Are Your Client's Needs Hypothetical?

Article by Kevin Wingert
President and Founder of American Retirement Systems, LLC

Added on: May 11, 2017
I recently googled the word “Hypothetical” to clearly define in my own mind what this currently popular term for describing past Fixed Index Annuity performance really means.

Not surprisingly the following definition appeared: “- supposed but not necessarily true or real.” Now that got me thinking. How do hypothetical past performances of Fixed Index Annuities fit into the retirement planning process of America’s seniors.

The only logical conclusion I could reach is they don’t! The retiring clients I talk to have very real goals, needs and dreams that require predictable and definable results. The very definition of hypothetical is not necessarily true or real! How can a clients’ real needs be met by creating unreal expectations in a retirement product? I once asked a retiree if they could give me a definition of “hypothetical” and their answer was “made up”. Exactly my point.

Many of the hypothetical illustrations for Fixed Index Annuities are being used in conjunction with an ever expanding selection of interest crediting strategies that are called proprietary indexes. These indexes are often created by large investment banks or money management firms for the exclusive use of certain insurance companies’ products and IMO’s. Interestingly, the creation of these types of proprietary indexes have drawn the attention of the SEC prior to becoming popular in the Fixed Index Annuity market place according to the 2016 Bloomberg article by Yakob Peterseil titled “ Wall Street finds new ways to sell old opaque products.” In this article back-testing (synonymous with hypothetical performance) is described by Joel Pickenson, head of investment research and development at Vanguard Group Inc. as follows: “the only indexes being brought to market in the form of new products are the ones that have done well in the back-test periods. It’s pretty easy to run a good back-test.”

The point here being to create a proprietary index strategy and find a good back-test to show the public. Ask yourself how many bad back-tests you’ve seen. One example of this type of testing is part of the marketing material for a current popular Index Annuity crediting strategy. In the brochure I saw back-tested performance described as hypothetical for information purposes only. The back-test period is for a single date twenty years ago and the actual proprietary index strategy was created within the last year. The strategy compares favorably to the returns on the S&P 500 for this particular date as illustrated in a brochure.

Several questions come to mind when I look at this example: First, this is a twenty year period. If we exclude the last five years as too recent for back-testing purposes, how does this index perform on the other 3,700 days that the markets were open during the other fifteen years? Does showing a single date for a newly created index fairly represent its’ performance vs. the S&P 500 for those other 3,700 days the markets were open? Does the single performance example illustrated in the sales brochure represent the actual probability of the index beating the S&P 500 over any given period of time? What does the back-tested hypothetical performance really tell my client about what they can expect in the future?

My point to all of this is that hypothetical returns may very well be creating unrealistic expectations of future performance for your clients and you. Overpromising and underperforming is a future disaster for your clients’ retirement and your business. Predictability is a key component of a good safe money retirement program.

Good luck and be careful when your real professional reputation is staked on hypothetical results. Back-testing may not always be on your side!