Annuities for high-net-worth investors; for many advisors, it's an oxymoron. Pricing and suitability issues remain a problem, they say, and the product's compensation structure simply doesn't fit with the asset-based business philosophy they preach. It's these issues - real or imagined - that lead them to discount annuities from the boomer portfolio altogether.
But Financial Planning 101 dictates that every client - and every client situation - is different; to be treated as such. If that's true, how can an entire product class be wrong for every client?
It's something Jeff Karelis is quick to note. A founding partner with Waltham, Mass.-based KSP Financial Consultants (a Commonwealth Financial Network-affiliated firm), he started out in 1969, and has grown with the modern financial services movement. In that time, he's seen annuity iterations that work and those that don't. The current crop, he believes, can be particularly effective in boomer retirement if used correctly. He sat down with Boomer Market Advisor to run through the reasons why.
Karelis' firm has $220 million in assets under management ("Thirty percent less than they were 16 months ago," he adds) with 500 households spread among five advisors. An excerpt of the interview can be found here. For more, visit www.boomermarketadvisor.com.
Boomer Market Advisor: Annuities and high-net-worth advisors; two terms we typically don't associate with one another. Have you looked seriously at annuities for your clients?
Jeff Karelis: When I started out, I worked with more "accumulators" than investors. I was in my 20s and 30s, most of my clients were in their 20s and 30s, and there were ways to effectively work with annuities. In the early 1980s, a client could get in without having to invest $50,000. It could be done by dollar-cost averaging. But in the 1990s, they simply got too pricey for what they delivered. And although there was no entry charge to get in, the surrender charges were too high for too long. I lost my taste for them and I didn't think they were a good fit for most of my clients.
BMA: So what changed? Why now?
JK: I moved to Commonwealth, so I no longer had one company offering the product like I did at my former broker/dealer. But the fact that we have more choices to offer isn't what makes them more attractive. The need for their cash flow to last until the day they die is one thing all clients have in common. And whether it's while they're working and they're exchanging productivity for a paycheck, or when they retire and they take their assets to produce income, ultimately cash flow is what they need.
In the past two or three years, guaranteed monthly income benefits have become more attractive. But, obviously, they're expensive and they have negatives about them as well. We fully explain what they are. With last year's revenue, my income from annuities was probably less than 10 percent of my gross income. But that was still more than the two or three years before. It's now a part of our business, but it certainly isn't the significant part.
BMA: What are the benefits to your boomer clients?
JK: (Annuities) enable clients to have belts and suspenders, which they need in the current market. For distribution purposes, clients benefit from knowing they have a steady stream of income that will increase every year. But don't forget the disadvantages. One is that the benefits aren't given away - by any stretch. They're expensive. I go over all the costs and surrender charges. I inform clients that the annuity should be looked at as an asset. They shouldn't touch the lump sum investment. They should use it to distribute income.
BMA: The downside protection/upside potential argument you describe is playing out before our eyes. Is the annuity story easier to tell? Are boomer clients more accepting of it now than in an up-market?
JK: Yes, it's an easier story to tell. But one of my concerns is the annuity portfolio values. When I first started, if they had a 5 percent or 6 percent potential distribution, we might at first use a more aggressive portfolio. But in view of what's happened in the last two or three years, what concerns me is that a number of these very good company portfolios (even if they're a 60/40 split) have decreased significantly in the last year. So yes, they'll get bumped up in terms of the amount they can take money off, but of course there's always the threat that the account value will go to zero. I never thought that could happen two or three years ago, but I'm seeing that it could very well happen the market continues in the way it's been going. It's a concern and discussion point with clients.
BMA: So how will that affect your annuity business? You said it's not the largest portion of your business. Do you think that's going to increase, decrease; how do you see it playing out?
JK: We're certainly starting to look at fixed annuities because some of the annuity companies - and I would only use one that is a very, very strong company - have shorter surrender charge periods. Maybe it's only a four-year period where they would guarantee an income of 4 percent or whatever. As conservative as that sounds, it's a positive return and people will at least know they're going to get their dollar back. Coincidentally, for about two weeks - not because we were doing this interview - I've been exploring fixed annuity possibilities with various companies. To answer your question, I still wouldn't want to make it a too big a percentage of a client's portfolio.
BMA: Are you talking traditional fixed, or are you looking at equity-indexed products as well?
JK: No, more traditional fixed. And with options like bonuses, I explain them all and let the client decide. They have to know they pay for part of the bonus through higher mortality and expense fees.
BMA: You entered the business as strictly commissioned-based in 1969, and now you're a fee-based advisor to the high-net-worth set. Your career tracks with the modern financial services industry. So what's the next chapter? How will all this shake out and how will you position yourself?
JK: Good question and I wish I knew the exact answer because we're quite concerned about what's going on.
BMA: Would you say it's unprecedented?
JK: Yes, absolutely. I started in September 1969, so I didn't see an up-market for 13 years. People are really scared. I remember when I was in my 20s and 30s my parents' generation used to say, "You don't remember the Great Depression," and that justified their behavior. If this lasts a little bit longer, there are going to be a lot of people who aren't going to get back into the markets in the way they did in the 1980s and 1990s. It's going to change the landscape for our clients and it does concern us.
BMA: How will you handle it?
JK: We're probably as conservative in our portfolios as we've been in a long time. The first thing to rebound will be the fixed income markets. The credit markets got us into this mess and that's how we'll get out. You're seeing some appreciation in municipals, high-yield corporate bonds and, obviously, treasuries. Fixed income will have better total returns than equities going forward over the next several years.
BMA: But how do you see it shaking out from a business standpoint? Is this an opportunity to gain new clients?
JK: Yep. But before we talk about gaining clients we've got to make sure we don't lose current clients. And we have lost very, very few clients. I think people understand what's happening. How it will play out if it continues this way (even if we do the very best job that we can) I don't know for sure, but it does lend itself to opportunity. And over the last ten years or so, longevity has really begun to increase. People are living longer, retiring earlier, spending more and saving less. They've been impacted in retirement by inflation, even though they didn't think they would be, and by health care costs.
BMA: That's pretty much the classic boomer problem, isn't it?
JK: Exactly. And it's been exacerbated by what's been happening recently. The paradox of thrift is that it hurts the economy because consumption decreases at a time when it needs to increase. If they spend less, companies make less and if they make less ... and on and on it goes in a vicious cycle. Someone once said, "Growth is arithmetic, contractions are geometric." But to answer your question, there are a number of major financial institutions that have gone out of business.
BMA: So you'll benefit from the disintegration of the wirehouse?
JK: Absolutely. People are quitting Merrill Lynch left and right. Plus the fact that in order to have an advisor you have to maintain certain minimum account levels. Now clients are going through an 800 number. If you have an advisor and he left and they put you in an 800 number, it seems that might cause you a bit of dissatisfaction. And this is to say nothing of the four or five other major companies that disbanded. That's one thing. And then of course there's the market, even if you're satisfied with the company you're with, people are more mobile in terms of moving from one advisor to another. So for those that stay in the business, do the right thing, and are compliant, there are more opportunities. We'll manage more money just because the markets will go up (hopefully soon), but also because more people are moving their money to us. We've had some of that happen already and I expect we'll have a lot more.
