There is a new sheriff in town! And his name is Fiduciary. Given the new Department of Labor (DOL) Fiduciary rules regarding individual retirement arrangements (IRAs) and qualified retirement plans along with the retention of fixed immediate annuity contracts under the PTE 84 – 24 exemption, I believe the time has finally arrived to compel a more thorough and complete fixed immediate annuity pricing disclosure. If all you carriers out there haven’t started thinking about the lowly immediate annuity in all this and can manage to pull yourselves away from your FIAs and VAs for a minute, it’s probably a good time to start.
One of the long standing mysteries surrounding fixed immediate annuity contracts and what can also be a big sale stumbling block is; how the carrier determines contract pricing. What financial advisor/agent now, unceremoniously turned Fiduciary after June 9th, wouldn’t want to finally know the interest rates and mortality credits associated with an IRA or qualified funds immediate annuity for any one particular client. I don’t believe the old standard one page immediate annuity quote is going to suffice under the new fiduciary disclosure standards. Now, instead of just jawboning about the benefits of mortality credits and interest rates, we can actually show the numbers; mortality credits, interest rates and expenses year by year for any one particular client. (Read on for Sample Price Disclosure – below)
Because of an actuarial blending of the pricing elements, it isn’t possible for a consumer or anyone for that matter, to review an immediate annuity quote and simply discern the assumptions/guarantees the carrier is using to price the immediate annuity contract on the purchase date.
Mortality based annuities advance mortality credits to all participants using an averaging method to level out/smooth payments from year to year. Interest rates are selected; yes more than one interest rate is used and an expense assumption is made. However, a by-product of this averaging method is an obfuscating of mortality based annuity pricing because consumers can’t reasonable determine the interest rates they receive vs. the mortality credits they earn and how company expense estimates come into play. This is all blended together and reflected in the disclosed immediate annuity price on the quote sheet.
Comprehensive immediate annuity pricing disclosure has long been a stumbling block for the industry and agents as a whole. The problem is; how to accomplish it to create more transparency for new DOL fiduciary disclosure purposes, in such a way that makes it meaningful to a consumer or a consumer’s financial advisor. Simply disclosing the pricing actuary’s formulas is not sufficient as most consumers would not understand the higher level math.
Currently, lifetime immediate annuity quotes consist of one or two pages depending on the age of the individual. Typically, the first page of the quote displays the inputs (age, gender, initial payment date, premium cost, etc.) selected to drive the pricing for the case. In addition, some carriers’ quotes display future annual income to some advance age to 100 or 110. This is primarily done for non-qualified contract purposes so individuals may understand how the carrier intends to report the future non-taxable distributions/income cost basis recovery and when it ends and when the period certain period (if any) ends.
Breaking down the three primary immediate annuity pricing elements; probability of survival aka “mortality credits”, interest rates and company expenses can be easily accomplished with simple math and disclosed in columnar form on a second or third page of the immediate annuity quote, depending your case. A separate column for each pricing element will greatly enhance understanding of how the immediate annuity price was determined. Let’s see what this might look like from an annuity payment perspective.
The sample case is for a male, age 75 (payment to age 90 for simplicity/discussion purposes) for a $10,000 lifetime annual income, with the initial payment starting after one year, utilizing an immediate annuity with 5 guaranteed (period certain) years.
SPIA Pricing Disclosure (For Your Immediate Annuity Contract)
|Age||Annual Income||Percent Probability of Survival to This Year(1)||Your Premium Cost After Mortality Credit/Discount(2)||Annual Interest Rate For this Year(3)||Premium Cost Assignment For This Year’s Income(4)|
|Total Premium Cost Before Company Expenses||$95,369|
|Total Premium Cost Before Company Expenses||Total contract Expenses Over the Life of Contract (5)||Total Premium Cost You Pay Today For This Annuity(6)|
Financial Disclosure Notes
(1) In your case, there are 5 period certain years, meaning: we have to make the $10,000 annual payment to you or your estate/beneficiary (if you die) therefore, you were credited with a 100% survival rate (no mortality credit/discount). Starting at your age 80, the company utilized various population studies and made survivorship projection estimates. Consequently, we believe, for males, age 75 today, there is an 85% probability you will survive to age 80 and we have to make the annual $10,000 payment to you. The subsequent following estimates from age 81 and on, show what we believe to be your probability of survival at these future ages based on what we know today. After this contract is issued and if these survival rates increase, we cannot decrease your annual income to reflect the longer payment period and the actual future experience. On the other hand, if future survival rates decrease, shortening the payment period, we will not improve your annual income.
(2) While the company is responsible for making the $10,000 annual income payment to you, this column represents the premium cost to you for this years’ annual benefit after the application of your mortality credit/discount but, before credit for your interest earnings. (See Notes 3 & 4)
(3) This column reflects the annual interest rates we are crediting to your contract. After this contract is issued and if these interest rates decrease, we cannot reduce your annual income to reflect the actual future experience. On the other hand, if future interest rates increase, we will not improve your annual income.
(4) The annual premium cost assignment from the single premium sum you paid for the contract and for any one year’s income is a function of your annual income for that year ($10,000) multiplied by the probability (your survival rate) we will have to pay it then, this product, is discounted to reflect the interest rate we are crediting for that year to your contract and the passing of time to the premium payment date (purchase date). For example at age 80, the calculation is ($10,000 x 85%) or $8,500 then, this amount is discounted to the present time (purchase date) at 2.50% each year for 6 years to arrive at the $7,328 cost for this age 80 premium cost allocation funding this years’ $10,000 annual income.
(5) The estimated Home Office expense assigned to your contract. After this contract is issued and if this expense increases, we cannot reduce your payment to reflect the actual future experience. On the other hand, if future expenses decrease, we will not improve your payment.
(6) The total premium cost you pay us is the sum of the Total Premium Cost Before Company Expenses ($95,369) plus the Total Contract Expense Over the Life of the Contract ($3,800) or $99,169.
A short comment regarding Note 5. There are Home Office expense estimates incorporated into the immediate annuity pricing decision made by the pricing actuary. Not recognizing this expense incorporation is understating the contracts’ total cost. In reality, what happens is; Home Office expenses are considered in the interest rate spread the carrier captures between the interest credited to the contract and the interest actually earned by the carrier. Just like in deferred annuity declared rate contracts, immediate annuities are primarily “spread based” products. In other words, if a company is crediting 3.00% on a fixed contract they are really earning 4.50%. Company expenses and any profit have to come out of the 1.50% (4.50% – 3.00%) spread. It’s a common misconception carriers earn an “underwriting” profit on the mortality credits/assumptions. Regarding immediate annuities, carriers do not earn long-term profitability from Annuitants dying.
Such a disclosure or one similar to it and plainly worded, would go a long way to help consumers and everyone else understanding how any given immediate annuity is priced on its issue date. With this kind of disclosure, one could easily see how the pricing elements (mortality discounts/credits, interest rates and expenses) interplay when making quote comparisons between competing carriers for the same annuity.
For the agent there is a side benefit. This kind of disclosure really hits home the financial benefit of mortality discounting and the immediate annuity. Look at the last year, age 90. This is only 15 years from the contract issue date. As you can see, only a very small premium cost, after accounting for the mortality credit/discount and interest earnings for that year, is allocated to fund the $10,000 annual income requirement/guarantee. $1,387 to be exact. I mean, really, where can you go and get a guaranteed $10,000 payment for such a pittance. As an agent, you can point a consumer to such a hard number calculation and basically say, “See what I can do for you!” Think you might want some of this?” Of course, with the caveat, you have to survive.
The probability of survival rates and interest rates used for this hypothetical financial disclosure are fictional. In both cases, I used numbers, I thought were close and made the math easier to illustrate my points. Also, if you try to duplicate the math I liberally rounded the numbers. However, annuity price comparisons between carriers is not the be-and-end-all it’s made out to be. Agents have to also keep in mind contract differences and not just focus on the pricing aspect to determine if one contract is “better” or more “suitable” than another for any particular client.
One contract and not necessarily the best priced contract may have the features you need for this particular client. For example, you may need a payment commutation provision or an off-modal payment ability or the ability for the Owner to change ownership on a post issue basis, or a contract provision for Annuitant death prior to the first payment date that pays the death benefit to the Beneficiary and not return the premium to the owner’s estate, etc. These and many other provisions/features are differences found in immediate annuity contracts and they can trip you up and turn your case south as much as an inadequate pricing disclosure. Immediate annuities are serious business. Should a problem occur and because they are permanent contracts, there is no chance to correct it down the road. The client will just have to live with it for the rest of their life. He/she will probably be none too happy about that. So, as an agent, you better know what you’re doing.
Given new Federal DOL Fiduciary rules, everyone is going to have to step-up their game; disclose more, become more transparent and legally maintain a higher level of client care. This includes the venerable old fixed immediate annuity contracts, the carriers that issue them and the agents who sell them. Under these new house rules, the tired old immediate annuity quote is just not going to cut it. Let’s face it, how many financial advisors and agents out there would finally like to know the real deal on immediate annuity pricing. Let’s get that old man out from behind the curtain and into the light of day. That’s the idea, “Always Keep Your hands Up” – The SPIA Book.