The power of recurring revenues

By Jason Kestler

Kestler Financial Group, Inc.


You’ve spent your entire career helping clients maximize their retirement income. You’ve helped them avoid market risk by providing "sleep insurance." Have you ever considered providing the same service to your own practice?

The challenges and opportunities facing an annuity producer these days are huge. The typical financial advisor today looks an awful lot like the typical client. He or she is probably staring down retirement, and wondering where those extra pounds and gray hair came from. He probably has a large book of stagnant business. Stagnant business can come in many forms:
  • Mutual fund or investment accounts that generate little if any income yet require ongoing service
  • Annuities sold years ago that require annuitization to maximize values
  • Variable annuities where the cash account can never catch up to the income base
  • Cash value life insurance where the death benefit is no longer needed
  • Portfolios with large bond components that are a ticking time-bomb in a rising interest rate environment
Now, consider the above in an environment where the stock market is hitting all-time highs. When (not if) we have a correction, can these clients afford a 20 percent loss? A 40 percent loss? We have a perfect storm of high-priced stocks, a bond bubble about to burst and 76 million baby boomers transitioning to retirement.

So what does all of this have to do with multiplying the value of your practice? Everything! Over the last 10 years, investment advisors have built huge incomes and valuable practices by converting to an assets under management (AUM) business model. Insurance agents, specifically fixed annuity producers, have historically worked on "heaped" first year commissions. While lucrative in the short term, this model creates stagnant assets that offer little in the way of value when you hope to make your last paycheck — when you sell your practice. A practice heavily comprised of stagnant assets offers little, if any, value to a prospective buyer. On the other hand, a business with significant, sticky, recurring income can garner offers from buyers around two to three times recurring revenue. That could be a significant final paycheck.

Until recently, most fixed and indexed annuity carriers offered only heaped commission options. The newest entrant to the indexed annuity arena, Nationwide Insurance, has just announced a significant trail commission option on their flagship New Heights fixed index annuity. Although commissions may vary by state and age, an agent can choose between a heaped 7 percent commission or a 1 percent first year commission plus a 1 percent annual trail (paid quarterly at 0.25 percent per quarter). The trail commission is paid on the annuity account value (AUM). The choice between heaped or trail commissions can be made on a case-by-case basis.

Now, let’s tie the pieces together. First, examine your entire book of business. Compare the future potential of the stagnant asset with the potential of the annuity mentioned above. Its uncapped design and superior performance may offer a better solution even to clients with existing surrender charges or annuitization requirements. It needs to be stated here that every case needs to be examined individually so that a suitable recommendation is made.
Next, as you add new clients to the practice, consider what portion of the transaction should be set up in an AUM model. The goal is not to convert to an AUM model cold-turkey, but to build a strategic plan to transition to that model over a several year period.

Let’s assume you are able to direct $3 million per year to an annuity and the average annual growth on each policy is 6.5 percent. At a 7 percent commission, you’ll earn $210,000 annually. Not bad. Now, what happens to cash flow if the same $3 million is re-directed to an AUM model with a 1 percent trail? After five years, the recurring revenue on the book of business is about $170,000 — assuming you never sell another policy.

If we carry this example out 20 years, the heaped commission agent would have earned a total of $4.2 million with a book of stagnant assets generating no recurring revenue. The AUM agent would have earned almost $10 million. By year 19, he’s making well over $1 million a year — before he goes to work — while the heaped commission guy is still knocking on doors.

But wait, there’s more. If the AUM agent wants to retire in year 20, he has two choices. He can dabble in his practice and continue to make well over $1 million every year. On the other hand, he can sell the business. Based on today’s going rates, he should expect to receive a sale price around $3.5 million — almost as much as the heaped commission agent made over his entire 20 year career.

But wait, there’s more. The sale of his asset (the business) would qualify for favorable long-term capital gains treatment. Therefore, the net proceeds from his final paycheck would most likely be greater than the net income from a 20-year practice for the heaped commission agent.

One final thought. Trail commissions paid on a book of index annuity business are more stable than AUM models for registered reps. Ask any advisor who was building an equity-based AUM business in 2007 and 2008 what happened to his recurring revenue. He most likely took a 40 percent cut in income while his clients took a 40 percent loss on their portfolios. An AUM business built around index annuities is not susceptible to market declines like an equity-based AUM model. So, when that inevitable correction occurs, your clients’ nest eggs will be safe and your income will remain stable. The ultimate win-win!

If you have already built an advisory practice using the AUM model, consider repositioning all or a portion of the bond component to an index annuity allocation. By doing so, you reduce the inherent bond risk in a rising interest rate environment and lower the beta on the overall portfolio. The Annexus Group has partnered with Ibbotson to build a dynamic tool that illustrates how using an index annuity as an additional asset class in an allocation model can significantly shift the efficient frontier.

An added benefit to advisors who use an index annuity with a trail option as a bond alternative in an allocation model is that the strategy not only stabilizes the client’s portfolio, it also helps to stabilize the rep’s income.