The 10/10 Rule: more unintended consequences

By Steven Delaney

American Annuity Advocates


The new 10/10 Rule has already been adopted by Florida and Texas, and a string of other states could follow. This spells trouble for seniors and our industry, unless we can make a good case as to why these states should change their minds.   Florida and Texas seniors will feel the brunt of this new rule, which will lead to less guaranteed income, and therefore, greater retirement insecurity.  I am sure the states had good intentions,  but they may not have considered all of the negative ramifications.  It can be easily illustrated that this 10/10 Rule actually hurts the very seniors they wanted to protect.
 
According to estimates from the 2010 census, the United States has 38 million people age 65 or older, so a lot of people will be affected by these rules.  
 
We're in the worst recession since the 1930s and state legislatures across this great land are implementing what is known as the 10/10 Rule. The result? Those aged 65 and older are being deprived of the opportunity for greater guaranteed retirement income. It’s true, but I doubt that those involved were aware of what the net result of their new rule would be.  But that is not the worst of it, which I will get to in a minute.   Hopefully, they will reconsider, change their minds, and reverse or modify their positions, but it will take some convincing conversations on our part.
 
What did the states do?  On the surface, they may have thought that they were protecting seniors by not allowing them to buy an annuity with a surrender schedule greater than 10 years; therefore protecting seniors from tying up their money up for too long a time frame.   Also, the rule states that there cannot be a surrender charge greater than 10 percent, the cost assessed to withdrawals greater than the free 10 percent withdrawal feature which is standard on most annuities offered today.   
 
First, I want to get a point across that should be very obvious. If an insurance company can no longer offer a bonus to a consumer of a certain age, but the insurance company does offer a bonus to those under age 65, does that hurt the senior, and does that discriminate against that senior?  Yes and yes. 
 
What do these new requirements mean to an insurance company designing and offering products?  Mathematically, if an insurance company cannot offer a product with a surrender charge greater than 10 years, and/ or one with surrender charges greater than 10 percent, then they cannot offer a premium bonus.  The actuaries and the investment advisers within the insurance company need time to make things work, and the surrender charge must be stiff enough to compensate the insurance company and protect all policy holders, should the client decide to walk away from the contract prematurely when the consumers receive a premium or vesting bonus.  If consumers were free to make their own informed decisions, free to choose from a full menu of products that included premium bonuses, and if the consumer genuinely wanted and/ or needed a particular product with a premium bonus in order to satisfy a financial need or concern, is it fair for the states to step in and say, “Sorry, you’re too old. You cannot have access to this product”?   
 
I brought this issue up recently to a senior who is financially savvy. She owns investments as well as fixed and fixed indexed annuities, and she said, “That’s discrimination.”  I know this does not represent a scientific sampling of the population, but I don’t think this issue will require as much. It simply requires  application of some common sense.  
 
These guaranteed insurance contracts make an offer of real value to real people.  So, why would an annuity contract with a certain bonus be taken away, just because it was 11, 12, 13, 14 or 15 years in length?   There is no Ponzi scheme here; the insurance commissioners are not missing something. These are legal reserve life insurance companies.  Perhaps choosing a product with a premium bonus of 5 percent or 10 percent would help a senior make up for, or offset,  a loss suffered in a market sensitive investment or produce a certain amount of guaranteed income a senior needs or simply desires.    
 
The study “Investing Your Lump Sum at Retirement” from the University of Pennsylvania’s Wharton Business School states: “Trying to replicate this advantage of a secure lifetime income, but without the risk-pooling of a life annuity, will cost you from 25 percent to 40 percent more money, because you would need to set aside enough money to last throughout your entire possible lifetime, instead of simply enough to last throughout your expected lifetime.” 
 
If the states take the time to acclimate themselves with what some of the brightest minds in financial planning are saying in this study, the states could come to reverse their 10/10 Rule.
 
Why would a state consider reversing these rules? 
Because if a bonus attracts someone to purchase an annuity, then all things being equal, without the offer of a bonus, more people are likely to find themselves invested in market sensitive investments.  If that happens, more seniors will not be afforded the protection of lifetime income discussed in the study.   With new information should come new understanding; a new perspective.  In terms of perspective, the states did not impose this 10/10 Rule on just the insurance/ fixed and fixed indexed annuity industry. Instead, they imposed this rule on seniors as well.  
 
How does a bonus of the premium or vesting sort affect guaranteed income benefits?   If you have a premium bonus, and the income rider is a constant, growing by “X percent”  (say, somewhere between 5 percent and 8 percent) and the withdraw rate based upon attained age “X”  is a constant (between 4 percent and 8 percent), will the guaranteed future income a senior will, or could, receive in the future be greater than an income stream that did not include a premium bonus?  
 
All things being equal, the answer is yes, it would be 10 percent greater with a 10 percent bonus. The premium bonus is not a gimmick, as some have stated.  It provides a real benefit.  So, when the states say you’re too old to choose from a full menu of products, I‘m sorry, but that’s discriminatory, even if it’s unintentional.   
 
How could the states ignore that the bonus being used in the calculation is utilized to determine future guaranteed income?  Think about it .These products simultaneously protect a senior’s principal, protect credited interest, provide guaranteed income, and provide more guaranteed income than would be available from any other financial product.  These products provide excellent liquidity, “protected liquidity,” as your principal plus your locked-in index-linked interest gains are available via a 10 percent free withdrawal.  And many of these same policies are 100 percent liquid if the consumer enters a nursing home or is diagnosed with a terminal illness. So, the premium bonus makes a great retirement savings product even better.  
 
The states can change their minds; they can reverse this rule if they want.  But what does it mean if they don’t?  I am not a conspiracy theorist — not usually. But we, in our industry, may become such theorists going forward.  Why?  Because the rest of the financial services industry as a whole would be the benefactors of a 10/10 Rule rolling across the country.  
 
When you use fixed indexed annuities with income riders, you uniquely leverage the conservative nature of an insurance company’s investment strategies alongside the actuarial life pooling principles of life insurance in an extremely cost efficient manner.  The life insurance industry  (read manufacturer of fixed and fixed indexed annuities) presents unique alternatives to consumers in terms of savings or investment products, and we really are tough competition for market sensitive investments, for  Wall Street; tougher than most people would think, and tougher than many people and organizations would like!  
 
As one can tell by reading the headline/story below from the WallStreetJournal.com Sept. 4, 2010, many are removing their savings from the ups and downs of the stock market in favor of fixed indexed annuities.
 
"Money has hemorrhaged out of U.S. stock funds for 18 weeks in a row, with an estimated $15 billion flowing out in August alone.Much of that is being soaked up by a form of insurance sold as a safer alternative to stocks. Fixed-indexed insurance products, commonly called ‘equity-indexed annuities,’ offer the promise of protection on the downside, combined with a guaranteed minimum upside. They racked up a record $8.2 billion in new sales in the second quarter and hit an all-time high of $168 billion in total assets as of June 30, according to LIMRA and Beacon Research.”  

Please don’t misunderstand me. Everyone needs to be on the same page relative to the fact that our insurance products are safe money products, savings products; they are in no way, shape, or form, substitutes for securities.  But, if our products are displaced with the stroke of a pen — which almost happened to us this past year with Rule 151A  — a lot more money will go into other financial products such as CDs, mutual funds, brokerage accounts and variable annuities.  Will retirement not be put at risk for more seniors if part of what draws some people to an annuity is a bonus, and those bonus annuities are removed from competition?  The answer is yes.
 
To someone outside our industry, all of this seems a bit odd, because usually, a state insurance or securities department would only remove choices from seniors if they thought the senior was being taken advantage of, was being treated unfairly or was being discriminated against, right?  Well, the insurance companies, the actuaries and the rest of us know that everyone is living longer. That is why at American Annuity Advocates we say, “Living longer, Living Better with Annuities.”  
 
So, who needs a guarantee of greater retirement income?  Who needs protection in terms of their savings because their highest earning years, or their earning years in general, are behind them?  Seniors. If a particular product guarantees $71,000 a year in guaranteed income and another product offers non-guaranteed income of $19,000 a year, which product would anyone — putting the senior first —recommend that the senior consider?   
 
I am getting ahead of myself here, but please read the disclosure below before we go any further:
 
The following information is provided for informational/ educational purposes only. This information involves a general discussion of various concerns related to retirement savings.   No investment advice is being given in regard to securities products.  Any recommendation to consider the repositioning of assets found on the spectrum of risk and return should not be interpreted as securities or investment advice.
 
Consider the following hypothetical, educational scenario.  Let’s say a person, age 60, picked up the phone and called the 1-800 number at a hypothetical consumer direct mutual fund company. After speaking with a customer service rep, they decided to place their $500,000 nest egg into a hypothetical benchmark index mutual fund because it was the “cheapest and best place to put their money if they were interested in the upside of the stock market and they were comfortable with the downside risk,” with a cost of only 18 basis points a year in this hypothetical benchmark index mutual fund. If they remained invested with all of the ups and downs and dividends were reinvested, 10 years later the senior would have $449,808, based on the time frame of Jan. 1, 2000- Dec. 31, 2009.  Now, if a person came to the conclusion that it was OK to withdraw 5 percent on their own, believing/ hoping it would last them the rest of their life, they would then be counting on receiving $22,494 annually. At this rate, the money may or may not last them the rest of their life, because such a withdrawal would not be guaranteed. 
 
Now, if the consumer worked with a financial adviser  who was assisting, either by purchasing this same fund for them or by putting together a custom portfolio to replicate, mirror or compete with this hypothetical benchmark index mutual fund, the consumer is likely to have some additional charges on top of the example we used here.  Let’s say the additional cost was 1.5 percent for conversation’s sake. They would then have $384,633, 10 years later, and if we use the same 5 percent withdrawal rate, they would be hoping that $19,231 would last them the rest of their life (again, because such a withdrawal would not be guaranteed).  
 
Well, with a 5.75 percent annual cap and utilizing the raw benchmark index with no dividends, the products the state agency is prohibiting seniors from purchasing would hypothetically produce $733,483.  Now, 5 percent of that would be $36,674 — not bad.  But it’s even better than that, or could be, because a guaranteed income rider (8 percent compounded growth in the income account value),  would produce $71,245 to the senior for the rest of his or her life.  This is all mathematical, factual and based on readily available public information.  If the hypothetical bonus of 10 percent were not available, the consumer would be guaranteed $64,768, or $6,477 less a year.
 
Not only will the client get less for the rest of his or her life, but what if the client, not being offered the annuity with the premium bonus, leads more people to stray away from annuities. What if they decide to try their luck in the share markets due to the lure of higher returns being touted by what they see on television, by what a market-oriented financial adviser discusses with them, or what they heard on the radio, touting strategies where “you can learn what the pros know”, “learn to trade options like the pros by calling 1 800 XXX XXXX” etc. With mutual funds and stock and bond portfolios, nothing is guaranteed for these seniors. Principal is not protected, no gains are locked-in and the client no longer has the “protected liquidity” I speak of.  This is the bigger picture here.  
 
The future for many consumers could be bleak if they were to find themselves  living on the $22,494 or the $19,231 which would not be guaranteed to last them the rest of their lives, instead of the $71,245 which would be guaranteed.  So we,  the fixed and fixed indexed annuity industry, are again unique competition for the securities industry, and you can now understand why I believe that the problem is bigger than anyone out there is talking aboutAnd where are all the senior advocates?   Not being offered the attraction of the bonus may lead more consumers to end up in the share markets, even though they cannot afford to take the risk.
 
If we do not act to fix this problem, “the noise the car is making will not go away.”  It will only get louder, and eventually breakdown on the side of the road, which is where we don’t want to see our seniors.  The number of states to adopt these same measures is likely to grow.  And if the insurance/ annuity industry wants to protect not just ourselves, but seniors, we need to do something about this! 
 
Financial advisers are entrepreneurs representing the spirit of America.  When you stop and think about it, they truly serve and protect the people who live in their communities, insuring families through life insurance and protecting retirement nest eggs with guaranteed savings products.  We, in the fixed and fixed-indexed annuity business, did not assist in losing peoples’ money.  We did not extinguish retirement dreams, but rather we protected them.  The industry can come to the rescue of the people our products are supposed to serve, but we must act.   
 
This isn’t exactly deliberate political corruption of a free market, but it is still a problem in which the states participated.  And yes, the 10/10 Rule can be viewed through the eyes of consumer protection; however, in the end, the net result is not a good one.    
 
As an industry, let’s not be stricken with myopia — the failure to see down the road.  Coming to terms with this may not be easy for the industry or the states, but we must not accept these 10/10 Rules or the consumer will lose again, and so will we.  I am an optimist, especially after the defeat of 151A, so my hope is that we can change the perspective of state legislature.   We want to solicit an open conversation and persuade Florida and Texas that it is more logical to offer beneficial choices to the consumer with proper disclosure of longer surrender charges and/or greater surrender charges than it is to take the option away from them altogether, simply because they are 65 or older.  The states need to realize the longer surrender charges or greater surrender charges are a trade-off for a real benefit, a premium or vesting bonus.  
 
Remember the good work our representatives thought they were doing with Fannie May and Freddie Mac?   They were helping people achieve the American dream of home ownership by putting them in homes they could not afford. But it didn’t turn out too well — more unintended consequences.  Just more proof that  financial decisions are really important, and that risk should be assumed only by those who can afford to take risk.  Thus, if certain products are not made available to seniors, where will these seniors turn? To the banks? To the stock market?