Annuity Surrender Charges and Commissions
They may be purchased by the client directly from the vendor or used in a advisory account and wrapped with a fee by an investment advisor.
Oddly, some of the advisory, no-commission products have surrender charges because there are still distribution costs and other allowables that must be recouped, even though no charge to surplus occurs for agent’s commissions.
Market Value Adjustments
But what about the fact that, in fixed products, the carrier must invest in longer-term bonds to make their promises work?
Don’t the surrender charges help the carrier invest out further?
That’s what the market value adjustment (MVA) is for.
The MVA is a separate and independent concept from the surrender charge.
In fact, in a rising-rate environment, a surrender in excess of the free-out amount may experience both a surrender charge (to make up for commissions) and an MVA (to make up for unplanned market losses on assets funding the product).
So, the surrender charge and the MVA are separate. However, an ancillary benefit from a surrender charge, from the carrier’s perspective, is that it further discourages surrenders during rising-rate periods for the purpose of the client gaining a higher rate elsewhere.
The process of a client moving money from a lower-rate product to a higher-rate product is referred to as “disintermediation.”
Reducing disintermediation is a side benefit, not a primary driver, of surrender charges.
The Talk
How does one explain surrender charges to a prospect? As always, and especially in this era of Regulation Best Interest and the much-needed emphasis on transparency, the truth is the best approach.
It may go something like this:
Folks, there is a seven-year surrender charge on this annuity.
That means if you want to cancel this contract within the next 7 years you will have to pay a fee.
The reason for this is that the insurance company pays me a commission to use this annuity in my client’s plans [tell them the percentage, or dollar amount, if you really want to gain their trust] and they need you stay at least seven years to earn it back in full.
Therefore, we must be certain not to allocate any more money to this idea than you can afford to leave alone for that long.
Putting the blame of the presence of surrender charges on anything else may be a misrepresentation, if one is not careful.
Are Surrender Charges Bad for The Client?
To address the assertions made at the top of this article, surrender charges are not a profit center for the carrier, nor are they intended to gouge anyone.
In many cases the surrender percentage in any given year will just be sufficient to compensate the carrier for the original commission compounded at their cost of capital rate (minus any earned compensation booked since issue).
Surrender charges do not fuel carrier growth, surplus does.
Surrender charges exist to protect surplus, not grow it.
To the extent surrender charges dissuade a client from making a rash decision they are beneficial. However, to the extent they prevent the free flow of capital to better opportunities or needs, they can be harmful.
Does a longer surrender charge schedule provide latitude for a carrier to enhance features? The short answer is: Sometimes.
Carriers could indeed enhance longer-term products’ interest rates and guaranteed income features even further, but unless they pay higher commissions the sales will not follow.
They must strike a balance between keeping money on the books as long as possible to enjoy their spread, enhancing benefits to attract clients, and compensating an agent for a multi-year lockup of assets under management.
If one could find a 10-year product with the same low commission as the five-year version one would expect a significant improvement in the client’s benefits — not an easy find.
Burt Snover, ChFC, CLU, is president of CompEdge Financial Services.
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(Image: Diego M. Radzinschi/ALM)
