“Equity abhors a windfall.”

Fiduciary law is largely based on trust, agency and equity law, with an emphasis on fundamental fairness. Any situation in which a fiduciary benefits at a beneficiary’s expense is a potential breach of the fiduciary’s duties.

The law takes a fiduciary’s duties very seriously. There are no “mulligans” in fiduciary law

A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior… the level of conduct for fiduciaries [has] been kept at a level higher than that trodden by the crowd.1

I have made no secret of my dislike for annuities. As an estate planning attorney, I have seen far too many well-designed estate plans destroyed by annuities.

Another problem I have with annuities dates back to my days as a compliance director. Yes, I did approve some annuity purchases because they were suitable, both in terms of amount and situational need.

My brokers quickly learned that my limit was approximately 25-30 percent of new worth, excluding one’s home. I am proud to say that I never approved an application for a fixed indexed annuity, and my brokerage firms supported me due to the liability exposure created by the misleading marketing connected with such products.

A final issue I have with annuities is the broker “greed” factor. Far too many times I had brokers submit applications for the purchase of annuity based purely on the amount of the projected commission. Brokers would submit an application proposing that a client put 50-70 percent of their new worth in an annuity.

Not going to happen on my watch.  My job as a compliance director was to protect the firm, the broker, and myself. Even today my compliance clients know my three favorite sayings about annuities:

1. “You can put lipstick on a pig, but it’s still a pig.”
2. “You can wrap an old fish in a new wrapper, but it will still stink.”
3.  “All God’s children do not need an annuity.”

Annuity companies continue to try to convince RIAs and other investment fiduciaries to sell annuities. Smart fiduciaries ignore and will continue to ignore such sales pitches.

The Capital Gains (2) decision established that investment advisers are fiduciaries and covered under the Investment Advisers Act of 1940 (40 Act).(3) SEC Release IA-1092 established that anyone holding themselves as a “financial planner” or  as providing financial planning is generally considered to be covered under the 40 Act and its regulations.(4)

Annuity companies have recently been touting “no-commission” based annuities as way to get around the fiduciary issues involving annuities. (#2 above) What the annuity companies do not explain to investment fiduciaries is that the issue with fiduciaries recommending/selling annuities is not so much the commissions as it is the inherent “fundamental fairness” issues with annuities and the fiduciary duties of prudence and loyalty.

For example, VA issuers quickly respond to any suggestion of the adoption of a meaningful fiduciary standard, as they know VAs will never pass such a standard. First, the inverse pricing method that most VA issuers us to calculate a VA’s annual M&E, or death benefit, fee is clearly inequitable, as it is designed to produce a blatant windfall for the VA issuer. Even an insurance executive admitted to the inequitable nature of inverse pricing.

Even more troublesome is that some brokers admit to not understanding the concept of inverse pricing or how it produces a windfall for the VA issuer at the VA owner’s expense, i.e., results in a breach of a fiduciary’s duties of prudence and loyalty. VAs typically guarantee that the death benefit will never be less than the VA owner’s actual contributions into the policy. That is the extent of their legal obligation vis-a-vis the death benefit.

And yet, they base the annual M&E/death benefit fee on the accumulated value of the VA. Given the historical performance of the stock market, it is reasonable to assume that the accumulated value of the VA would significantly exceed the VA owner’s actual investment in the policy, resulting in a fee significantly higher than one based on the VA issuer’s actual legal exposure. That is a classic example of a windfall.

Furthermore, the actual value of the death benefit is open to debate. As Moshe Milevsky pointed out, given the historical performance of the stock market, and thus the VA’s subaccounts, the chances that a VA owner’s heirs would need to invoke the death benefit are minimal.(4) Miklevsky also points out that VA issuers are typically charging an annual M&E/death benefit fees 4-5 times higher than the benefit’s inherent value. All of which supports the sayings that “a VA owner needs the VA’s death benefit like a duck needs a paddle” and “VAs are sold, not bought.”

I realize that some RIAS and other investment fiduciaries are recommending immediate annuities…in reasonable amounts and with reasonable fees. The facts in each case will determine the reasonableness of such recommendations.

I will continue to advise my fiduciary clients to avoid annuities. I am on record as saying that I expect a heavy level of litigation in connection with Reg BI violations in connection in rollovers involving recommendations to buy annuities. To me, just not worth the risk.

Overall, the fact that annuity issuers and advocates go to such lengths to avoid the negativity associated with the term “annuities,” using such terms as “guaranteed income products” and “retirement wellness products” instead, says all I need to know.