Surrender Fees and Bonuses: Bonus Dollars Must Exceed Surrender Fees
Comparing surrender fees to bonuses is not a percentage vs. percentage comparison. Just because a variable annuity has a 7% surrender fee and a fixed annuity has an 8% bonus, does not mean the replacement is suitable. The reason you cannot make a percentage vs. percentage comparison is because the surrender fee on the variable annuity is based on the account value and the bonus for the fixed annuity is calculated off of the variable annuity surrender value (which will be lower than the account value). You must compare the dollar amount of the surrender fee to the dollar amount of the bonus. The easiest way to make this calculation is to compare the current account value of the variable annuity to the account value of the fixed annuity upon issue. The account value of the fixed annuity must be greater than or equal to the account value on the variable annuity.
Death Benefits: Avoid Reducing the Benefit of Death
As a general rule you should avoid reducing your client's death benefit when replacing a variable annuity. This can be a real challenge during a period of market loss. It is not uncommon for market losses and fees to erode the account value of a variable annuity, but due to contractual guarantees the death benefit may greater than or equal to the original premium and possibly much greater than the current account value. Our primary demographic, the middle market, rarely buys a variable annuity for the death benefit. Their primary concern is preservation of principle, growth, and guaranteed income. That being said, just because the client doesn't care about the death benefit that does not mean it can be ignored. Review what other life insurance the client has, how significant the death benefit is that they are giving up, and what death benefits they need. If necessary, offer the client the opportunity to purchase life insurance to replace what they are giving up. If the client understands and desires to give up the death benefit associated with their variable annuity, then have the client sign a letter of explanation (see below).
Income Benefits: Avoid Reducing the Benefit of Lifetime Income
Just like death benefits on a variable annuity, living benefits can also maintain or increase in value even if the account value is going down. Most fixed annuity lifetime income benefit riders require a one year deferral so an immediate comparison is impossible. To make sure you are not decreasing your client's lifetime income benefits, compare the lifetime income options on the fixed annuity based on the date the client will first become eligible to receive them. Use the same date, if possible for the variable annuity. For the variable annuity you must look at the lifetime annuitization option (even if the client would not want to annuitize) as well as any income benefit rider options. The lifetime income payout options on the fixed annuity should exceed the payout options that are available on the variable annuity.
Letter of Explanation:
The issue of suitability is not always black and white. One complicating factor is that sometimes what the client wants would not be considered suitable by regulators or insurance carriers. In the process of serving your client to meet their objectives you must also protect yourself and the insurance company you represent. Client's needs and wants change over time and what they say when they buy an annuity might not be what they say about the annuity replacement ten years from now.
In cases that are borderline, where the client is very motivated to get out of the variable annuity despite the loss of some benefits, (i.e. The death benefit on the variable annuity is higher than the death benefit on the fixed annuity) you need to get a letter of explanation. A letter of explanation is a letter from the client agreeing and acknowledging what they are giving up.
For Example: Mr. and Mrs. Jones own a variable annuity with a $400,000 account value. Their death benefit is $425,000 and there is no income rider. They have $500,000 in life insurance and another $500,000 in other variable liquid investments. The surrender fee is $37,000 which means that the premium that would transfer to the fixed indexed annuity you are recommending is $363,000. Your product has a 10% bonus and an income rider with an 8% roll up. After applying the bonus the fixed indexed annuity account value would be $399,300 as would the death benefit. In this case Mr. and Mrs. Jones account value would be $700 less then with their current variable annuity and they would also lose $25,700 in death benefit at the time of transfer. Mr. and Mrs. Jones have expressed that their primary objective is preservation of principle and lifetime income after a 8 year deferral period. You have helped Mr. and Mrs. Jones compare the two products and they have determined that the fixed indexed annuity will better suit their future need for guaranteed lifetime income.
The letter of explanation would read something like this:
To ______________ (name of FIA carrier and agent):
I, Mr. and Mrs. Jones, do hereby acknowledge and are fully aware that by purchasing the ______________ (name of the FIA annuity contract) we will be losing $700 in account value and $25,700 in death benefit at the time the ______________ (name of FIA annuity contract) is issued. It is our desire to forego these benefits in our _______________ (name of VA annuity contract) so that we will receive income rider benefits under our contract with __________________ (name of FIA annuity contract) as outlined in the __________________ (name of the FIA annuity contract brochure and disclosure). Our primary concern is preservation of principle and guaranteed growth for the purpose of a lifetime of income. It is our assessment that the death benefit of the ________________ (name of FIA contract), our life insurance, and our other assets is and will be adequate for us and our beneficiaries.
We have read all product brochures and disclosures pertaining to ______________ (name of FIA annuity contract) fully understand their content. Based on the contract benefits mentioned in the _________________ (name of FIA annuity contract brochure and disclosure) we have decided that it is in our best interest to purchase the __________________ (name of FIA annuity) with funds surrendered from _____________________ (name of VA annuity contract).
Name of clients