An Introduction to Annuities 2.0

12/10/2012 7:00 am EST


One of the pioneers of e-banking, Mitchell Caplan of Jefferson National, has set his sights on shaking up the stodgy annuity market. He also gives us a little insight into how the fiscal cliff dilemma will work out.

Gregg Early: I am here with Mitchell Caplan, Chief Executive Officer of Jefferson National. Mitchell, it's December and the only thing more important than Christmas is the fiscal cliff.

You have been re-engineering tax-deferred investment strategies for a while now. Could you wrap those two concepts together and give us your view on what's happening now in the marketplace, and what can help investors in their tax-deferred investment strategies?

Mitchell Caplan: Happy to do it. It is fascinating now because we, at Jefferson National, have spent the last four or five years sort of building a platform with a set of solutions around tax-deferred investing.

Our thesis has been that it is a category that was ripe for change in 2005, and that if you, in fact, could try to re-engineer the process from the front end-which means how you distribute variable annuities and you do it through fee-based advisors and don't pay any commissions-you could dramatically lower your cost in distribution.

That would begin to give you a significant amount of pricing power to be able to say the cost for that tax-deferral is now much lower, and you get to retain the benefit of tax deferral.

Where many of the competitors in the states, quite candidly, offer the same sort of tax-deferred investing, but they do it at a cost of 130 or 140 basis points a year. The way that we were able to re-engineer it, it drops our costs to about ten or 12 basis points a year on $20 a month. It really puts a sense of value into the product.

In addition, our view was that the annuity product had transformed or changed so dramatically to where it was almost an arms race. It was a bunch of carriers who were trying to figure out what was the best benefit they could give in terms of a death benefit, or a living benefit or a rider, and they were charging a lot for that. Probably far more than advisors felt they wanted to pay on behalf of their clients or consumers wanted to pay directly. They just felt it wasn't something they needed.

Our view was, could we re-engineer the platform? And what we were really offering was not a guarantee, not a benefit, not a rider, but the ability for people to accumulate wealth by saving more, by saving at a much lower cost and by saving in a tax-deferred fashion.

That is the platform we built. I would like to think of it in the long-term in many respects as being very relevant.

The reason it has become even more current is because, as you have asked, about the fiscal cliff. There are really two components to the cliff in my mind. One is the timing around the resolution and the implications for that, and what that really draws is the analogy of continued volatility in the market.

You can see it every day that there is a belief that there will be resolution and the markets move in one direction. Every day that there is a concern that there's the lack of progress or a stalling around the solution; you can see the volatility enhance in another direction. Our thesis is that will continue.


Even if there is a solution by the end of this year, and everybody has the count down until the end of the year, it may likely only be a temporary solution. Even if it turns out to be something that gets hammered out between now and the end, not different from other solutions which have come out of Congress-Sarbanes-Oxley, some of the financial reform acts-there are so many questions that continue to arise and get answered over the following 12 or 24 months, it continues to enhance and increase the volatility.

In our mind, there will be a lot of volatility as we progress through the solution around this looming fiscal cliff.

Gregg Early: It is kind of Europe or Greece in the volatility we see in the marketplace...when Greece is going to come out of the euro, or Greece is going to stay in the euro.

Mitchell Caplan: A perfect analogy.

Gregg Early: It is the US version of that, so anybody that's in the market can expect that their retirement funds and anything that is going to happen is going to be up and down until...the longer-term problems, these aren't simple problems that we are trying to solve.

Mitchell Caplan: That's exactly right. You know, when you are investing for retirement, you should be investing for the long term and thinking about your future. Then it goes back to the basics of saying I need to save, I need to save low cost, and I can save tax-deferred.

Our solution has always been if you are an individual investor, you should absolutely be buying IRAs. You should absolutely be maxing out on your 401(k). You should be doing those things. Then to the extent that it is appropriate for you, continue to invest in a tax-deferred platform with tax-deferred funds.

That's what we built. We really built a platform that is low cost, has a great technology component to it, so it has ease of use and ease of convenience for anybody who wants to be on that platform. Our business model really is about serving fee-based advisors, but also their end consumer, so it's a great front-end.


We give lots of choice, so rather than a few funds, we are giving a choice of almost 400 mutual funds in the form of a variable insurance trust, so that they are tax-deferred. It really is about this broad platform that creates a solution and ways in which people can utilize tax deferral to help them achieve their goals of accumulating wealth.

Gregg Early: It is also about freeing up the annuity from the very inflexible models previously that were always expensive and generally underperformed. It sounds like what you're building is something much more investor friendly and customizable.

Mitchell Caplan: Couldn't agree more. The history of us as a management team is that many of us now with Jeff Nat have worked together over a ten-year operating history from 1990 to 2000 where we built...what ultimately became the largest branchless bank.

We have a history of trying to figure out ways in which we could re-engineer distribution and use technology to create better value products. In those days it was better value around FDIC-insured savings products, and the ability to help people by making the simple choice of, if it isn't necessary for you to walk into brick-and-mortar branches, then why pay for that real estate? Here is a more interesting and compelling way to save at better returns. We re-engineered that process.

To your point, when we look at the annuity marketplace, what we thought is, annuities were originally developed as a mechanism to help people save and accumulate wealth in a tax-deferred fashion. Very much like the IRA or a 401(k).

If you think about any of the qualified plans, they changed and evolved over the years, in fact, because the cost of those annuities got so high. As I was saying earlier 130 to 140 basis points, there are plenty of studies done by the University of Chicago and others that say a consumer building wealth will get about 100 or 120 basis points out of tax deferral in a minimally structured (from a risk perspective), pretty standardized portfolio.

When you are paying 130 or 140 basis points in annual costs, you're wiping it out. So all of the sudden, sort of the secret in the industry is, if the client recognizes that they are not getting the benefit of tax deferral, then what I'm really selling them at that point are all these benefits and riders, which just doesn't make sense. I mean, very often, the end consumer doesn't understand what they are buying, doesn't need what they buying, doesn't want what they are buying, and they are incredibly opaque and unbelievably expensive, in our mind.

We thought there was an opportunity to re-engineer the model, and basically strip it down and use the annuitization process and the concept of the variable annuity as simply the chassis that allowed you to have tax deferral, and then give advisors and their investors and consumers a choice of hundreds of funds in a way in which they could build strategies that worked for them over the long term.

Then the discussion really becomes what is the asset class, what are the mutual funds I want to hold? If the fiscal cliff is looming, if you think there is going to be volatility in the bond market, or if you think that, to your point, in Greece there has been a real concern about going outside the US and what does it mean for the euro, then you can built a strategy around that.

There is the flexibility of moving into and out of funds on this overall platform that we've built as a financial solution, with literally hundreds and hundreds of different funds, different strategies, different styles, which puts the power back in the hands of the advisor and the consumer low cost to be able to save tax-deferred.

Related Reading:

The Real Indicator to Watch

No Yen for the Yen

The Flip Side of Risk

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