Should Your Financial Advisor Be in Jail?

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It looks like insurance agent Glenn Neasham is about to get his ticket punched at the big house. The California advisor found himself in hot water after selling an indexed annuity to a woman with dementia back in 2008.

Annuities are structured investment products sold by insurance companies like Genworth Financial (NYS: GNW) , or, in this case, Germany's Allianz. Indexed annuities are more complex than plain vanilla annuities, as the interest they pay is derived from a formula based on market indexes like the Dow (INDEX: ^DJI) or the S&P 500.

Prosecutors claimed that Neasham took advantage of 83-year-old Fran Schuber to sell her an indexed annuity for $175,000 and, in the process, pocket a $14,000 commission for himself. While there normally isn't a legal issue with selling an indexed annuity to an 83-year-old (more on that in a moment), Schuber was suffering from early-stage dementia at the time and may not have been able to understand what she was buying.


Glenn Neasham isn't the problem
From the press reports, it's tough to tell whether Neasham really is the predator that the jury apparently saw him as. But what bothers me about this story goes well beyond Glenn Neasham.

Selling a complex insurance product to an 83-year-old with dementia is unconscionable. However, that it's A-OK to sell this product to any 83-year-old -- or, perhaps, any average investor at all -- boggles my mind.

Allianz's MasterDex 10 Annuity -- the product sold to Fran Schuber -- is an illiquid, long-term product. In order for holders to get any of the many promised benefits, the bulk of their investment will stay tied up for more than 15 years -- first a five-year deferral period and then a minimum 10-year annuity payout. Schuber would have been nearly 90 before she could have reasonably started taking payouts from the annuity.

But even for younger folks, the complexities of indexed annuities like the MasterDex 10 are daunting. Not surprisingly, Allianz's marketing materials make the supposed benefits very clear:

  • You get a 10% "bonus" added to your investment right up front;
  • Your interest is based on equity indexes; and
  • "Your premium and bonus are protected from index losses."

The downsides, however, are far less clear.

Though the brochure outlines a handful of ways to tap into the money tied up in the annuity, many of those options are far from attractive.

Withdrawal Option

Downside

Take a contract loan You can only borrow a limited amount, and the interest rate was a usurious 7.4%.
Take a 10% withdrawal You can only do this once per year, and the total of the withdrawals can't exceed 50% of your premiums without triggering penalties.
Take a lump sum or distributions over less than 10 years You lose the upfront bonus, you lose all of the highly touted market-index gains, and you're left with 87.5% of your original premiums and a 1.5% interest rate.

If that isn't enough for you, the actual index-based interest that you receive may leave you disappointed. Sharp-looking graphs in the brochure show that between 1995 and 2004, $100,000 in the MasterDex 10 would have -- with the help of that 10% upfront bonus -- grown to $234,427. But because of the way interest is calculated for the MasterDex 10, that performance was far short of the index's actual return. An investor that simply bought and held SPDR S&P 500 (NYS: SPY) over the same period would have ended up with $72,355 more.

Got all that? Great! Sign here.
Somebody reasonably adept at math and willing to sit down and think through the details could probably figure out why one investment advisor called this "the investment from hell." But it usually doesn't work that way. Statistics from a 2009 FINRA survey are very revealing:

  • 58% of non-retired households have not tried to figure out how much they need for retirement.
  • 29% of those with mortgages on their homes said they didn't know whether the mortgage was interest-only or had an interest-only option.
  • 53% of those with an auto loan said they didn't compare offers with different lenders.
  • 26% of investors with self-directed employer retirement plans or non-employer plans don't know whether they have more or less than half of their account in equity products.

With many Americans apparently ill-equipped to make "normal" financial decisions, how do they have any shot at unwinding the reality of a complex financial instrument like an indexed annuity as it's being pitched by a slick broker?

When we look at the case of Glenn Neasham, the question shouldn't just be whether Allianz's MasterDex 10 was appropriate for Fran Schuber -- obviously it wasn't -- but rather, whether these types of financial products are appropriate at all for the mass market that they're aimed at.

Beware of free
The word "free" comes up quite a few times throughout the MasterDex 10 marketing materials, but the word "fee" only shows up twice -- both times in a section touting the lack of fees or sales charges. For any consumer, the alarm bells should start to go off as soon as it looks like you're getting something for nothing.

Remember:

  • In the Neasham/Schuber case, Glenn Neasham was paid a whopping $14,000 for selling this product.
  • As promised in the brochure, the buyer "gets" a 10% upfront bonus. For Fran Schuber, that would have been $17,500.

And yet there's no mention anywhere of what Allianz gets out of this. I don't think I have to put on my tinfoil cap to suspect that somebody's getting screwed here -- and it's probably not Allianz.

The bottom line is that though Glenn Neasham may be on his way to jail, the real story here is much bigger than Glenn Neasham. This is not just a story of one particular broker doing ill to a client. This is a story of an entire system that pits brokers and advisors at odds with clients in a savage battle to scalp clients for big profits.

To really tell this story, though, we need your help. Whether you're a broker or financial advisor yourself, or a client of a broker or financial advisor, we want to hear your side of the story. Chime in down in the comments section or send us an email at tips@fool.com.

At the time this article was published The Motley Fool has sold shares of SPDR S&P 500 short. Motley Fool newsletter services have recommended creating a put butterfly position in SPDR S&P 500. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.Fool contributor Matt Koppenheffer owns shares of Genworth Financial, but does not have a financial interest in any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.

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