pricing. The answer is, it depends on the scenario. Also, it depends on the carrier. Many carriers have rules such as, “As long as the net loss (after premium bonus is taken into consideration) is less than two percent or three percent, then we will allow you to use our annuity to replace the old annuity.” Of course, that is me paraphrasing.

Also remember, this interest rate environment that we are in is exactly why “Market Value Adjustments” on annuities were created—to insulate the carrier from the bond losses they would have if your clients cashed out their annuities after interest rates have increased. It is no coincidence that the MVA formula in most policies is a similar formula as the formula for bond pricing. With bonds that the carriers are buying, as interest rates increase the value of their bonds decreases. With an annuity, as interest rates rise, the client’s surrender value decreases, all else being equal. The MVA is the mechanism the companies use for passing through bond losses or gains to the clients, at least if the clients are going to cash out their annuity prematurely.

We have all read about the failed Silicon Valley Bank that had to liquidate treasury bonds at a severe loss, which accelerated their demise. This loss in their treasury bond portfolio was because of one thing—rising interest rates that diluted the bonds’ values. If the bank had a way to pass on those losses to consumers, it may have helped. Alas, that is not how bank products work. With annuity contracts however, insurance companies have the luxury of having “MVAs” that provide some insulation against interest rate risk (the risk of rising rates).

So, if you are considering surrendering a client’s annuity to go into a new one, understand that there is a lot to take into consideration such as:

  • Market Value Adjustments
  • Carriers’ rules on “replacements”
  • Losing a “benefit base” that may be very high on the old policy
  • Losing an enhanced death benefit
  • Fees on the new policy versus fees on the old policy
  • Comparing new guaranteed income levels to that of the old policy
  • Premium Bonuses on new policies to offset surrender charges on the old

On the last point about Premium Bonuses: There are great premium bonus products out there that may help put the client in a better position than what the client currently owns. These premium bonuses can often offset surrender charges and MVAs. But, there are also premium bonus products that may be inferior to the existing product the client currently owns. Premium bonuses are rarely given because the carrier just wants to be nice. That pricing is always made up elsewhere in the product.

GLWB Economics: Are GLWBs Even A Good Thing?

This article is somewhat of a meshing of my last couple of monthly columns. In one article I discussed the economics and the “internal rates of return” by delaying your Social Security benefits. In another article I discussed indexed annuity GLWBs versus the old four percent rule. This article is bringing both concepts together—GLWBs and internal rates of return.

First, what is a GLWB? Quite simply, a GLWB is a rider that attaches to an annuity that allows for the client to continue to receive income from that annuity beyond the point where the accumulation value (the consumer’s money) hits $0. Without a GLWB, the alternative may be that the consumer lives so long that they spend all of their money and are left with no income from that point forward. GLWBs are “longevity insurance” that can be attached to a base annuity, usually for an additional fee. That additional fee may be one percent of the “Income Value/Benefit Base” for example. The consumer’s withdrawals under the provisions of the GLWB go on for as long as the consumer lives. Now, obviously that doesn’t mean the consumer can choose whatever level of income they would like! There are maximums that are specific to the company, the product, the amount of time the consumer defers payment, and the age that the consumer is when he/she elects to activate “lifetime income.” The economics of those GLWB maximums is what we are assessing in this article.

With interest rates increasing the way they have, GLWBs have better “economics” than what they had just one or two short years ago. As a matter of fact, the guaranteed income from these GLWBs dwarf the “safe withdrawal rules of thumb” that I discuss in previous articles. However, although it sounds good to say “GLWBs will generally pay out higher income than the four percent rule,” what does that mean? What kind of returns are GLWBs expected to give consumers over a normal lifetime in exchange for that one percent or so rider fee? Are they more sizzle than steak?

The benefits that GLWBs provide to consumers are highly dependent on how generous the carrier is with pricing their GLWBs, along with a ton of other “macro” items like interest rates, consumer longevity, etc. At any one point in time, the carriers are all dealing with the same macroeconomic environment and consumer longevity. But even with that being the case, some carriers have great GLWBs, some have lousy GLWBs, some carriers do not even offer GLWBs.

My company’s job as an IMO/FMO is to identify the carriers that have great GLWBs for my agents among other things. But even if that “best” carrier is identified, the attractiveness of their GLWB can vary from situation to situation. Some carriers may have their GLWB priced the best for consumers that start their income at older ages, or younger ages, or the consumers that delay taking income the longest, or scenarios where the husband and wife want “joint income,” etc.

Think of term life insurance. There are carriers that usually have the lowest prices on term life insurance in general. However, within those top carriers, some carriers may focus on the “smoker” niche. Some may focus on the “Super Preferred” niche. Some may stand out relative to their peers with substandard health ratings. The list goes on. Many of us have seen term insurance “heat maps” where the best carriers for a bunch of different ages and situations are mapped out. Finding the right GLWB for your consumers is very similar. The following analysis is just the tip of the iceberg in what we can look at with GLWBs, but I think it does an adequate job of addressing the three goals of this article:

  1. What are the “economics” to the consumers of GLWBs?
  2. How can GLWB pricing vary from carrier to carrier?
  3. Even if we identify a “favorite carrier,” how does the GLWB attractiveness vary from scenario to scenario?

I have done research on several GLWBS. However, in order to keep this article digestible, I am only going to use a couple different examples.

One of the top products that my company offers is a product that has 10 percent simple rollups until the client activates their income. At that point in time, the “benefit base” stops receiving the 10 percent rollups and the client gets a percentage (payout factor) of whatever the benefit base is. Naturally, the fact that the benefit base is increasing year after year means that the consumer is rewarded with higher GLWB payments the longer he delays. Plus the payout factors increase with age as well, which is the case with most GLWBs. The flipside is, every year that the consumer delays is one year less that they will be taking income because they are one year closer to their death. That sounded morbid, didn’t it? So, the million dollar question is, do the increasing payments outweigh the fact that for every year that goes by, you shave off one year of income? This is where it comes down to internal rates of return and finding the product’s sweet spot. A lot like what I did with my previous Is Delaying Social Security Worth It? article.

Let’s say we have a 60-year-old male that is retiring this year. With $100,000 he is looking for income that will supplement his Social Security payments that he will get eventually. He has plenty of other money but he would like a guaranteed baseline of income that he will have for the rest of his life. Because he has other money, he has the freedom to take the GLWB income now, or delay. Whatever makes the best financial sense. So, you run the illustration on the product that I just mentioned. On the illustration, that product will show you (and him) the levels of income that he is guaranteed if he were to activate the GLWB at various ages. For this product, those numbers are represented in my green bars.

Those green bars indicate that if he wants to take income immediately, he is guaranteed $5,000 per year for the rest of his life. If he waits five years, he gets $9,750 per year. (Note: How are these numbers versus the four percent rule? I discussed that in last month’s column.)

The most interesting part of the graph is the red line. The red line represents the internal rate of return on his $100,000 premium if he chooses income at those respective ages and lives until his approximate life expectancy of age 85. For example, if he were to take his $5,000 income immediately and have that income until age 85, that is only a 2.23 percent internal rate of return. Not real great! Conversely, if he were to wait until age 65 to start taking income, you are now talking about a 5.22 percent internal rate of return. Not a bad bond alternative! To really take the scenario to the extreme, if he were to live until age 100, his IRR would be 6.79 percent.

Notice how the IRR spikes up if he delays five years instead of four years? That is because the payout factor on this product is banded at every five years and thus shoots up at age 65, age 70, etc. In other words, if our guy came to me and said he wanted to start taking income at age 64, I would be inclined to encourage him to wait an extra year.

Also note, I have seen people want to start taking income on the “contract anniversary,” without paying attention to anything else. Pay attention to ages and if there will be a birthday soon that would significantly bump up his payout factor. If so, it would behoove him to wait to get the higher payout factor!

What if he wanted “Joint Income” with his spouse that is the same age? The second chart represents the same product, just a different IRR Curve. This assumes the second spouse will “unalive” at age 92.

Now check out the next product that is completely different with a different carrier. If my couple has the additional money that allows them to defer taking income from this annuity for 10 years—until age 70—I would likely recommend this one. By delaying until age 70, they are looking at an IRR of 6.32 percent, assuming the income stops at age 92. This is a great “Joint Income Later” product that is priced at a whole 50 basis points higher than some of the other ones I have seen.

It is interesting to see the different shapes of various carriers’ IRR curves and how they price their products. Of course, there are calculators that I use that tell my agents the highest paying products for each scenario, but it is interesting putting the numbers into IRR context and comparing that to the yields that carriers are getting on their investments today.

It also raises a lot of carrier actuarial questions such as:

  • What life expectancy assumptions are carriers using? Is the 6.32 percent IRR so high only because the carrier expects everybody to die sooner than the other carriers?
  • What about lapse assumptions? If everybody cashes out their policy at the end of the surrender period, then the IRRs are a moot point. Remember the variable annuity carriers “buying out” the clients with GLWBs? This is because the IRR analysis was too high for the carriers to support paying out.
  • Future interest rate assumptions?
  • Assumptions on accumulation value growth? Afterall, a GLWB can be a moot point if consumers never ran out of their accumulation value because of stellar performance.

With scores of GLWB carriers out there and all of the possible scenarios that each GLWB can have, there are thousands of different scenarios that we can choose. By giving you a sample of a few, I hope this article at least demonstrates how every carrier and every product can vary in attractiveness depending on the exact situation. Partner with an IMO that understands the nuances.

If we wanted to get even more complicated, we could use the IRR analysis of these GLWBs in conjunction with the IRR analysis on delaying Social Security! If we only had the financial flexibility to delay taking income from one of those two sources, which one would I take income from first, Social Security or the GLWB? It depends on the IRR tradeoffs between the two…

Is Delaying Social Security Worth It?

This article is intended for financial professionals that have the wise business practice in helping consumers plan for Social Security, and also for consumers.

For folks that may not be interested in number crunching or those that are not real familiar with financial calculators and cash flow analysis, this article may shed light on if delaying Social Security benefits is worth it. For the layperson, it may sound good when one hears, “If you delay Social Security Retirement Benefits from age 67 until age 70, you will get 24 percent more in income by waiting those extra three years.” Well, is that a good deal or a bad deal taking into consideration “Time Value of Money?” Let’s discuss.

Time Value of Huh?
The concept of “Time Value of Money” is that $100 today is generally better than $100 received in the future, which is a large reason why around 50 percent of folks take Social Security early.

Taking it further, what would you prefer to have—$100 today or $103 one year into the future? That is a more difficult calculation because it depends on what prevailing interest rates are in the economy and if you could turn that $100 today into more than $103 one year from now by investing your $100 today. My personal choice would be to have $100 today because I know that I can invest that into something that would give me a guaranteed rate of almost six percent (Guaranteed Rate Annuity). That means that I could turn my $100 into $106 in a year. (Note: I am not taking into consideration taxes in my example.)

With Social Security analysis, we need to view what we are foregoing today—also known as “opportunity cost”—in order to get X in the future as this: What you are foregoing today is the “investment” in order to get X as the payoff in the future. The lost opportunity—or “opportunity cost”—is an economic term that much of the financial world revolves around.

In other words, if I were to invest $100 today and get $103 back one year from now, then that means the internal rate of return on my money was three percent. That means that if you are given a choice between $100 today and $103 in a year, but can only get three percent on your money, then the $100 today is exactly equivalent to $103 one year from now. Again, simplified because we are not considering taxes on the growth. The decision between $100 and $103 is a toss-up if you can only get three percent.

Another decision that is a toss-up is, if you were offered $100 today versus $106.09 two years from now. Why is that a toss-up? Because if you could invest $100 today at a rate of three percent per year, you would have exactly $106.09 two-years from now after compounding. So again, $100 today is equivalent to $106.09 two-years from now, at least if you could only get three percent on your money. Three percent is the “discount rate” that makes $106.09 two-years from now equivalent to $100 today. It is no coincidence that if you punched into a financial calculator that you are investing $100 and getting back $106.09 two years from now, that the internal rate of return will come back at three percent. Well, again, if I can get a six percent internal rate of return on my money, instead of three percent, then I will choose to take the $100 today. That $100 today can grow to $112.36 two years from now at a six percent rate.

That is how “time value of money” works.

Case Study:
Now let’s get to Social Security. With Social Security analysis, we will use the same logic as above except we are not trading one small payment today for one small payment in the future. We are trading a series of dollar amounts over a number of years for a larger series of dollar amounts in the future. So, the math is more complicated but it is utilizing the same logic.

Let’s take Rob, who has a Social Security “full retirement age” of 67. Rob’s full SS benefit—also known as his primary insurance amount—is $20,000 per year. He has a choice: Does he take his Social Security benefit today at age 67, or delay?

By my 67-year-old delaying filing until age 70, he is giving up total income of more than $60,000 over the next three years. I say “more than” because technically that $20,000 that he would receive today—at full retirement age—is generally increased with inflation. So this year Rob may be giving up $20,000, but next year he may be leaving $20,700 on the table by not filing—assuming a hypothetical 3.5 percent inflation rate.

But what is his tradeoff? The positive tradeoff in waiting until age 70 is that after three years his Social Security payments would amount to $24,800 per year—not including inflation adjustments—instead of the original $20,000 per year. This is because he would have received eight percent per year in “delayed retirement credits” that the Social Security Administration gives us for delaying, which amounts to an additional $4,800 in yearly benefits. Again, it would actually be more than $24,800 because it would technically be inflation adjusted. We will reflect on inflation in a bit.

So, we understand that he would get roughly $4,800 more in Social Security payments, but for how long? And most importantly, is that a good deal? Our 65-year old male has a life expectancy (per the Social Security Tables) of approximately 15 years. Therefore, we can plan on our “approximately” $4,800 in additional Social Security payments going for 15 years.

As we analyze the question of “is it worth it?” think of the scenario as the following analogy: Rob would be paying into an “annuity” for three years to the tune of $20,000 per year plus inflation. That is the “opportunity cost” of delaying. We will assume a 3.5 percent inflation rate because that is the historic long-term average. That “annuity” will start providing lifetime payouts in the fourth year of the additional $4,800 per year that is adjusted for inflation every year. That last point is important. Rob is not “just” getting an additional payout of $4,800 per year. We are getting an additional inflation adjusted $4,800 per year!

TABLE 1

In (Table 1) I laid out the cash flow of our scenario. The parenthesis represents the lost opportunity of $20k per year for three years, which adjusts for inflation each year. Then, at age-70, the benefit that our retiree gets starts rolling in. As mentioned, the $4,800 is adjusted each year for inflation as well. With inflation of 3.5 percent, our $4,800 today will “inflate” to $5,321 three years from now, and so on.

Our ultimate question is this: In our “annuity” analogy, what would the rate of return be on this annuity where we paid in over $60k in return for the additional income? What “internal rate of return” does delaying Social Security provide, at least based on our 67-year-old male, this lifespan assumption, and this inflation assumption? 5.66 percent. Not a bad rate, especially if Rob is receiving his Social Security tax-free. If Rob was in a 22 percent tax bracket, then that is a “taxable equivalent” rate of return of 7.26 percent. Can Rob get that kind of return elsewhere? If he can, then maybe taking Social Security at “full retirement age” is the best option.

\Table 1 is merely some quick IRR analysis of Rob’s decision using certain assumptions. Technically, there are other variables and factors that he should look at as well before making his decision, but we will discuss a few of those in a bit.

TABLE 2

Rob Lives Longer than “Life Expectancy”
One such “variable” is, what if he lives shorter or he lives longer?

Let’s assume he lives an additional five years beyond life expectancy. (Table 2) is our new cash flow table that shows our internal rate of return as being 8.10 percent! That is a taxable equivalent of 10.38 percent, assuming his 22 percent tax bracket. If Rob has good genetics, he may want to consider delaying!

Other Factors:

  1. Different Inflation Assumptions: If you think inflation is going to be higher than my 3.5 percent, then the internal rates of return will increase relative to my examples above and vice versa.
  2. Taxes: If your Social Security is being taxed, as almost 50 percent of recipients’ are, then my “taxable equivalent yield” goes out the window. However, many times, delaying Social Security to age 70 helps the tax situation because you are generally “spending down” your pre-tax dollars in those “bridge years” from age 67 to age 70. This can lead to less reliance on pre-tax dollars at age 70+ that can otherwise add to your Social Security taxation. Said differently and to exaggerate, if you spun down all of your pre-tax dollars from age 67 to age 70, then you would not be taking any of those pre-tax dollars in the years you are taking your Social Security. This means possibly less taxes on your Social Security because your provisional income would be relatively less! Furthermore, by spending pre-tax dollars in your bridge years you are reducing what you will ultimately have to take in required distributions at age 73.
  3. It’s not just about Rob: Stats say that one of a couple that is in their mid-60s will live until age 92. So, if Rob has the higher SS payment between he and his wife, she will ultimately inherit his benefit. And if she lives until 92, for example, then my IRR number is even larger. The internal rate of return on Rob delaying until age 70—and assuming that his wife lives until age 92—is 8.94 percent, or a taxable equivalent IRR of 11.46 percent.
  4. Annuity Payments: Let’s say Rob has an annuity where he can start taking lifetime income. Many annuities “reward” you if you delay, like Social Security. So, if at age 67 Rob is deciding among delaying his SS into the future and activating annuity benefits right now or taking SS now and delaying activating his annuity payouts into the future, that could be some interesting analysis. For example, if the IRR on delaying an annuity payout is greater than the IRR on delaying the Social Security payout, he may want to consider taking Social Security now.

Retirement Income Software is Invaluable!
This article reflects just a few variables and components of hundreds. Therefore, each consumer should work with a financial professional that has the planning software that will project how much each filing scenario will give them over their lifetime, on an after-tax basis and after inflation basis. Then and only then will a consumer feel confident that they made the right choice. It’s better than flying by the seat of our pants. If you are a financial professional and want to learn more about software (or Social Security in general), feel free to contact me.
If done correctly and in a manner that reflects “time value of money,” you will see that the difference between filing correctly and filing incorrectly can be a difference of tens or even hundreds of thousands of dollars.

“If I Don’t Sell That Product, It’s A Bad Product”

A while back, I posted something on LinkedIn about how to assist consumers that desperately need help get qualified for Medicaid. As you know, Medicaid can pay for long term care (nursing home care primarily), if a consumer is deemed financially incapable. It is not a replacement for long term care insurance, but it can help consumers that did not prepare. And now those consumers are in a time of distress and need. Afterall, this is what we do as an industry—help folks in their time of need. After posting these Medicaid planning tips that leveraged “Medicaid Compliant Annuities,” there were several positive responses from agents who wanted to learn more.

However, as with any social media post that gets thousands of views, there were a few negative posts—although a tiny percentage of total responses. I would divide these negatives into four different camps:

  1. An attorney: All the attorney had to say was that all financial professionals should hire an attorney if they choose to help clients with this, and it’s ridiculous that I should even comment on Medicaid because I am not an attorney. Basically, only attorneys are smart enough to cover this topic.
  2. Fee-Only Advisor: This guy had nothing to say other than annuities are bad and include a lot of “fees,” which was ironic to me. (By the way, single premium immediate annuities for Medicaid purposes generally have no fees!)
  3. The life insurance guy that downplayed Medicaid: Because if everybody owned life insurance with a chronic illness rider, the client would never be in that position in the first place. (PS. I am a “life insurance guy” myself but disagreed with him bashing the client in hindsight.)
  4. My Favorite: The guy that must’ve viewed my post as taking away from his long term care insurance sale. This guy wanted to criticize me because I called it “Medicaid planning,” like the rest of the world—including the CFP Board! (He didn’t realize that I am a significant fan of long term care insurance.) He took the opportunity to plug his designation course for all that were viewing. LOL. Consumers are destitute because of long term care expenses, and we are quibbling over terminology?

My social media post—believe—is an unfortunate microcosm of what can take place in this wonderful industry. All four individuals above viewed that scenario of helping clients who previously failed to plan as taking from their paychecks. I am sure they would not admit that, but that is where the negativity came from. Any proposed solution that was outside of how they got paid in their own world is a bad solution. To the Chevy guy, there is not a Ford on Earth worth anything and vice-versa. This mindset does our collective industry no good. It is OK to be cheerleaders for products and strategies that are different from what we offer and still make great money! There is about $30 trillion in financial assets that Americans own currently. There is enough to go around.

In politics, if you listen to the commentary from our “leaders” on both sides of the aisle, there is never anything that the other side does that is any good. If one party comes out and says, “We cured cancer,” the other party will discuss how that “horrible development” will put a strain on pharmaceutical sales and the industry will collapse. Therefore, those politicians stand on the platform of negativity, as if that will help their party’s cause. What about the “Party” of the American People? Why not just view it all as one party—The American People Party?

I like the social media example above because of the amount of irony. I use attorneys every single week. I am pro attorney. I am also an “investment advisor” that charges fees on securities assets. I am a part of that “party.” As many of you know, I love life insurance and I especially love the chronic illness riders. What about long term care? If everybody in America owned an LTCI product, consumers would be in better shape. I am pro LTCI.

My point is not about how bad social media, or our industry, is, my point is about how we as professionals need to think beyond our immediate paycheck because the “partisanship” in financial services does nothing good for our business as a whole. For instance, is there anybody in our business that thinks Ken Fischer has done anything good for our industry and the reputation of financial professionals? This is the guy who says he would die and go to hell before selling an annuity. Where is he today as the stock market is down over 20 percent and the bond market down 15 percent? Do you think he has turned a few consumers away from our business because of his messaging? Absolutely. I am sure there are consumers that have not saved much in retirement dollars—whether in annuities or with Ken Fischer—because of Ken Fischer’s messaging.

There was actually a fifth camp in my social media post. It was one gentleman that effectively said that he was previously interested in the medicaid planning topic but not so much anymore because of the “partisanship” and confusion. I agreed with him!

Just as important to me is the power of one’s word. When people realize that you are a “partisan” that cheerleads only about your product/strategy, then all of your words ring hollow from there. This is why nobody believes what politicians say, especially when they are speaking about the other party.

When you are a “partisan” in financial services, your recommendations will be scrutinized heavily and your constructive criticisms will be discounted. And when your words become hollow to your prospects and/or clients you will not achieve full potential. Because of this, I do believe in transparency and calling out bad actors and bad strategies. For those close to me, you know that is my style. When my 15-year-old asks me how I thought he did in his basketball game, he knows what he is going to get whether good or bad. But, he is all ears and takes my feedback seriously. He doesn’t even ask my wife (his mother) how he did because she will invariably tell him “Great Honey!” every single time because she is such a positive and wonderful human being. In short, honesty is important but just because some person or some strategy was not in the same “Party” as you does not make them a “bad actor” or their options “bad strategy.” Our words need to mean something.

I listened to a podcast a while back where Neil deGrasse Tyson—an astrophysicist—was talking. He was discussing the deepest part of Earth’s surface and also the highest part of Earth’s surface. He stated that the Mariana Trench in the Pacific Ocean is the deepest—being over 30,000 feet deep. That is about six miles deep! Additionally, the tallest point on Earth is Mt. Everest at around 30,000 feet high. Almost six miles high! These are huge peaks and valleys to us small Earthlings. However, if you were a giant that was holding planet earth that was now about the size of a cue ball, you wouldn’t even feel that valley or that peak. In other words, in relative terms, the Earth is as smooth as a cue ball when you think “big enough.” This makes sense because twelve miles of difference between the deepest part and the tallest part is nothing compared to the overall size of the planet which is almost 8,000 miles in diameter!

Now I am not saying that our industry is as perfect as the surface of a cue ball. What I am saying is that I think it is important that we “think big picture” when it comes to our industry. Are there peaks and valleys when it comes to some products and some strategies? Absolutely. However, by more consumers being involved in our industry, those consumers and the world will be a better place. Partisanship does not help that cause.

GLWBs, Step-Ups, And Other Random Annuity Thoughts

A few weeks ago I was preparing an indexed annuity illustration for one of our agents who had a client that wanted guaranteed lifetime income. So, I was running one of my favorite indexed annuities with the GLWB rider. As I looked at the printout, I came across something that I hadn’t seen in years. It was a “step up!” It had been such a long time since I’ve seen one of these, at least on this type of a GLWB rider, that I was confused until I realized what was happening and why it was happening: The 11.5 percent S&P 500 “cap” was outpacing the GLWB rollup rate. Now that is not something you saw when caps were at five percent!

Over the last few weeks I have also had a few questions from agents asking me, “Can you explain what is happening in this illustration?” So, I felt the topic to be worthy of a column along with a few other random thoughts on GLWBs.

A couple decades ago I was with a very large company that was a leader in the variable annuity space. At the time, the hot item with variable annuities was “guaranteed lifetime withdrawal benefits”(GLWBs), and its predecessor, “guaranteed minimum income benefits” (GMIBs). These were very popular because, on the back end of the dotcom crash, consumers were looking for guarantees to protect them from the turmoil they had just experienced. The GLWBs separated themselves from the GMIBs in that the GLWBs did not require annuitization, just “withdrawals.” Hence, with the GLWBs, the company did not require the client to lose control of their account value by locking it into a perpetual income stream.

At that time our hot VA product story was that the client had a “benefit base” that was guaranteed to grow by seven percent every year, regardless of what the actual account value did on that variable annuity. Even if the account value lost 50 percent, again, the client had that baseline guarantee that they can eventually take income based off of. Furthermore, the variable annuity world marketed an additional benefit, and that benefit was “step-ups.” The notion of a step-up was that if, at the end of the year, the actual account value is higher than the benefit base—meaning that the account value increased by more than what the seven percent rollup percentages had done—the client’s new benefit base would “step up” to what that account value was in that year. And then the ongoing seven percent roll up percentages would generally apply to that higher value. Later on came quarterly step-ups, monthly step-ups, and then daily step-ups. Then the economy crashed in 2009, interest rates plummeted, and these robust variable annuity benefits “stepped down”…but I digress.

We all know that GLWBs on indexed annuities came from the variable annuity world. The first GLWB was put on an indexed annuity chassis around the year 2006, after the variable annuity business had been running with the concept of GLWBs and GMIBs for years. This made sense to the indexed annuity market because the VA business had used these riders with huge success. The VA business was a good business to copy because the VA business at the time was about six times the size of the indexed annuity business. 2006 VA sales were $160 billion and indexed annuity sales were around $25 billion.

Over the last two decades these riders have evolved like everything else. I now discuss that there are two different categories of GLWBs in general: a) Performance-Based (the newer breed); and, b) Guaranteed Rollup Riders (the traditional breed).

The performance-based riders generally have minimal (sometimes none) “rollup rates.” These riders largely rely on the account value to increase in order to have the benefit base (and eventual income) increase. An example of one of these GLWBs may be, your benefit base will increase by two times what the amount of credit/performance was in your account value.

The performance-based riders are a good option for the clients/agents that believe that the performance of the underlying index may enable the benefit base to grow faster than what a guaranteed rollup rider may be able to do. These riders effectively rely on “step-ups” like what I discussed with the variable annuities.

The other category—at least how I categorize them—is “Guaranteed Rollup Riders.” These are the traditional seven percent, 10 percent, etc., benefit base rollup rates. These GLWBs are for the clients/agents that want straight guaranteed income without any reliance on the account value. These are the riders that have been on indexed annuities since the beginning.

Generally, the “performance-based” riders will show “non-guaranteed” income that is higher than the guaranteed-rollup riders, at least based on the illustration. However, from a guaranteed income standpoint, the guaranteed rollup riders will generally show the highest guaranteed income.

With the guaranteed rollup riders, something odd is starting to happen with interest rates having spiked the way they have, and that is the potential to receive a step-up on the benefit base… If the indexed annuities in the early years had much potential for “step-ups” back then, then I certainly don’t remember it. If there was ever much potential then it only lasted until the financial crisis, when interest rates really started to plummet.

Why no step-ups? Two primary reasons:

  1. Low interest rates: Because caps and par rates on these products were so low that the odds of having the accumulation value outpace the “benefit base” was almost nothing. (Caveat: There are some “volatility-controlled indexes” that show very high “backcasted rates” that have been able to show a step-up, but that has not been the norm.)
  2. Bifurcation of objectives: Another reason that you have not seen step-ups on this flavor of GLWB is because the GLWB focused annuities are “generally” watered down from an accumulation standpoint relative to the same company’s accumulation focused annuities. If you compare the cap rates, par rates, etc., on a product that provides very good guaranteed income, you will find that the tradeoff is “usually” the lack of accumulation performance. (Note: There are exceptions to this rule in that there are products that have the same cap as their “accumulation focused” counterpart. Hence, the product I used in the first paragraph.)

With interest rates having increased the way that they have, and by choosing a product that also has great accumulation potential, there may be opportunities to show the consumer the potential for an occasional step-up on their indexed annuity. But be cautious of rosy illustrations.

One last point on income focused products that also have great caps, par rates, etc. Even without a “step-up,” a great income focused annuity represents less of an “opportunity cost” to the client—versus a purely accumulation product—when that income focused annuity also has great accumulation potential.

Buckle Up! We Are Going To Create An Indexed Annuity!

Get out your financial calculators, spectacles, and your pocket protectors because we are going to have some fun with this column. We are going to create a product. Of course I am being somewhat facetious because there’s much more that goes into “creating a product” than just the numbers, such as: Non-forfeiture requirements, state filing, illustration parameters, surrender charges, MVAs, utilization rates, etc. I do not pretend to be an actuary, but I am about as “actuarial” as a sales guy can be. My wife tells me that’s like being the tallest elf.

Regardless, this elf is going to show you the not-so-basics of creating an indexed annuity with a “cap” based on today’s (October 7, 2022) interest rates and options prices. The purpose of this is to not make everybody into actuaries but rather to enable you to easily answer many questions about these products by having a deep understanding of how they are created.

Here is the product we—the insurance company—are going to create. This will be a 10-year indexed annuity that utilizes an annual reset S&P 500 strategy. This strategy has a “cap” that we will need to figure out based on today’s interest rates and options costs. This product will have a seven percent commission to the agent. Furthermore, we—the carrier—have shareholders that require a “return” on the company’s capital to the tune of eight percent (more on this later).

Agenda:

  1. Determine how much we, the insurance company, can get in yield when we invest that client’s money.
  2. Based on our IRR requirements from the shareholders, how much of a “spread” do we shave off the top of the yield that we are getting in bullet point number one above.
  3. We then take what is left of the difference of number one and number two above and that determines our call option budget.
  4. We take our call option budget, and we buy and also sell call options based on today’s option prices. Based on the pricing of call options, you and I will be able to identify what cap rate a person can get in today’s environment. Sounds pretty cool huh?

1: How Much Yield Do We Get?

First off, when a carrier takes a client’s $100k (example), that carrier will invest almost all of that money in the bond market. Although a lot of folks use the 10-year treasury as “the benchmark” for the yield rate, a better benchmark is the Moody’s Baa bond yield. This is because carriers generally invest more in corporate bonds than they do in Treasury bonds. Why? Because corporate bonds provide a higher yield. For instance, an index of “investment grade” corporate bonds might represent a 5.99 percent yield. This is much better than the 10-year Treasury bond that is currently yielding 3.88 percent. Thus, the reason corporates are favored over Treasuries.

Now that the insurance company knows that it can invest their money and earn approximately six percent on this money that is going into their “general account,” the carrier needs to allocate that money between the bonds and the call options. The bonds will be purchased to guarantee the money grows back to $100,000 every single year, regardless of what the S&P 500 does. This is how the carrier is able to support the policy guarantees. The call option chunk will give the indexed annuity the “link” to the stock market in the up years. Again, Bonds=Guarantees and Options=Upside.

2: The Carrier’s Cut

Before we calculate how much money goes to bonds and how much money goes to the call options, the carrier takes their cut… This is where the “carrier spread” comes in. That is, the carrier shaves a little off the top of that six percent (technically 5.99 percent in our example). That “spread” is how the carrier makes money. How much spread does the carrier require? It depends…

Our carrier has shareholders that require them to make a certain amount of money on the carrier’s capital. And make no mistake that putting a case on the books costs a carrier capital. Afterall, the carrier has to pay for the administration, paperwork, and the big one, agent commission. This is why if you have ever seen a carrier grow “too fast” they will shut off new sales.

There are various measurements on the amount of money the carrier makes off their investment, such as Return on Investment (ROI) and Internal Rate of Return (IRR).

To simplify this, let’s say that we, the carrier, pay $7,000 to put our $100,000 on the books, or seven percent. This is simplified because our agent commission is seven percent and there are technically more expenses than that but bear with me! If the carrier shareholders demanded an eight percent internal rate of return over the 10-year life of our product, what annual income would be required for the carrier to achieve that? If you put this in your financial calculator, it would require $1,043 per year to the carrier (PV=-7,000, N=10, %=8, FV=0, solve for PMT). In other words, by the carrier “investing” $7,000 of their own money, in order to get an eight percent return over the 10-year life of the product, that carrier would need 1.043 percent ($1,043) off the top of our six percent. Hence, a spread of 1.043 percent. (Note: In corporate finance you learn that if the IRR is greater than the carrier’s “cost of capital,” it is a project that is worthwhile. Hence, if a carrier borrows money at six percent and gets an IRR on that money/capital at eight percent, that is a product that has a positive “Net Present Value” and is good!)

For our example, let’s simplify the above and say that the carrier’s yield is six percent and the carrier spread that is required to keep the shareholders happy is simply one percent. No need to get crazy here with the decimals.

3. Calculating the Call Option Budget

After the carrier takes its one percent off the top, we have five percent to play with for our client and their $100,000. This is where we need to divide the money between the bonds and the call options. The bonds need to guarantee $100,000 at the end of every year to—again—support the policy guarantees. So, what dollar amount needs to go into the bonds—earning five percent—so that those bonds in the general account grow back to $100,000 at the end of the year? Hint: The correct answer is not $95,000! The correct answer is $95,238. Thus, if you add five percent to $95,238, you will get $100,000. So, if the insurance carrier is investing $95,238 in bonds, what are they doing with the other $4,762? Call options. We have arrived at our call option budget.

Review:
What have we done so far? So far, we have designed the commission level on the product at seven percent. We also calculated how much the carrier needs in spread to make the shareholders happy, and we have also arrived at our call option budget of 4.76 percent that will soon determine the cap. (Note: All of these calculations revolve around the interest rate of six percent—technically 5.99 percent. This is why indexed annuity pricing has gotten better over the past year.)

4. Buying and Selling Call Options to Arrive at Our “Cap”

So, we have $4,762 to buy call options that link our client’s $100,000 to the S&P500. That is a call option budget of 4.76 percent of our $100,000. So, the first thing we want to do is look at the prices of call options on the S&P 500 (SPX). We want this call option to give us all of the upside of the S&P 500 between now and 12 months from now, because our product is an “annual reset.” (Note: My discussion is going to be largely about percentages. The exact dollar amounts to link the client’s $100,000 would be just a function of buying multiples of what we are talking about below. The exact dollar amounts are not important. The call option budget percentages are important.)

Table 1 represents five rows—out of hundreds of rows—that represent today’s (10/8/22) option prices for an S&P 500 option that expires approximately one year from now. Because we want this option to give us growth on our client’s money from where the market is today (3,639), we need to find the “strike price” that is close to that number. In other words, we want to buy an “at the money” call option. So, we need to see what options sellers are “asking” for these options. It appears that we can buy an option for $432.10 on a S&P 500 value of 3,625. This call option represents a whopping 11.92 percent (432.10 divided by 3,625) of the “Notional Value” that is linked to the market! We have a problem here because our options budget is only 4.76 percent.

No fear, there is a solution here. That solution is that we can buy this option but then immediately sell another option that will give us back approximately 7.16 percent. This will ensure that our net options cost is only 4.76 percent. In other words, by us buying an option for 11.92 percent and selling one for 7.16 percent, our total net cost will be our options budget of 4.76 percent (11.92 percent-7.16 percent=4.76 percent).

So above, let’s buy the “at the money” option for 11.92 percent of the “notional value.”

Selling a Call Option
As you can see in the options pricing tables, the higher the “strike price” on call options, the cheaper they are. It is because the “strike price” represents the point in time where the option purchaser actually starts making money. Hence, “in the money.” So, if we are selling a call option, we want to go as far down the “strike price” as we can. This is because when the market increases to that number, that is the point that we will be giving the upside to somebody else! Ideally, we would just purchase the option that we already did above and not have to sell a call option. However, we don’t have the large call option budget to do that, therefore we must sacrifice some upside. So, let’s go down the list and see what we need to sell. We need to produce about $259.55 (7.16 percent of 3,625) so that we net out to our 4.76 percent budget.

We found something close! We can sell an option for $257.20 at a strike price of 3,950. What does this mean?

  • We netted out to a cost of $174.90 (Paid $432.10—Sold $257.20). This represents something very close to our call option budget—4.82 percent (174.90 divided by 3,625)
  • We just created a product with an approximate “cap” of nine percent. This is because we are participating in the upside of the market starting at 3,625 and handing off the upside “participation” in the market once it crosses over 3,950. 3,950 is approximately nine percent (8.97 percent technically) higher than 3,625.

What we have just done is created an indexed annuity that:

  1. Guarantees the client’s money will never be lost. This is because the carrier has the bonds that grow back the money to $100,000 every year, assuming rates stay the same.
  2. Gives the shareholders their IRR, assuming rates stay the same.
  3. Gives the carrier a 4.76 percent call option budget to buy the call options after they expire every year, assuming rates stay the same.
  4. Gives the carrier upside potential of nine percent that they can pass through to the client in the form of a “cap.”
  5. Pays the agent a seven percent commission.

Although my calculations are my own calculations and not specific to a carrier, the product I just explained with those caps, commission rates, etc, really does exist today. So, those calculations are not pie in the sky.

Technically, one of my favorite products is the same as what I laid out here, except the A-rated carrier just announced a cap increase to 10.5 percent for premiums over $100k! How can they do that? Numerous ways. Maybe the carrier is demanding less spread for themselves. Or maybe the carrier is able to get investments at higher yields than my six percent. Both of these would mean more call option budget.

I am fully cognizant that this was a three-coffee article for you to read, but I promise you, if you are serious about indexed products, this article will help you in the future when it comes to answering questions about “How do the carriers do it?.”

Suggested Commission Split Structures For Agents

My dad, who was the wittiest and toughest person I ever knew, owned a construction business (underground utilities and concrete) for 40-years. As somebody who “dug ditches” since his early teens all the way up to his death, he had a way with words that I usually don’t repeat but I will here. He once told me jokingly, “How do you know when the deal was negotiated fairly for both sides? When both sides of the agreement feel that they have been screwed.” Now, that’s not something that you learn in business school, nor do I condone that method of thinking. He tended to say things for the effect.

Rather, I prefer the thought of both sides feeling that they received a fair deal. That is how you make for happy business partners and a sustainable and reputable business. I do believe that when agents partner with other agents and “split commissions” that there is a structure that—based on my experience—does exactly that. It makes both sides feel the deal is fair.

Oftentimes a “junior agent” might seek to partner with a veteran agent. The reasons for this partnership are obvious. If the junior agent cannot get the sale without the help of a veteran agent, it would be silly to not utilize a veteran (assuming one is available) even if it means that the junior agent would get less than 100 percent of the total compensation. As they say, 100 percent of $0 is zero compensation. By the way, if you are a junior agent and don’t have access to a “veteran agent,” partner with an IMO that will help you with the sale. In many cases—as with my IMO—there would generally not be a commission split unless I am hopping on an airplane.

A second scenario might be the inverse of the above. This is where a veteran agent will seek to partner with a junior agent. Why would a “rainmaker” want to partner with somebody junior? For the veteran agent to free up time to do what he/she does best—rainmaking. Thus the veteran agent may seek to offload some of the time-consuming legwork to a junior agent.

A third example may have nothing to do with junior versus veteran. It may be a scenario where an insurance agent is partnering with a CPA or an attorney. Many times the CPA has a captive audience and they just need an “insurance expert” to do the case design and also close the case for them.

These three scenarios are great business scenarios and very smart! They allow each individual to do what they do best while not trying to do a task that neither person is optimal at, while at the same time the junior advisor (or the CPA/Attorney) is learning from the veteran agent. The three scenarios are efficiency at its finest and what makes our industry’s compensation flexibility such a great thing. However, you must know what a fair “split” arrangement looks like so that neither party feels ripped-off.

So, what is a fair split arrangement? This is the main topic of this article.

The Million Dollar Round Table (MDRT) was the first—that I know of—to really prescribe a breakdown of what commission splits should look like. These commission split percentages that they recommended were generally based on the types of services that each agent would provide. The below breakdown is very similar to what the MDRT first came up with except for some slight verbiage changes that we applied. This is merely a guide, but I believe a very good guide.

  • 20 percent—Prospect Delivery: This is where the agent has brought the client to the table, whether through past relationships, a referral, or marketing activities.
  • 20 percent—Data Collection and Delivery: This is where the agent collects all the data needed for the sale (health information, financial information, fact finding) and also delivers material to the client that is needed prior to the sale.
  • 20 percent—Case Design: This is where the agent designs the strategy, which includes: running illustrations, modeling scenarios, seeking the right prices, organizing the end plan that is to be presented, etc.
  • 20 percent—Closing The Deal: This is where the veteran agent comes in many times to “make it rain.” This is where the final presentation/conversation occurs with the clients. This is the inflection point—the case/plan either gets implemented here or dies here!
  • 20 percent—Ongoing Service: This is the delivery of the policy, annual reviews, continuous updates for the clients, etc.

With the above being said, a common approach would be that the veteran helps close the sale. That would mean that the veteran could easily justify getting 20 percent and the junior agent getting 80 percent. If the veteran also did case design, then he/she might ask for 40 percent.

As an IMO, I work with scores of agents per week and they often ask me how they should get compensated on cases they “split” with other agents. I have never had an agency balk at the above MDRT method.

Indexed Products Are Designed To Beat Fixed Rates, Not The Market

I have never had a client balk at my indexed annuity or indexed universal life insurance conversations when I tell them that the products are designed to do better than their fixed rate peers, not the stock market. I will tell them that if fixed rates on fixed annuities today are three or four percent, then over the long run they can expect to potentially get four, five, six, or seven percent in an indexed annuity. However, these are not guarantees. If the client balks at that conversation, then it is usually because the client is not the right fit for indexed annuities. For example, if I am talking with a 25-year-old kid who is expecting double digits between now and his retirement, then he will likely scoff at four, five, six, or seven percent. But that is OK because that tells me that he is a bad fit for this product type. Conversely, if I set the expectation that these products will perform for that 25-year-old the way he wants, I would be setting myself up for annual reviews that are as pleasant as colonoscopies. (Note: I would argue that indexed annuities as a bond alternative is something that even some younger folks should think about, but I digress.)

The fact that consumers are fine with indexed annuities, without having to inflate the story, is why I am perplexed when I see in marketing material or hear in a sales pitch how “XYZ product has performed 12 percent over the last ten-years.” To be clear, I have spoken about the true past performance of my clients’ indexed annuities and think that great past performance should be cheered. In fact, I am seeing biennial statements for a few of my clients that are indicating 20 percent interest credits over the last two years. So, am I speaking out of both sides of my mouth here? What is my problem with marketing “12 percent ten-year returns on XYZ Indexed Annuity?” A few things:

  1. There is a difference between stating what has truly happened and setting the expectation that it will happen in the future.
  2. It can be disingenuous: Many times, those returns are not true returns. In fact, oftentimes the product has not even been in existence for 10 years. So how are they marketing that? They are marketing that because that is what the illustrations are able to show. Per illustration regulations, the illustrations are able to show “back casted” performance over the last 10 years, as if that particular index and product had been in existence.
  3. The A-10 Warthog: That favorable “back casting” oftentimes is what the product was designed around. Like how the A-10 Warthog jet was designed around the giant 30 mm gatling gun, versus the gun being put into an already existing airplane, carriers oftentimes find—or create in partnership with an investment bank—indices that “back cast” beautifully and then design the product around that. As we all know by reading the Dalbar Studies, chasing history can be a losing proposition.
  4. It goes against basic economics. If a carrier is able to take a call option budget equal to, say, four percent of the entire premium and turn that four percent into a 12 percent return over a year, it is unsustainable. That is a 200 percent return on our call option budget! If many of the very smart people on Wall Street believed that the carriers’ call option strategies would consistently deliver 200 percent returns, they would swarm to those call options themselves and bid the prices up so high that the ultimate return on that call option strategy would be nowhere near 200 percent. Markets may not always be “efficient,” but I can guarantee that they are efficient enough to not allow 200 percent returns for very long.

These products are beautiful products and the time is right for these products, with the bond market (AGG) being down around 10 percent ytd. and the S&P 500 also being down double digits. Although in a down year a client has the potential to lose out on a four percent interest credit with indexed annuities, I do believe in the notion of “risk premium.” That is, if the carrier were to take that four percent and buy call options with it, they should be able to get more than that four percent back, over the long run. For example, over the long run stocks have done better than bonds, because of the fact that stockholders have always been rewarded for taking on that extra risk. I view the carrier’s call option budget no differently. The carrier may not always get a 200 percent “risk premium,” but an additional one, two or three percent to pass through to the clients on top of the original four percent call option budget would be nice. Said another way, indexed annuities have outperformed their fixed rate peers over the long run, and I believe they will continue to do so. Thus, the title of this column!

My First Client Meetings

My first meeting with a “rich guy”:

As I drove my 1990 Pontiac Grand Am through the gated community lined with multi-million-dollar houses, I was increasingly getting nervous as the house numbers ticked down to John’s house number. I could feel the butterflies in my stomach start to kick in as this was only my third or fourth client meeting ever. What kept going through my fresh 23-year-old brain was the opening introduction to a “good sales meeting” that my branch manager taught all of us new recruits. Beyond the introduction, I also thought that I had every scenario in my head planned out so I could pivot to a good “product” once I uncovered the opportunity during the “fact finding” process. I felt fortunate that my manager had given me this lead, and I was dead set on bringing back the sale. This was also a pleasant change from the list of family and friends I had been hammering on since I started with this captive/career company. John’s original advisor had just retired, and he was an “orphan” who accepted my meeting request once I called him from my lead cards that my branch manager had given me.

As I drove closer to John’s house, in my head I was confident that I would snag this big fish because he was already warm to our company as he already owned several large insurance policies with us. Plus, nobody knew “product” and the technicalities better than I did. Even though John had not expressed any need for any assistance from me or the company, he agreed to meet with me for some reason.

When John answered the door, he was very welcoming and joked, “You’re a tall drink of water aren’t you?” I am sure my response was not real charismatic as I was just trying to not lose my concentration on teeing up the “sales meeting.” Tunnel vision.

As we proceeded across his marble floors to the giant dining room table, I felt awkward because I didn’t know what to say to a wealthy person almost three times my age. It was about 20 seconds of silence. My manager never taught me about “breaking the ice.” But hey, I looked good in my newly purchased suit with my briefcase that had a never-read Wall Street Journal sticking out of the pocket. As we sat down he broke the ice by asking me about his old advisor who had resigned from our company. After telling him that his former advisor had retired and moved to the coast, I immediately dived into my introduction and the need for me to update our “fact-finder” on him. He agreed to give me his updated information. So, I reached into my briefcase and pulled out the sole contents of it, the “Fact-Finder.”

Just like they taught me in “training,” I went through the fact finder line by line and John told me everything I wanted to know. However, as we approached the middle of the fact-finder, I could sense that he was getting a little annoyed by the redundancy of the process and the uncertainty of exactly why I was there. But I continued to ask the “fact-finder” questions anyway.

Once I completed the fact finder, I could only identify one gaping problem that John had in his portfolio—the lack of long term care planning. After giving him the long term care “product pitch,” he was non-responsive like there was something else he would rather talk about. That is when he said, “I think right now I have a bigger fish to fry in that I just sold my construction business for $10 million. I think it would make sense for you to come back another time with your manager so we can figure out what I should do with this money that is just sitting there.” I may have been 23 years old, but I was smart enough and self-aware enough to know when I have been snubbed! I was also smart enough to know that this was an opportunity. I needed help! So, we agreed to reschedule for a different time when my manager would accompany me.

When I got to my car I was dumbfounded as to why he wouldn’t discuss the sale of the business with me, because I felt that I knew technicalities, product, etc. very well. Plus, I did exactly what they taught me in training!

As a competitive, athletic, high-octane young guy, I was slightly embarrassed to tell my boss I needed help. But I did. And he said, “Book the meeting!”

My Boss “Riding Along”
As my boss—who I will call Dave for purposes of this article—and I drove down John’s street in Dave’s BMW 740, I was getting even more nervous this time as I had my boss observing me! My boss was still the jokester that he always was, telling stupid jokes and talking about sports as we approached John’s house. I could tell that this meeting was just another day in the office for him. As we walked up to John’s house, Dave—who was much more casually dressed than I was—was pointing out that he thought he knew a couple of the neighbors. He also had some stupid story about his experience with one of the neighbors getting really drunk at a party once. I wasn’t paying attention because, again, I had tunnel vision.

As John answered the door, he was very friendly once again. I shook John’s hand again and so did Dave. Except Dave jumped into saying, “Do you know your neighbor XYZ and ABC?” Of course John knew who they were and immediately smiled and joked about them. As we walked across that marble floor, Dave had observed pictures on the wall of John and his two sons fishing in Cancun. That generated a conversation that continued to the large dining room table.

As they were conversing about Cancun and fishing, I dug into my briefcase—that still had the same WSJ in the pocket from the week before—to grab one of the three items I had in it—the fact finder. By the time I had pulled out the fact finder they were already discussing the sale of John’s business and his concerns with what to do with the money so that it grows and passes on to his kids. After Dave told a quick story about his own dad selling his business and the observations that he has had with his dad’s process, he quickly dived into the options that John can do with his money. It was a conversation! And it was natural!

Interestingly, through the course of the conversation that I was merely spectating, Dave had uncovered a significant amount of “fact-finding content” that I had not in my previous meeting with Dave. As my boss had the conversation with John, I was flipping back and forth through the “fact-finder” to fill in the gaps that my tunnel vision had not even identified previously.

Then it naturally turned to “product.” This is where Dave knew almost nothing as he was not technical. (Note: Dave was a “ready, fire, aim” type of guy, but the best salesperson I ever met. I know you know the type.) This was my chance to shine, and I did. I knew every fee, subaccount, death benefit rollup rate, surrender charge percentage, etc. that the proposed variable annuity had. I also knew every mutual fund that we had in our arsenal. We also turned to the long term care option, that Dave also tee’d up, and I knocked the product details out of the park.

In the end we walked out of that house having a new friend in John, having helped John with investing some of his business proceeds, and also making significant sales of variable annuities, fixed annuities, mutual funds, and a long term care policy.

Observations

  • Sales happen when you are yourself. People buy from people and if you hide behind the “cloak of formality” it does not matter how technically smart you are—you will not get the sale. This requires confidence and sometimes confidence takes time in the business, but be confident and be yourself. If the client does not like “yourself,” then it was never meant to be. As another manager once told me, “Why be scared? It’s not like they can kill you.”
  • Be observant: My lack of confidence and tunnel vision made me too stiff where I should have been observing the pictures on the wall and the things that are important to John. If you can connect with what is important to the client, natural conversations happen. When natural conversations happen, sales get made.
  • Listen to understand the information and block all other thoughts out: In my first meeting with John, I listened to respond (versus to understand) and missed the hidden gems in John’s words. I did not even know, until he volunteered it, that he just sold his business for $10 million! I also see this occasionally with presenters that are asked questions from the audience. They miss the actual question because they are busy thinking about a zinger response. Let the client talk. Be an elephant (big ears), not an alligator (big mouth).
  • Product is important but not the most important: It was Dave’s likeable nature and his ability for him to show the client that he understood the situation. He could not even spell “variable annuity.” My product knowledge certainly helped in the end, and built my credibility, but it was secondary. Dave would have still made the sale without me, but the client would have likely gotten bad information on the product that he now owned.
  • Stories matter: Millions of years of evolution has us humans working off our “reflexive” part of the brain that has allowed us to survive the saber-toothed tiger. Stories scratch the “reflexive” itch that we have. Some would call it the “right brain.” Notice how this entire column is a story? That is on purpose.
  • Partner with somebody that compliments your strengths: Dave and I were a good match. I was fortunate to have him as a bit of a mentor because I learned through observation how to connect with people and how to make it a conversation versus a mission to check off all of the “fact-finder” boxes. My experience with Dave fit together nicely with my technical knowledge that made me well rounded in the end.
  • Just last: Was it John Savage that said the secret to our business is, “To last?” There is truth to this. Much of what I lacked as a 23-year-old was confidence and wisdom, which takes time. Now, 21 years later, I feel that I have that. However, it took time and it took having the right mentors. This is why, if you are new to the business, if you can “last” through the first couple of years your chances of enormous success dramatically increase. Then you are much better equipped to speak with those clients like “John” than I was at age 23. If you don’t have a good mentor, partner with a veteran agent or a good IMO that has the willingness and talent to serve that role.
  • Lastly: Like Dave, just have fun!
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