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Criticism of Buffer Annuities: Is it Justified?

Have you heard of “buffer annuities?” They’re described as sort of a cross between variable and indexed annuities. Through exposure to structured products like options contracts, they boast a protection to the downside in exchange for a cap to the upside. Several industry players have reported an increase in complaints against these products, but according to a recent article from Investment News, the criticism may not be warranted.

One such critic of buffer annuities is Andrew Stoltmann, founder of Stoltmann Law Offices in Chicago, a firm that exclusively represents investors from across the country.  

“I can’t think of two more odious products than a combination of a variable annuity with a structured product,” said Mr. Stoltmann. “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.”

This type of annuity is relatively new, having developed after the latest financial crisis as a means to provide insurers with a way to cater to clients looking for caps higher than that of an indexed annuity in a low-interest environment. They were first offered by AXA Equitable Life Insurance Co. with its Structured Capital Strategies product in 2010. MetLife Inc. and Allianz Life Insurance Co. of North America followed in 2013, and Members Life Insurance Co. launched one, the Members Horizon annuity, in July of 2016. And while they’ve been available for several years, it’s only been in the last year, or so, that sales have really grown, and garnered the attention of some regulators.

“I spent some time with my team trying to see how this thing works,” said Donald Lopezi, regional director for the Financial Industry Regulatory Authority Inc.’s western region. “It’s very complicated. I can’t speak nationally ut we are starting to see some complaints on those products in the west region.”

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

Buffer annuities are designed 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. Specifics vary from one product to the next, but for example, they may have a 10% buffer to the downside, meaning that the insurance company eats the first 10% of market loss in any given year, and the investor picks up the rest. On the other hand, caps are typically around 8-9% as compared to about 4.5% for an indexed annuity. Buffer annuities aren’t invested directly in a market index, like the S7P 500, but instead about 90-95% of the premium buys fixed-income securities. The remainder diverted to derivatives like options, futures and swaps.  It’s this blending of indexed products with complex variable components that have critics concerned.

But some feel the criticism is not justified. Senior product manager for annuity solutions at Morningstar, Kevin Loffredi, claims that buffer annuities are more straightforward than indexed or variable annuities with a purchased income rider.

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

Senior vice president of product innovation at Allianz, Matt Gray, added that there’s “[investor] appetite for something in the middle” of indexed and variable annuities. He thinks that buffer annuities are “probably the cleanest and simplest way to get there.”

In the last four years, AXA has received 43 sales complaints and one Finra complaint, while Allianz, which sold 13,000 policies last year, only received three formal complaints. The issues being reported are similar to variable annuities: suitability and misrepresentation of associated risks.

“It is all about disclosure and making sure the client knows exactly what they’re getting,” said Chris Finefrock, vice president of investments at independent broker-dealer ValMark Securities Inc.

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