Why many FMOs are Standard and Poorer
By Kevin Startt
The myths about FMO value adds have certainly been exposed on Producers Web and in these blogs. After having spent 20 of my 33 years on the investment side, I continue to be amazed at how FMO consultants use a one-dimensional head fake to try and help advisors capture maximum index returns through correct product index allocations.
In fact, despite relishing the compliance requirement that “past returns do not indicate future results,” much of the typical FMO consultant's pitch is spent espousing living benefit riders whose reserve requirements have yet to be tested in reality over the lifetime of a senior.
Variable annuity wholesalers made the same mistake twice with guaranteed minimum income benefits (GMIB) in the early 2000s and then again in the mid-2000s with guaranteed minimum withdrawal benefits (GMWB). What happened to understanding that the cash surrender value of both VAs and FIAs are critical to the performance of these contracts?
Even though crediting methods are priced to provide a return within 1 percent of each other, 1 percent can make an astounding difference because of the eighth wonder of the world: compounding interest. The difference between a $100,000 FIA allocated to the S&P 500 at 4 percent over 30 years and the Russell 2000 at 5 percent is approximately $116,000, or more than the original principle sum invested!
With the Russell 2000 at an all-time high, why is more than 80 percent still invested in the S&P, despite huge shortcomings in the index? Primarily, because as one $4 million advisor told me over lunch the other day, most FMOs have few clues about the investing of money outside the realm of index annuities or life. When asked to provide a complete portfolio overview, the myth of an FMO providing value is non-existent or, because of licensing issues, non-functional.
I believe proper allocation is imperative for index annuities, and that conviction of future performance should be conveyed as convincingly as past performance is used. Virtually all institutions, mutual funds and exchange traded funds invest in the companies that make up the S&P 500. FMO consultants will not tell you that what is good for big institutions is not what is best for individual savers. Most FMOs are “me too” when it comes to advice. All they care about is keeping up with the competition and finding the next direct mail campaign or seminar sojourn. There’s no doubt, these giant large companies steal the headlines when they outperform, as they did in 1999 and 2007. Most FMO reps will not tell you this only happens about 20 percent to 30 percent of the time. As an example, small caps that are found in the Russell 2000 have trounced the S&P 500. Since 1940, small caps have provided 10 times the return of the S&P 500. FMO reps would rather push a bond index that touts double digit returns based on a bubble that is likely to produce a lot of zeros at an all-time low for interest rates. It’s easier to sell for the rep and much more challenging to look inside what returns the index annuity is likely to return.
A $1,000 investment in the S&P 500 would have produced about $2.2 million, while those investing in small cap indices like the Russell 2000 would have returned $23.5 million. How much more lifetime guaranteed income could have been produced by astute FMOs that understand that diversification and index allocation are just as important as crediting and rider strategies in an FIA? Since, the S&P is a" me too" strategy that ensures the great American pastime of buying high, selling low and losing money (can you say Apple?) and creates “sequence risk” rather than reducing it, new strategies are coming that ensure a broader approaching to crediting and indexing, as happened with variable annuities and exchange funds. Stay ahead of the curve as an advisor by debunking the myth of FMO value adds.