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How The Financial Services Industry Misleads Consumers To Sell Products

Jun 3

6 min read

Summary/TL;DR

In their effort to sell products to unsuspecting consumers, the financial services industry will often deploy sales material with deceptive and misleading content. An example of this content is discussed in today’s post, which highlights the pitfalls of trusting those whose prime motive is the sale of products as opposed to the provision of advice.


Introduction

I recently onboarded new clients who had money in a product that they “didn’t really understand”. After sending me their statements, it was quickly apparent that they were sold fixed indexed annuities from a very well-known insurance carrier. As I began to investigate, I became increasingly frustrated with the sales material used to sell this annuity and decided to write about it. The deceptive tricks exposed below are very common in the financial “services” industry, and readers are highly advised to develop a strong sense of skepticism towards anyone touting these products based on this type of material.


To Buy, Or Not To Buy

It’s important to begin with some context.


To sell their annuities, insurance companies must convince consumers that their features are worth bearing the fees and contingencies that come with them. To accomplish this, they need to show that the investment options available in their annuities are comparable to investment options that the consumer could invest in on their own. Otherwise, consumers will obviously decide to forgo purchase of the product for the less expensive and better performing alternative. They are therefore incentivized to positively skew the performance of their products relative to these inexpensive alternatives.


In addition, insurance companies also need to earn a profit from these products. In the case discussed today, this profit is earned in the form of a spread between what the insurance company can earn with your money and what they credit your account with. This introduces an additional incentive to only provide investment options that will underperform. In fact, the greater the underperformance of the investment relative to the market, the higher their spread. This will be important to keep in mind towards the conclusion of our discussion.


Lies All The Way Down

Now that some background has been laid, let’s look at what was in this sales material that made my blood boil. It all begins with this chart, which supposedly shows the performance of an index (available for investment in this annuity), the Zebra Edge II Index, against the S&P 500.

Chart of compound annual returns of various indexes

Beneath this index is some small font “fine print” that we’ll discuss below, but for now let’s focus on what this chart is claiming to show.


At first glance, it looks like the Zebra Edge index holds up relatively well to the S&P 500, especially during the “lost decade” of the 2000s. In the top left corner of this chart, we see that this index supposedly returned an annual growth rate of 4.37%, compared to the S&P 500’s return of 5.18%, during the 23-year period from 2000 to 2023. And it accomplished this with exceptionally steady growth and little to no volatility.


Pretty impressive, right! Unfortunately for the Zebra index, this entire chart is a lie. It contains subtle tricks that only trained eyes will be able to spot and is a prime example of how the financial services industry systematically lies to consumers to sell products. Here’s what’s left out:


1. It Begins With One of The Worst Stock Market Periods in All of History

For starters, the year 2000 marked the beginning of one of the worst periods of returns in all of stock market history, during which the market crashed over 50% on two separate occasions! In the past 50 years, there have only been three times in which the market has crashed over 50%, and two of them were during the ten-year period between 2000-2010.

S&P intra-year declines vs. calendar year returns

To put into perspective how poor returns were over this decade, consider the following. The median annualized return over a 10-year period for US stocks since 1871 is about 8.9%, but the 10-year return from 2000-2010 was only 0.35%. Furthermore, the market has only ever been down over a 10-year period 2.9% of the time, with the last time that this was the case being the Great Depression and the inflationary period of the early 1940s.

Table of annualized rolling stock returns - 10 years
Chart of 10 year annualized rolling stock returns
Source: lazyportfolioetf.com

This is far from a non-bias selection of stock market data to compare the Zebra index to, as it essentially gives the index a 10-year head start relative to the S&P. If the insurance company wanted to be truly objective, they would have compared the Zebra index to the S&P over multiple different time horizons.


At this point, you might be tempted to jump to the insurance company’s defense in picking a largely skewed sampling of stock market data. After all, annuities are often sold under the pretense of being a safer place to keep one’s wealth relative to the “volatile” stock market. Let me assure you, however, that this is only the tip of the iceberg.


2. The S&P Returns Don’t Show Dividends Being Reinvested

Let me be very clear: there is no reason to do this besides being misleading! Dividends comprise a substantial source of stockholder returns, especially over long periods of time. Every seasoned financial professional understands this.


If we include dividend reinvestment over the period visible in this chart, we find that the actual return of the S&P 500 was 7.15% (not 5.18%), and that $1 invested would be worth $5.24 today (not $3.27). Had they charted returns correctly, the S&P 500 would literally be “off the chart”, as the y-axis ends at only $3.50. In other words, omitting dividend reinvestment from the S&P 500’s performance allowed them to understate its returns by 60%!

Stock market returns between 2000 and 2023

My final point on this issue is that dividends (interest) are shown to be reinvested in the 10-year Treasury and T-Bill on this chart, leaving no room for excuses when leaving them out on the S&P 500.


And if this isn’t enough, I’ve saved the best point for last.


3. The Zebra Edge II Index Was Incepted on 10/06/2020

Wait a second… how are they presenting 20+ years’ worth of performance for an index that’s less than 4 years old?


To answer this, we need to look at that fine print that I mentioned at the beginning of this post:

Fine print of annuity sales material

The Zebra Index “was designed with the benefit of hindsight, to historical financial data” (emphasis added). That means that they found a strategy that performed well relative to the S&P since 2000 and constructed an index around it in 2020. But the performance before 2020 is purely hypothetical!


To understand how truly disgusting this is, consider the following example. In 2024, I notice that AAPL, MSFT, and AMZN have performed very well relative to the S&P 500 since 2010 and, on this pretense, I decide to add them to the mix that I use for my client portfolios. Then, when prospective clients ask me how my portfolios have performed, I show them a back test that includes AAPL, MSFT, and AMZN as if I had owned them since 2010!


And here’s the best part about this point – at the time of this writing, the Zebra Index is down 4.32% while the S&P 500 is up over 50% since 10/06/2020. In fact, the only time that the Zebra Index even goes down in this chart is in late 2020… as soon as it comes into existence!

Chart of compound annual returns of various indexes

No Escape

To add insult to injury, this annuity has a 12-year surrender schedule, which is a period during which the annuitant is severely penalized if they try and take their money out of the contract.

Annuity surrender schedule

If they decide to take their money out of the annuity within the first 5 years, they will owe a 10% fee!


In fairness, the annuitants are always entitled to some of their investment penalty free, but only at a clip of 7% per year, meaning they must choose between leaving 93% of their investment sitting in this terrible product, or paying an unreasonably high fee to get out.


Conclusion – Buyer Beware

Recall the point I made in the introduction of this post where I discussed the incentive structure of insurance companies that sell these products. By artificially inflating the performance of their products relative to inexpensive alternatives, they entice unsuspecting consumers to buy them. Then, the underperformance of the actual investments increases their profit margins. Finally, long lock-up periods with severe penalties for escaping ensure that they get away with a killing whether you catch on to the ruse or not.


This insurance company knew exactly what they were doing when they made this chart. Their intention was to negatively skew the returns of the S&P 500 relative to an option available in their product, and to make that option appear as though it had track record that it did not. In other words, they set out to mislead and deceive unsuspecting consumers – to lie – to sell their products. Period.

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