#295 | Dispatches from Annuityland – Part 3

photo of pathway surrounded by fir trees

Since starting The Life Product Review in 2012, I’ve been committed to delivering independent and objective product intelligence. But I knew there would come a day when I would be writing about something that I’d been involved in bringing to market. That time is finally here. This article discusses the forthcoming F&G Trailsetter Indexed UL. While I can’t divulge the specifics of my consulting engagement, I can say that my work on this product was focused on the topic discussed in this post and Trailsetter’s key differentiating feature – compensation structure. Naturally, I’m excited about what F&G has created with Trailsetter when it comes to compensation and, as you’ll see in this article, I think it’s a disruptor that’s long overdue.

If you’ve read the previous Dispatches from Annuityland, you might have the overall perception that although the two lands are different in some ways, the differences are more style than anything else. It’s like how I think most Americans view Australia – it’s basically the same except that Australians have a funny accent, drink Fosters (rarely) and eat at Outback (never). Now imagine that an American with that perception of Australia touched down in Sydney and opened the left door of their rental car expecting to find a steering wheel. It would be highly disorienting. It would be even more disorienting to realize that the reason the steering wheel is on the right side of the car is because these “blokes” drive on the wrong side of the road. Australia may be America Down Under but, when it comes to driving, it’s a completely different deal.

The analogy applies well to compensation in Annuityland and Lifeland. In Annuityland, compensation is usually paid as a percentage of deposit or as a percentage of the Account Value. The percentages are (generally) uniform regardless of the deposit amount and client age and sex, except in some outlier situations. Understanding compensation in Annuityland is pretty easy and straightforward. Not so for Lifeland, where compensation (as you undoubtedly already know) is based on completely arbitrary Target premiums that vary by age, sex and rate class and can be banded by death benefit, plus excess and renewal percentages that vary by carrier, product and duration.

Think about it this way – if a client were going to put a single $100,000 premium into a Fixed Indexed Annuity (FIA) or an Indexed UL product, how easy would it be to calculate the compensation? For an FIA, the calculation would be as simple as multiplying $100,000 by the commission percentage which, let’s just say, is 6%. That’s $6,000 of compensation to the agent. End of story. For an Indexed UL, we’d have to know the Target premium which, let’s say, is $5,000 and then multiply the Target premium by the payout percentage, which is usually between 70% and 100%. Let’s say it’s 90%. That yields $4,500. Then we’d have to subtract the $5,000 from the $100,000 and apply the Excess compensation percentage (let’s say 2%) to yield $1,900. Adding $1,900 back to $4,500, resulting in $6,400, which is $400 more than the annuity. But it’s damn harder to do the math, isn’t it? And it only gets harder if the $100,000 was a single deposit into an annuity versus spreading the premium out over 10 years on the Life policy, where there may be renewal premium compensation that varies by year.

What annuities lack in complexity of compensation, they more than make up for in variety. It’s common for an annuity to simultaneously offer multiple compensation arrangements on a single product chassis, where the fees, rates and surrender charges directly reflect the various compensation schedules. In the Variable Annuity world, these are referred to as share classes. The usual heaped compensation structure is a B-share. C-shares are AUM-only. L-shares offer better liquidity but higher fees. And then there are share classes made specifically for different distribution firms, like the O-share for Edward Jones and the R-share for Raymond James. And, of course, there are zero-commission products, which are typically referred to as “fee-based” because the advisor charges a fee instead of earning a commission. The same sorts of structures exist in fixed products, they just aren’t called share classes.

In life insurance, compensation typically comes in one form (heaped), but the actual amount of compensation can sometimes be modified via blending. There is a huge range of opinions about blending. Some people love it because it allows the agents to adjust their compensation for each sale. But most people hate it. Why? Because it puts agents on the horns of a dilemma for every sale and potentially exposes them to some guy (real or imagined) across the street who will blend down their comp to win the business. This type of blending doesn’t exist in annuities. Different comp structures have different tradeoffs, but the comp is the comp.

In short, annuity compensation is simple and rigid, but varied. Life insurance compensation is complex and flexible, but uniform. Should it be that way? It seems like life insurance compensation is the worst of all worlds. It’s highly complex. It affords producers a myriad of ways to both decrease and increase their compensation for any particular deposit, whether through blending or simply by selling more life insurance coverage than is necessary.

And, to make matters worse, heaped compensation is an extremely inefficient way to pay compensation, as I wrote in #261 | The Compensation Conundrum. The life insurer essentially has to finance the heaped compensation and repay themselves through fixed policy charges over time (usually 10 years). Because of the carrier’s high cost of capital and policy decrements (lapses and deaths), the rate charged to the client for financing the agent’s commission can range anywhere from 9-20%, depending on the product. It’s the equivalent of telling the client to pay the agent’s commission using their credit card and then paying the loan off over 10 years in equal installments. The total cost to the client of financing heaped commissions ends up being 2-2.5 times the actual heaped commission payout. It’s an extremely inefficient structure.

My bet is that if clients actually knew what was going on, they’d demand to pay the commission out of their own pocket to save themselves the policy charges. But for some completely bizarre reason, we don’t give them that option.

Enter F&G Trailsetter, which rolls out Monday through a select group of IMOs/BGAs. The basic idea behind the product is simple – pay commission as a percentage of premiums paid. That’s it. No Targets, no excess, no renewals, no payout grids. Compensation to both the agent and the brokerage is a percentage of premium. The compensation is paid for by a premium load that matches the compensation dollar-for-dollar, percentage-for-percentage. In other words, the life insurer acts an intermediary between the client and the agent and brokerage. The ratio of commission-driven policy charges to actual commission payouts is always 1-to-1 versus 1-to-2+ in a typical heaped comp policy. It’s an inherently more efficient design.

So where does that extra efficiency go? Well, there’s a wide spectrum. If the goal is to just match the same compensation as a typical UL policy but spread it over the premium payment period (7 years, let’s say), then the benefit will go to the client in the form of significantly reduced policy charges. Or, on the other end of the spectrum, the policy charges could be increased so that the overall charge structure looks like a typical UL, but now the compensation is twice what it would have been without any reduction in benefits for the consumer. The choice is up to the life insurer.

In the case of F&G Trailsetter, the choice was to transform the newfound efficiency into greater total compensation. Street compensation is 9.5% of premium. To put that into perspective, typical FIA products pay 6% of compensation with a 2% brokerage override and the potential to earn a 1% bonus, for a grand total of 9%. F&G doesn’t publish the override percentage, but applying the same ratio of street to override as in FIAs yields an override in Trailsetter of about 3.5%, bringing the total compensation to around 13%. By annuity standards, Trailsetter pays good-ol’-days compensation.

Comparing Trailsetter to typical Life policies is a bit trickier. To avoid spilling the beans on brokerage compensation at each insurer, I’m just going to focus on Street comp for Trailsetter and I’m going to assume that it’s 100% of Target. Take a look at how Trailsetter’s 9.5% of premium for a $15,000 7 Pay on a 41 year old Male (that’s the illustration I got!) compares to other Indexed UL policies. The ratio of Trailsetter comp to IUL comp is to the right.

Carrer & ProductCumulative Charges Through Year 10Street CompensationComp Ratio
F&G Trailsetter28,5969,9751.00
F&G Pathsetter22,4954,0712.45
Mutual of Omaha10,3324,0832.44
Global Atlantic22,8634,1082.43
John Hancock43,2424,7362.11
PacLife PDX 226,9675,5691.79
PacLife Horizon IUL29,7165,5691.79

Over 7 years, Trailsetter pays a whopping 1.66 to 2.52 times what other Indexed UL products pay for the exact same cell. But take a look at the total charges through year 10 – Trailsetter is expensive, but it’s not as expensive as some other products that have significantly lower compensation. If you were to adjust these products to match the total commission to Trailsetter, then Trailsetter would be the cheapest product by a country mile, with the sole exception of Mutual of Omaha. The average cumulative charges for the other IUL products over 10 years would be around $51,000, 78% higher than in Trailsetter. That’s the power of actually matching commission payouts with policy charges on a dollar-for-dollar basis. It’s just flat out a better mousetrap.

But it does create some weird optics. Typical premium loads across Indexed UL products range from 3-9%, with a couple of outliers above that. Trailsetter’s premium load is 19.5%. But, if you think about it, that’s to be expected. Out of the 19.5%, somewhere in the neighborhood of 13% is directly related to compensation. The remaining 6.5% load would put Trailsetter in-line with its peers. Because compensation is paid for with a premium load, there is no per thousand charge in Trailsetter above age 49 and the charge below age 49 is nominal. In this cell, for example, it’s just a couple hundred dollars a year compared to an average of almost $1,500 per year for the other products.

The other spot where Trailsetter zigs when you might expect it to zag is surrender charges. Given that there is no heaped compensation, you’d expect that Trailsetter also wouldn’t have a surrender charge, but it does. Why? For two reasons. First, surrender charges are important for setting investment duration. That’s why fee-based fixed products in Annuityland often have surrender charges even though they don’t have commissions. Second, and more importantly, surrender charges are a source of profit for life insurers. Consider Mutual of Omaha, which has the lowest policy charges of any IUL product in the group. In this cell, it pays a Target of $4,083, but it has a first year surrender charge of $8,100. The Target, of course, also pays an override to a distributor, but there is clearly a profit margin being baked into the surrender charge. And this is pretty common, although there are some carriers who are clearly taking a different approach. Take a look at the surrender charges and Targets of all of the products in this study for this cell:

F&G TrailsetterAllianzPacLife PDX 2LincolnJohn HancockSymetraPennMutualGlobal AtlanticMutual of OmahaF&G PathsetterAIGSecurianNationwide
Year 16,07810,6064,4438,1197,1569,2894,1875,6788,1004,0717,7977,7215,638
Year 25,96010,3672,2217,9537,0109,1143,7265,2997,5003,8687,7977,5855,638
Year 35,80110,1282,0007,7866,8658,9393,2654,9216,9003,6657,5287,4465,638
Year 45,6849,8891,7767,6176,1178,7652,8054,5426,3003,4617,5287,3074,934
Year 55,5659,6491,5557,4475,8518,5872,3454,1645,7003,2577,2597,1684,229
Year 65,4479,4071,3325,9395,5656,8691,8843,7855,1003,0547,2597,0253,524
Year 74,8169,1681,1094,6505,2735,1511,4233,4074,5002,8516,9906,5382,819
Year 84,1447,6388882,8284,9823,4339633,0285,5032,6476,9904,3582,115
Year 93,4346,1114441,3794,4891,7155032,6504,6562,4436,7212,1791,409
Year 102,7234,584004,180002,2713,8092,2396,7210705
Year 111,9733,054003,955001,8932,9632,0365,37700
Year 121,5781,52700328001,5142,5401,6294,03300
Year 131,1840000001,1361,6931,2222,68900
Year 147890000007578478141,34400
Year 153950000003790407000

The thing about Trailsetter, though, is that the full (or nearly the full) surrender charge is also surrender margin because there is no heaped compensation to cover. It stands to reason that surrender margin is a big line item for overall product profitability. But is that a problem? It just means that the surrender value in Trailsetter looks like any other Indexed UL product. F&G seems to have a made a decision to specifically not court sales focused on early values or liquidity. It’s hard to fault them for that. Retail life insurance is cast as a long-term commitment. The same goes for Trailsetter.

One of the arguments against what I’ve laid out so far might be that I haven’t factored renewals and excess premium into the math and yes, that’s true. Part of the reason why is because my experience is that most agents don’t really look at excess and renewals, despite the fact that it can be pretty rich in some situations. But the primary reason is because Trailsetter also pays renewals, just in the form of asset-based compensation – and if you had the choice, you’d probably take the asset-based compensation. Trailsetter pays 20bps to the street and 10bps to the brokerage, both for 20 years. Yes, for those of you connecting the dots on the pun, Trailsetter has set trails. Nice one, right?

Over time, Trailsetter’s asset-based “renewal” component is significantly more than typical renewal compensation. Using the illustration I was given with $15,000 in premium for 7 years and assuming a $4,200 Target, in line with peers, total renewal comp would have been about $2,300 based on a 2% street payout and 1% brokerage payout. But over 20 years, Trailsetter’s asset-based renewals would have paid out a total of nearly $9,000. It takes 10 years to match what the standard renewal compensation pays out in 7 years and everything after that is gravy.

Trailsetter is hardly the first product to provide alternative compensation structures. Early Cash Value riders have long offered spread compensation in exchange for better policy liquidity. The late, great MetLife Premier Accumulator UL (PAUL) paid a 0.85% asset-based trail. Sammons has a product with something like 5 different compensation structures. What separates Trailsetter from the rest is that it not only changes the structure of the compensation, but it also pays significantly more compensation than any other product by any metric. Arguably, that’s what it will take for life insurance producers hooked on heaped compensation to consider moving to a levelized structure. The carrot has to be big and juicy. Trailsetter delivers.

But Trailsetter has another trick up its sleeve. F&G has one of the highest pure-bred S&P 500 caps in the industry on its heaped comp Pathsetter product, currently 13.5%. They also pay one of the highest fixed account rates in the industry at a whopping 4.75%. There is a lot of juice at F&G to support Indexed UL products, at least for now. That affords both Pathsetter and Trailsetter an advantage in terms of illustrated performance compared to peers, both when illustrated at the maximum AG 49-A rate and with a full Fixed Account allocation. Both products go further, though, by using proprietary indices and fixed interest bonuses, the illustration tactic de jour that life insurers are using to optimize illustrated performance under AG 49-A. If you’re selling Indexed UL and you’re willing to buy into the silly illustration games that our industry plays, then Trailsetter is a no-compromise product – it has 2.5x the compensation of a normal Indexed UL and illustrated performance at the top of the benchmark.

Will Trailsetter be a success? We shall see. This type of compensation structure has been tried already in Annuityland in the form of annuities with sales loads (O-shares) with mixed results. There will be agents and brokerages who just can’t get their head around anything other than heaped compensation. There will be agents and brokerages who absolutely love the massive recurring revenue in Trailsetter. There will also be agents and brokerages who think the compensation should be dialed back to give more benefit back to the consumer. There will be folks who rightly point out that Trailsetter isn’t a lean, low-cost Indexed UL policy. There will be other folks who will be rightly skeptical of F&G’s ability to maintain above-market caps for the long-haul.

All of these scenarios assume the same thing – that people are talking about Trailsetter. Regardless of where you land on the product and its compensation structure, you can’t ignore it. Trailsetter is the first real shot across the bow at heaped compensation that’s structured and priced to get agents to make the switch. It is, for lack of a better term, the Tesla Model S of Indexed UL. Hear me out. Prior to Tesla, all EVs traded performance for efficiency, betting that the natural market for EVs was granola-crunching tree-huggers who aren’t into cars anyway. Tesla rewrote the script. The Model S was an absolute rocketship. Why buy a Tesla? Because you can spend $75k and get a car that goes 0-60 faster than a V12 Aston Martin.

The story for EVs became performance. Enter Rimac, the makers of a 2,000 horsepower EV that goes 0-60 in 1.8 seconds, rips a quarter mile in 8.5 seconds and tops out at 260mph. Enter Rivian, the makers of an electric truck that goes 0-60 in 3 seconds and corners like a McLaren. Enter Lucid, the makers of a sedan with 1,111 horsepower. Enter the Mustang Mach-E. The Ford F-150 Lightning. See what happened? Tesla had to put gratuitous amounts of power – at the expense of pure efficiency – in their cars in order to get people excited about EVs.

The same logic applies to Trailsetter. F&G seems to have felt that they had to put gratuitous amounts of compensation into the product to get people excited about it. And I think it’s hard to fault their logic.

Over time, it’s highly likely that compensation in Annuityland and Lifeland start to converge. Trailsetter is a step in that direction, as is Nationwide’s upcoming RIA-focused Variable UL. Surely, more products will follow suit, especially if either one of those are successful. The convergence will accelerate further under some sort of unified Best Interest standard for both products. I made the case in a previous article that life insurance tends to lag annuities by a decade on most issues, but equally as true is the fact that annuities tends to lag trends in the overall investment landscape by a decade or more. Fees and commissions have been compressed extensively on the asset management side of the world. There’s no reason to think that’s not going to happen for life insurance and annuities as well. The whole financial services industry seems to be shifting towards a fee-based model – is it really reasonable to think that life insurance and annuity products will continue to be exceptions for the long run? Probably not.

And we should welcome that. Compensation is a sticking point for consumers and some advisors for both life insurance and annuities. Why do annuities get a bad rap? Because they’re perceived as high-commission, low-value products. Nevermind that’s not true. Nevermind that a managed money account usually produces more revenue to the advisor than the commission on an annuity over the same period of time. The simple fact that annuities and life insurance pay commissions makes them suspect. A better model is to make the products so straightforward, so appealing and so easily sold that advisors incorporate them as a seamless part of the comprehensive planning offering for their clients. It’s a dream world – but maybe, just maybe, it’ll happen one day.