Castlepoint Partners’ Jake Weatherford, CFP®, and Adam Lee, CFA®, discuss the intricacies of insurance policies and insurance fees, with a particular focus on annuities, and emphasize the need for transparency and awareness.
In this Jake’s Take video, Jake and Adam express their respect for insurance plan providers but emphasize the importance of being aware of fees. They explain how insurance companies invest customers’ funds and return some gains but caution about hidden fees and complex structures, citing AIG’s notable profit margins. They note that complexity often leads to higher fees, underlining the need for transparency on compensation and costs. Their advice stresses the importance of understanding fees in insurance products and ensuring that they align with individual needs.
Video Transcript:
Jake Weatherford:
Welcome to Jake’s take. I’m going to let Adam join me for this one. As you know, he joins me for just about every one of ’em, so maybe I need to adjust the name. Adam and I are going to dive into some insurance topics. Here’s what I’ll tell you. We don’t hate insurance. We don’t hate all insurance, we don’t hate insurance companies, but what we find with annuities and things like that is that there’s things in these policies that we like people to be aware of. There’s fees. There’s fees for anything you trade in the open market. We understand that. We just want you to understand that. So Adam, why don’t you dive in a little bit to what a typical fee structure looks like in an annuity, maybe a little bit on the insurance side, and just tell us what should we be aware of when looking at these types of products?
Adam Lee:
Yeah, I think the biggest thing to be aware of is the insurance company. It’s a little bit different than investing in a fund or directly in a stock, right? Because the insurance company sits between you and the investment. So when you give money to an insurance company, whether it’s for life insurance, like a whole life policy that has some investments related to it or an annuity, if the insurance company takes that money and then they don’t really tell you what they go do with that money, all they say is like, Hey, we’re going to give you X amount of dollars subject to this index, or whatever they say. It can be a very complicated product or a more simple one, but on the backend they’re going to go invest that money somewhere. The question is how much of what they invest in gets passed back onto you.
And now insurance companies, it’s not just an investment product. And so a classic example like term life insurance is a really good idea for a lot of people. And you can’t go get term life insurance in the stock market. That’s the death benefit and the security that could bring your loved ones, that’s an important thing that you can’t get by going and buying a stock of Apple. But a lot of times they kind of rope in other investment things alongside that. And so I thought it’d be interesting given that structure, you’re not necessarily always going to know all of the fees. A lot of them are just baked in. So if I say, Hey, I’ve got this great deal for you, it’s called Adam whole annuity whatever, and I say, I’m going to give you 70% of the s and p five hundred’s return, right?
Well, you’d probably look at me and say, well, I can just go invest in the S&P 500, so why would I take 70% of it? The truth of these insurance contracts is they function somewhat like that, but they’re much more complicated. So it’s not as easy to say, oh, you’re only giving me 70% of the return. They’ll say things like, we’ll give you all of the S&P 500 return, but capped at this amount with a floor here, and then there’s going to be this minimum, but this fee here and behind the scenes, what they’re doing is they’re going out to the market and they’re buying derivatives and things like that on the backend to create that same return for themselves and then pass a little bit less of it onto you. And so anyways, we took a look at the financial statements of AIG big insurance company.
If you look at their life insurance division, the profits they make, all the money they taken from customers, the returns they make on the investments from the customer’s money, less the money that makes it back to the customer, and also their expenses like paying their staff commissions and things like that. They end up with about 4% profit on life insurance, which is a good little business, but it’s not crazy high. That’s not a crazy profit margin. You look on the annuity side, it’s more like 30%. And that doesn’t include, again, the commission that the agent that’s selling you that annuity is getting. And again, this is on average across all annuities, but 30% is a large amount to take as profits. And that’s not to say they’re never a good idea, but when somebody’s making a 30% margin in a way that’s not disclosed, it is just an extra level of caution you need to bring to evaluating that product or that investment.
Jake Weatherford:
So this company made 30% on annuities, 4% on life insurance. You think within the life insurance that includes probably all life insurance, like term whole and all that, which, why do you think it’s such a difference between life insurance?
Adam Lee:
It’s a good question. It’s a question I have myself. I need to do more digging to know if whole is included in that life insurance or not. Or if maybe they split it out and they kind of have, Hey, here’s the life insurance part of the whole life product and here’s the investment part of it. But I would say life insurance, and we even see this on the annuity side is maybe the better way to answer your question. So there’s things called fixed annuities, which are usually the simpler annuities, Hey, you’re going to invest this amount and then we’re going to pay this fixed amount back to you every year until you pass. And then there’s more complicated ones like variable annuities where it’s like, okay, you’re going to pay this amount, but then we’re going to return to you something that’s linked to an index with a cap and a floor. And we actually see a difference in those two products and they make not quite twice as much, but close to twice as much on the variable annuities as the fixed annuities. So I think it’s like any other product you buy, the more bells and whistles and customization, the harder it is to comparison shop that product versus another product. Probably the more margin a company’s going to be able to get away with charging. And so if you go out right now and you try to buy a used Honda Civic with 30,000 miles, there’s probably thousands of those for sale in the U.S. right now, you’re going to get a pretty tight range. But if you’re trying to go find a ’75 Camaro that’s been in less than one wreck, that is a certain color, it’s going to be really hard for you to know what to pay. You’re probably going to have to get some special book of all these classic cars or whatever. And so anyways, the more complex the products, the more hidden and baked in the fees are typically probably the more money somebody’s going to be able to make. And I would say that’s a general thing, not for insurance, but we’re the only fiduciary advisors. I feel strongly that whenever you’re talking about an investment product or investment advisor relationship, any types of tools, one of the most important things to understand first is who’s getting compensated? How are they getting compensated? How much is the compensation and how much transparency is there around it? And that’s not to say you can never engage in a relationship or purchase a product where you don’t fully understand how they’re being compensated. Like if I go buy a car, I’m not going to ask for the pay stubs, the guy selling it to me. But it should definitely heighten your level of caution when you’re unsure about what the arrangement is and how much you’re really paying for something.
Jake Weatherford:
That’s a good place to end is with your car analogy, is that some people’s plan requires that unique ’75 Camaro. And if your plan requires that, then maybe you need insurance to solve it, maybe. But just be aware of what’s inside there. Be aware of why you’re doing it, be aware of the cost associated with it.
The content of this video is developed from sources believed to provide accurate information. The information is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation. All expressions of opinion are subject to change. This content is distributed for informational purposes only, and is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products or services. Past performance is not a guarantee of future results. Index performance does not reflect the expenses associated with the management of an actual portfolio.
