Buffer annuities, an index-variable hybrid, garner mixed reactions

While some call the annuities 'odious' due to complexity, others believe they're more straightforward than other annuity products

Feb 1, 2017 @ 4:15 pm

By Greg Iacurci

While brokerage regulators and some attorneys have seen an uptick in complaints lodged against a type of annuity known as a “buffer annuity,” there's mixed reaction as to the validity of criticism lodged against the products.

Buffer annuities, a sort of cross between indexed and variable annuities, offer a measure of protection to the downside in return for a cap to the upside. They accomplish this through exposure to structured products such as options contracts.

Andrew Stoltmann, the founder of an eponymous law firm based in Chicago, is one individual lobbing strong words against buffer annuities.

“I can't think of two more odious products than a combination of a variable annuity with a structured product,” Mr. Stoltmann said. “I feel like when these two investments come together, I'm about to witness the landing of the Hindenburg on the deck of the Titanic. It's bad, we just don't know how bad it's going to be.”

Such annuities are relatively new to the insurance market. They started cropping up post-financial crisis as insurers sought a way to cater to those who wanted caps higher than what they could get with an indexed annuity in a low-interest environment.

AXA Equitable Life Insurance Co. was first to market, with its Structured Capital Strategies product, in 2010.

Allianz Life Insurance Co. of North America and MetLife Inc. followed in 2013 with Index Advantage and Shield Level Selector, respectively. Members Life Insurance Co. launched one, the Members Horizon annuity, in July last year.


Sales of buffer annuities, which are purchased with an accumulation, rather than income, focus, represent only a small fraction of the overall variable annuity market. Sales grew to $2.12 billion in 2015, following three relatively flat years of about $1.3 billion-$1.5 billion, according to Morningstar Inc. data. (Morningstar doesn't track MetLife sales because its annuity isn't technically a variable annuity, even though it operates similarly to the others.)

Sales have been strongest through the independent broker-dealer channel, followed by banks, Morningstar data show.

Despite their modest sales figures, buffer annuities seem to have garnered the attention of some regulators.

Donald Lopezi, regional director for the Financial Industry Regulatory Authority Inc.'s western region, said last week at an industry conference that he'd started seeing complaints about such products.

“I spent some time with my team trying to see how this thing works,” Mr. Lopezi said. “It's very complicated. I can't speak nationally but we are starting to see some complaints on those products in the west region.”

While Finra declined to provide additional detail for this article, Mr. Stoltmann, who represents investors in arbitration claims lodged with Finra, said he's seen a similar trend.

“Up until about six months ago, I had never even heard of these investments,” according to Mr. Stoltmann. “Now, in the last six months, I've got probably six or seven calls from investors who've purchased buffer annuities.”


Brokerage executives and insurers say buffer annuities are appropriate mainly for investors with a risk tolerance less than that of a traditional investment-focused variable annuity but greater than that of an indexed annuity.

Similar to an indexed annuity, which doesn't credit investors less than 0% interest but has a cap for upside performance, buffer annuities have downside protection, but to a lesser degree.

Depending on the specific product, they may have a 10% buffer to the downside, whereby the insurance company eats the first 10% of market loss in a given year, and the investor is on the hook for the remainder. However, they have higher caps — typically around 8%-9%, as compared to about 4.5% for an indexed annuity, according to Chris Finefrock, vice president of investments at independent broker-dealer ValMark Securities Inc.

Buffer annuities are structured almost identically to indexed annuities in that they don't invest directly in a market index such as the S&P 500. Rather, about 90-95% of investors' premium buys fixed-income securities, with the remainder diverted to derivatives such as options, futures and swaps.

“People get confused enough about indexed products, and now you blur in the complexity of the variable side as well,” Mr. Finefrock said. “So it just compounds the complexity.”


However, some feel the criticism is overblown.

Kevin Loffredi, senior product manager for annuity solutions at Morningstar, said buffer annuities are still more straightforward than indexed or variable annuities purchased with an income rider. Those carry complex features such as roll-ups, as well as differences between a contract's true value and the value of its benefit base, he said.

“There are less moving parts and it's for a simpler client purpose,” according to Mr. Loffredi. “This is ... for clients ... looking for accumulation. Living benefits are solving for an income need, which is inherently more complex.”

Matt Gray, senior vice president of product innovation at Allianz, said there's “[investor] appetite for something in the middle” of indexed and variable annuities, and that “this is probably the cleanest and simplest way to get there.”

Mr. Gray and Kevin Kennedy, head of individual annuity at AXA, said they haven't seen elevated product complaints as have Finra's west division and Mr. Stoltmann.

Over the past four years, AXA has received 43 sales complaints and one Finra complaint, according to Mr. Kennedy. Allianz, which sold 13,000 policies last year, received three formal complaints, Mr. Gray said.

Complaints have centered on similar issues to variable annuities, according to Mr. Stoltmann — suitability, and misrepresentation of risks associated with the investment.

Mr. Finefrock said his firm sells buffer annuities, but he's seen “fairly limited adoption” because they're appropriate in “niche circumstances.”

Confusion typically crops up around lock-up periods for an investment choice (which differ from surrender periods) and differences in product features such as a “floor” versus a “buffer,” he said.

“It is all about disclosure and making sure the client knows exactly what they're getting,” he said.


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