As an insurance consultant to RIAs, I am often asked to review legacy annuities. Every case is unique, but often I'm reminded why commission-based annuities are identified as one of the biggest violators of consumer value within financial services. Rider driven variable annuities are the most common review requests that I receive. They tend to be the most complicated and expensive. Often, the policy owner doesn't understand the product or even know why they own it. So, for the advisor, it's not surprising that an annuity review can create more questions than it answers. RIAs are left asking, "How can I improve upon something I didn't sell to my client, and, frankly, didn't want to inherit?"

Here are some practical strategies that RIAs can use to more easily assess a clients' existing variable annuity:

1) Start with a suitability check

Perhaps nobody knows your client's financial needs more than you. As you begin your annuity review, focus on general suitability. Consider if and how the annuity asset will help your client achieve their goals.

For example, many variable annuities are purchased to protect growth and subsequently provide guaranteed income from within the same account. It's important to determine whether protected growth and especially income will be needed or wanted from the policy. The client may already have those needs met elsewhere. I often see a client paying high fees for a contract with features that they don't plan to use. If growth is an objective for your client, examine the level of insurance the annuity offers for protection against losses within the rider. This is important, since logic dictates that allocations should shift into conservative funds to protect against sequence of returns risk as a client ages. If you find that the annuity is designed to insure against market losses however, there is arguably no need to be conservative since the risk has shifted to the insurer, albeit at a high cost. I see this misstep often.

In terms of guaranteed income, it seems that advisors are afraid to liquidate policies because they are afraid of giving up any guaranteed values. Does your client need or want to take withdrawals? How much are they paying for the guaranteed withdrawal they will receive? It's important to know the numbers, as well as the objectives. This way, thoughtful consideration is given to replacing an annuity with a more suitable product or liquidating it, or simply leveraging the features of the existing product. This consideration is important, especially when compared to the costs of doing nothing.

2) Skim the statements

When reviewing an annuity, I start with the basics. Policy statements may help you uncover some interesting things:

Look at the policy issue date. Older-vintage variable annuities with guarantees may hold additional consumer value, especially if the policy was issued before the financial crisis in 2008. Policies issued after 2009 were mostly repriced, as insurers saw worst-case scenarios test their guarantees. This means potential cost advantages or higher guarantees may exist in annuities issued prior to 2009.

Check values. Review the statement for values such as Surrender Amount, Cash Value, Death Benefit Amount. Discrepancies between cash and surrender values will reveal if there is a penalty for moving or closing the account.

Check for enhanced rider values. Included on the statement will be the death benefit amount of the policy, which will be paid to a beneficiary. Sometimes, enhanced riders will lock in initial premiums or high value anniversary amounts. It's especially important to review the death benefit values against the cash value; it may uncover additional insurance within the policy to provide legacy assets to heirs. Additionally, many variable annuities are sold with the promise of income, which the owner can't outlive. They offer riders that provide for income or withdrawals for life. On a statement, look for values associated with ‘Guaranteed Benefit Amounts' or ‘Guaranteed Base Values'. While these values cannot be fully accessed for immediate withdrawal, they are used to determine how much income can be drawn from the policy over the client's life. A quick way to gauge consumer value when looking into these riders is seeing if the stated "income base" is higher than the cash value. Also, calculating the size of that gap. This way, we can see if the client is paying for an enhanced value which they can use. The goal should be to identity the amount lifetime income which can be drawn. Sometimes, the figure is included on the statement, sometimes it's not. Before changing anything within this type of contract, doing additional research is recommended. The product prospectus, often online, will have the information you need.

3) Know the numbers

Variable annuities are often sold to clients without a discussion about fees associated with the product. Knowing the numbers behind annuities is important because your client may not realize how much they pay.

Typical annuity costs: Most annuities carry multiple fees within a contract. For starters, variable annuities will assign a mortality and expense (M&E) fee. This fee ranges in size, but common within commissioned variable annuities is 1.35% of the total value as an average. Fund expenses add to the overall costs as well. A 1% figure for the underlying funds is fairly common. Lastly, enhanced riders can add considerably to the costs. Some of the most popular riders cost over 1% to maintain. Consider a 3%, 5% Rule: as you add the typical annuity costs, M&E fee, fund costs and rider fees, annuities typically cost near 3%, sometimes more. In terms of guaranteed income returns, many provide roughly a 5% stream of income, varying depending on the age of the client and the contractual obligations. These figures can serve as a compass for examining consumer value. Obviously, the lower the cost or the higher the guarantees, the better. Some older products, sold prior to 2009, may offer upwards of a 6% lifetime guarantees for under 3% in fees, for example.

4) Consult with an Expert

As you consider an annuity review, you may decide that the complexity of the contract and the knowledge needed to fully understand how variable annuities work is beyond your desired scope. In this case, the most efficient and ethical solution is to find an expert or a consultant who specializes in insurance and annuities to review the case. You will save time, and ensure you understand the drawbacks and advantages of the product(s) your client owns, as well as possible alternative solutions to improve client outcomes with an alternative product or strategy.

Your clients want and need insurance and the benefits it provides. It's why the variable annuity market is about $2T, almost the size of the RIA market. The good news is that insurance carriers are starting to build more value and transparency into their products. New low-cost, commission-free products, including annuities and life insurance, are available for fee-only advisors and their clients. I work for DPL Financial Partners, an independent and fee-only insurance network for fiduciary advisors. We serve as strategic partners to RIAs, offering unbiased reviews of annuities and other insurance products for our members, as well as access to commission-free products and strategies for holistic financial plans.

Meet the Author

With a long history of serving RIAs and their clients, Jeff Rancourt is well-equipped to help RIAs create opportunities to grow their practices and better serve their clients through DPL’s innovative insurance network. Jeff holds his Series 6 and 63, Chartered Mutual Fund Counselor (CMFC) designation, along with his Life Insurance License.