Most states have statutory schemes set up designed to prevent or stop the physical, mental or financial abuse of the elderly. In Massachusetts G.L. 19A, §§14-26 sets out a framework for the reporting of elder abuse and for the providing of protective services to those at risk. One thing that the state laws really are designed to do is to protect elders from the sale of inappropriate financial products, oftentimes by unscrupulous sales agents.
The vast majority of stock brokers, investment advisers, financial planners and life insurance selling agents are honest and employ appropriate sales practices trying to sell products that are suitable for their clients. Unfortunately, there is an unscrupulous minority seeking to sell products primarily for the payment of commissions who often target the elderly population because of its vulnerability.
The purpose of this blog is to just briefly identify some of the investment products that should trigger the degree of skepticism and concern among children or relatives of at-risk senior citizens.
Shame on Fred Thompson, Robert Wagner and Pat Boone for pitching this product as government-insured and seemingly without risk. This product allows eligible individuals to receive, cash, a line of credit or a monthly income stream from the equity built up in their eligible residence. The threshold age for applying for such a mortgage is 62. The amount one can borrow against one’s house depends on the age of the applicants and the extent of the equity in the home.
Reverse mortgages have extremely high up-front costs. For example, the standard home equity conversion mortgage (HECM) administered by HUD has an up-front 2% mortgage insurance premium predicated on the appraised value of the house, not the loan. Thus, if one were to take out a $100,000 reverse mortgage on a house worth $500,000, the initial mortgage insurance premium would be $10,000. In addition, an annual 1.25% premium is charged based on the amount of the loan. Further, loan origination fees and closing costs charged generally are twice as expensive as normal mortgage charges.
One risk of reverse mortgages is that the homeowner still is personally responsible for paying the property taxes and home insurance. If this does not happen, the loan will be in default. It is estimated that approximately 46,000 reverse mortgages are currently in default with approximately 61% of these in repayment plans.
Another concern arises for married couples if both spouses are not on the loan. Because the amount of the loan available increases with an applicant’s age, there is a temptation to only have the older spouse sign the loan to increase the amount of funds available. If, however, the older spouse dies or has to move into an assisted living facility, the loan becomes due.
Reverse mortgages are not risk free. The best protection currently afforded is the requirement for HECMs that an applicant see a counselor, presumably to discuss the suitability of the product. Nevertheless, these instruments are relatively complex and anyone hearing that a parent or an elderly relative is considering one, should try to take steps to ensure the appropriateness of the product.
Perhaps no product has been set up with a sales structure to tempt producers or sales agents as much as the annuity market. Many annuities pay a commission between 7 and 10% to the sales agent and the products then have significant surrender charges in the event an investor decides to withdraw funds from the annuity.
Initially, annuity products primarily consisted of variable or fixed income products where the annuity payments eventually would either be dependent upon the investment return during the deferral period, or based upon a fixed rate of return. It was generally recognized that variable annuity products were to be sold through broker dealers and be subject to states’ securities laws, whereas fixed income annuities were life insurance products subject to regulation by state insurance commissions.
Then came hybrid deferred annuities. These products purported to guarantee a certain yearly income return to be increased by a invariably complex formula predicated upon gains and losses in the S&P 500 index. The contract documents themselves contain pages of indecipherable definitions followed by pages of complex formulas as to how annual gains would be calculated under various scenarios. Numerous class action lawsuits were brought asserting that sales programs were being put together by annuity companies, specifically targeting the elderly population and selling them misleading and unsuitable products.
To compound the problem, many of the companies selling these annuity products did not have their own internal sales forces selling them. Instead, the insurance companies relied upon licensed “independent” sales agents, who in most circumstances were required to become affiliated with a field marketing organization, which again was independent from the insurance companies. The bottom line is the sales practices were not supervised. While some annuity companies promulgated internal standards for the sale of the annuity products, no system of supervision existed to monitor producers or sales agents who were on their own.
One of the latest annuity products being floated by insurance companies is the so-called “Contingent Annuity”. This product basically guarantees a specified income stream for life predicated upon a designated portfolio, e.g. a pool of mutual funds. The customer pays an up-front premium based upon the specifics of the annuity contract. A cynic would categorize this product as a bet by the annuity companies that either the pool of investments would have sufficient growth, or the customer would die quickly enough so that the annuity company would win on its bet.
As commentators have noted, selling these products as providing a guaranteed income stream is misleading. Some companies tout these products as providing a 5% income stream for life. In reality, the payments to individuals after the deferral consist of a return in part of principal and accrued income.
One major issue with respect to these proposed investments is concerns over potential reserve problems. As a result, at least one major insurance company, Metropolitan Life, has announced that it will not sell these contingent annuities.
The National Association of Insurance Commissioners has been struggling over the proper characterization of these investment products. Some posit that the product is a form of investment guarantee which would be subject to securities regulations and, in fact, illegal in some states. Others assert that the annuities are simply a life insurance product to be regulated by state insurance commissions. There are numerous reasons why senior citizens become vulnerable to unscrupulous sales practices. Many seniors are reluctant to give up control over their investments even as they are showing signs of senile dementia or other mental infirmities. Oftentimes, it is difficult for family members to recognize the signs of early senile dementia. Finally, the topic of trying to take away control over a parent or other loved one’s finances is in many instances something which people want to avoid due to the prospect of harming a cherished relationship.
Avoiding the subject is a potentially huge mistake. There are not only unscrupulous financial planners and life insurance producers out there who will sell inappropriate products in order to make large commissions, there are truly despicable individuals with no conscience who, under the guise of providing financial planning service, will steal as much as they can from vulnerable senior citizens. When substantial embezzlement occurs, law enforcement will arrest the embezzler and send him away to jail. The embezzler’s sentence will no doubt contain a provision requiring full restitution to the victims. The Life Insurance Commissioner or Secretary of State will eventually get around to suspending whatever licenses the embezzler had. The victims will receive no financial recovery, unless perhaps they find a good lawyer.