Suitability

Insurance products can be suitable for a variety of different circumstances and situations. Annuities are utilized for retirement income, while life insurance provides a death benefit upon the death of a family member or close friend. In this chapter, we’ll highlight elements of suitability in regard to these products.

Annuities

Both fixed and variable annuities can provide income for life. After a contract is annuitized, payments are made until the death of the owner. While this is beneficial to those seeking retirement income for life, it presents a risk to the holder’s family and/or beneficiaries. What if the contract is worth a significant amount once a life annuity is annuitized, and then they die shortly after? With a life annuity, the insurance company keeps everything minus the payments already made. This is a huge risk to those the holder may leave behind, including spouses or children. Therefore, this type of annuitization is most appropriate for those that do not want to leave annuity assets to beneficiaries.

Fixed annuities provide consistent payments upon annuitization that grow annually at a fixed rate. Similar to bonds, fixed annuities are subject to inflation risk. For example, let’s assume an annuity holder’s payments are increasing annually at 3%. If inflation levels reach 5%, the price of goods and services rises faster than the annuity payments. This results in a loss of purchasing power for the annuity holder.

Variable annuities also provide consistent payments upon annuitization, but the payment level fluctuates based on the returns of the separate account. If it performs well, payments increase, and vice versa. The annuity holder may allocate part or all of the separate account to common stock investments, which tend to outpace inflation over long periods of time. This highlights the “push and pull” when comparing fixed and variable annuities. Fixed annuities provide payments that grow at a guaranteed fixed rate, but are subject to inflation. Variable annuities provide shelter from inflation risk (if invested in common stock), but are subject to declining annuity payments if the separate account underperforms.

Most financial advisers do not recommend making any type of annuity as a person’s primary retirement plan. Other accounts like a 401(k), 403(b), or individual retirement account (IRA) tend to provide better tax benefits, more investment flexibility, and fewer fees.

Annuities are best suited for those looking to supplement their retirement savings. Let’s assume a 30-year-old investor has access to a 401(k) through their work and an IRA. If possible, they should maximize the contributions to these accounts, especially if their employer is matching contributions into the 401(k). If the investor still has extra money to save for retirement, it would be suitable to contribute those funds to an annuity. If you want to bet on the growth of the stock or bond markets, a variable annuity is most suitable. If wanting to avoid market risk, a fixed annuity is most suitable.

Life insurance

Life insurance is most appropriate for those at risk of losing benefits due to another person’s death. For example, assume a working mother provides all the income for her family, which includes her husband and two children. If the mother dies without life insurance, how will the surviving family members provide for themselves?

Term life insurance is most suitable for those seeking cheap life insurance over a specified period. A common suitable profile involves a young couple in a low tax bracket with a newborn child. The low tax bracket indicates the family makes a small amount of income, and therefore wouldn’t be able to afford large premiums. If something were to happen to either parent during the specific term, a death benefit would be received.

All the other types of life insurance are suitable for those seeking coverage their entire life. In recommendation-based questions, you will likely be provided with the priorities of the client. If the client seeks a flexible premium, they should obtain universal types of life insurance. If the client is concerned with inflation risk, they should seek out variable types of life insurance. If the client prefers a guaranteed growth rate, they should purchase whole or universal life insurance. The more comfortable you are with the characteristics, the more likely you’ll answer these questions correctly.