Dave Postal: Variable Annuities and Better Disclosure

Dave Postal joins Coach Pete for a December 2011 conversation about variable annuities and disclosure. They discuss his reporting on living benefits, investment options, and the information consumers were receiving at the time. Call 800-661-7383 or text PLAN to 600-700. Transcript Automatically transcribed from this episode; timestamps are approximate. 00:00 And hey, folks, welcome back in to the Financial Safari, of course, weekly show looking inside that complex financial world. And like I like to do each and every week, go out into the public and find an author or a nationally known person and get them to give you some education from their perspective. We are very lucky this week to have Dave Postal. He's the Washington Bureau Chief for the National Underwriter Magazine. Dave, welcome to the Financial Safari. Thank you. Yeah, now, you've been writing articles for how many years? Perhaps 50 years on financials. And so you've seen financial products come and go. You've seen financial salesmen come and go then, haven't you? That is correct. And there was an article you'd written about a month ago, 00:46 and the title was SEC Presses for Better Disclosure on VA, which is Variable Annuity, Living Benefits, correct? That is correct. Now, what can you share? First of all, can you educate our listeners on what a variable annuity is and then go into what caused you to do some research on this, and let's try to expose some of the dirty tricks out there. How does that sound? That's fine. Variable annuities are an insurance product that provides a tax exemption for people to buy mutual funds with a variety of equities in them, stocks in most cases. And these products are wrapped to provide a tax advantage. 01:38 The tax does not have to be paid while the product accumulates value, i.e. goes up. But it does have to be – taxes have to be paid when it is sold, either by the person who is the owner of it or by their estate, by the people whom they give the money to when they die. In this particular case, what we're dealing with here, these are products that provide a return, a dividend, while they're being owned by the person who bought them. 02:27 I think that the annual return is around 5%, 6% now. It varies. But the idea is to put your money here and get two things. One, you have an equity product, which offers you an upside if the market goes up. But at the same time, it provides you some money, which is a very important issue at this time because certificates of deposits and other and bond products are offering very, very low returns as the Federal Reserve and other agencies try to stimulate the economy. But what's involved here is these variables – this is a hot product. 03:18 And the Securities and Exchange Commission is warning insurers through their lawyers that they're going to keep a close eye on these products to ensure the disclosures are adequate. And these products are allowing insurers to compete extremely effectively with mutual funds that don't offer this protection. And the reason Eileen Rominger, who heads the bureau at the Securities and Exchange Commission, that deals with these issues and oversees these products is two independent data groups have indicated over the last several weeks that because of living benefit riders, 04:04 variable annuity sales are approaching the levels reached during the boom year of 2007, before the worst economic downturn in 70 years began. According to LIMRA, which is a Windsor, Connecticut firm that tracks insurance industry trends, from 86 to 90 percent of variable annuities are now being sold with living benefit riders. Competing equity products like mutual funds don't have this option. One of the concerns of the SEC is that the insurance industry got in trouble during the market downturn, partly because of the guarantee it provided to VAs. A Government Accountability Office report released October 31st on what happened that required the bailout of AIG 04:53 noted that industry officials, state and federal, that between September 16, 2008, and January 2009, insurance companies other than AIG lost approximately $1 trillion in market value, and many were on the verge of bankruptcy. This concern later dissipated as the Fed efforts to revive the economy approved. But, and there were many other factors in the industry's troubled position. For example, property and casualty insurers did a lot of investing in mortgage-backed securities as reserve for their products. But guarantees on VAs did suffer, and the industry was hard-pressed to deal with this issue. 05:46 But now, the view of analysts is that insurers are better managing the risk associated with granting guarantees. But it is something regulators, both state and federal, as well as analysts, are keeping a close eye on. For example, Andrew Kligerman, a life insurance analyst at UBS Securities in New York, said there was a lot of pain in 2008 and 2009 because of the living benefit products insurers wrote. I think they will do it better this time. But he said there are a number of issues involved with this. Okay? The business can be written profitably, but it is a company-dependent process. 06:32 Okay. One issue that concerns analysts, et cetera, is that the market has become concentrated, with three players dominating the market and others competing only in niches. And that is another important issue. Okay? For example, Neil Strauss, who is vice president and senior credit officer at Moody's Investor Service, he said that the reason that the insurance industry is providing these guarantees is that they're not available anywhere else. 07:19 The key here is the guarantees, he said. Even if the equity markets don't do well, you get some sort of return. Generally, this is not available anywhere else. Okay? But the difference between 2007 and now is the trend is toward the company having greater control and the policyholder having less opportunity to allocate the investment as he or she might desire. Okay? For the customer, he said, there are less choices and more limitations. And these initiatives provide protection to the company in a stress scenario. Now, the reason that Ms. Rominger, who is the director of the SEC Investment Managing Division, 08:09 is voicing concern is about because this is such a hot product. Right. These concerns include disclosures related to using derivatives to enhance the yields, about the guarantees including in these products, and about living benefit products, as Strauss noted, that limit the investment options offered to purchasers. Okay? Okay. Okay. Now, in a talk to lawyers for insurance companies at an American Bar Association meeting several weeks ago, Rominger encouraged insurers and their lawyers to assess the effectiveness of disclosures in VAs that feature living benefits and use derivatives to enhance yields. 08:59 She said this should include elimination of boilerplate disclosures that do not reflect the actual use of derivatives in a fund's portfolio. Okay. Ms. Rominger said that disclosures should clearly reflect the actual role that derivatives play in the overall investment strategy of your funds because derivatives are very complex and volatile, and this is an extremely volatile market. Okay? And she's basically telling them that the disclosures relating to the limited benefit riders is just as important 09:44 as other disclosures and variable annuity products. Okay? And she said, indeed, purchasers of these optional benefits are facing increasing limitations on investment choices, reflecting an effort by insurance to limit volatility of the investments that are subject to the benefit and, therefore, their potential losses. So there is a lot of scrutiny by the agency and analysts, including Moody's and UBS, about the potential profit impact on this. Yeah. Now, and there's a lot of confusion that people have out there because they don't realize there's a big difference, Dave, between income protection and principal protection, right? 10:35 That is correct. That is correct. That is a big issue. But they're limiting the investment options to limit the potential cost of the guarantees if the market takes a steep plunge. And the European situation, the deficit situation, are very serious. And the market has went up in the early part of December and late part of November. But there is still major concern by analysts that Europe, which directly affects the U.S. because we export a lot of our goods to Europe, could impact the U.S. economy. 11:23 And another thing is that the U.S. banks have a stake in these, in the bonds, troubled bonds issued by these European countries that are in deep trouble. And at the top of the list is Italy and Greece. They are in the most serious trouble. But you have Portugal, you have Spain, you have Ireland, Belgium as well. So all of these, and even the stronger countries like France, are being impacted. And there is great concern in France about retaining their high credit rating. And Germany is seeking to create more unity so they can impose more discipline on expenditures 12:19 by members of the European Union. But it is very difficult because these people think their sovereignty is affected. And this downturn has had major, major effects. So U.S. investors are deeply concerned. And they're mostly concerned about the U.S. banks and their ratings, et cetera, et cetera. So that is why there is great concern about these guarantees, about what would happen, and also whether the companies can continue to pay the dividends. For example, MetLife, which is the market leader, which is a dominant player in this field, 13:08 they cut their guaranteed rate to 5.5% for the current quarter. And they're going to reduce it to 5% in January out of concern that they want to sustain this as a profitable product. Absolutely. So all of these are concerns. The companies, smaller players in this market, they're reducing their distribution, but they're offering higher yields. But at the same time, they're watching these yields closely. And they're trying to retain their market share while ensuring that they don't go overboard. 13:55 And this becomes a loss leader for them. That's the issue. There's a lot to think about here for folks, and they need to be very careful. And I really appreciate you taking your time today. Again, this is Dave Postal, folks. He's the Washington Bureau Chief for the National Underwriter Magazine. Dave, I really appreciate you taking your time to be on the financial safari today. Thank you. And, folks, we'll be right back after this. Thanks, Dave. I mean, yeah, so it's such a complex area. I see MetLife just announced record-setting sales in the third quarter for that variable annuity, too. That's exactly right. Yeah. Crazy, isn't it? Right, but they're cutting the guarantees. Yeah, so people are getting trapped in something that's not going to be as good as they thought it was going to be. That's exactly right. 14:42 Yeah, and once the market goes down and then the company limits their investment options, they basically can never recover once they go underwater under principle. That's correct. Yeah, it's scary. Scary. Hey, I appreciate your time, and let's see if we can get you back on in 2012 to talk about what's going on in the variable annuity world or just the annuity world in general. Thank you, sir. Thanks, David. Thank you. Take care. Okay.