Recently, with the decline in fixed annuity rates, I have received many calls regarding products with large first year bonuses. My response to agents looking for big bonus products is beware! Let’s examine what a "bonus" is and where it comes from. I spent over 20 years working for insurance companies.

I was National Annuity Director for a major carrier and did quite a bit of product design and building. When a fixedb annuity product is built, certain expenses get amortized over the length of the initial surrender term. For example, a 5% commission paid on a 10-year surrender product will reduce the credited rate by .50% per year. Basically the client pays the commission by having the gross rate reduced to cover the cost. When a company pays an upfront bonus we must ask where does that bonus come from.

If a company pays a 5% bonus on a 10-year surrender product the credited rates must be reduced by .50% per year to cover the cost of the bonus. Well, if it has to be paid back is it really a bonus? Not in my mind. It is actually an advance of future interest. Consider that insurance companies work on about .50% annual profit on a fixed annuity.

I recently heard from a customer being offered a 10% bonus. Presented as a way to offset her surrender charge on the existing annuity, the rep was offering a product from a company, which FSD does not represent (by our choice). I asked the rep why his company was giving up 20 years worth of profits (10% divided by .50%). He assured me that they weren’t. However, when pressed he couldn’t tell me where that "bonus" money was coming from. After some prodding he did admit that the customer would receive a lower credited renewal yield to offset the "bonus".

So how is that a bonus? The point is that agents should understand the dynamics of a product building and pricing.

A bonus today may result in a very unhappy client when the renewal rates are well below market expectations on behalf of a client. You can explain that the renewal rate is lousy because the client got that first year bonus – clients tend to forget that or expected it was a free bonus. Remember – clients pay all commissions and clients pay all bonuses.