Investors who did not recognize that the stock market was in a multiyear bull market and didn't fully participate simply lost an opportunity to increase their wealth. Their actions didn't hurt anybody else, just themselves. Investors who expected interest rates to increase missed an opportunity to earn high returns in stocks and bonds, but their inaction didn't hurt anybody else. There is, however, an institutional example in which the belief that the bull market was not for real and the belief that interest rates would rise combined to cause a disaster and hurt a lot of people. First, some background.

You may have noticed on investment advertising the disclosure “Past returns are no guarantee of future results.” That warning is a standard requirement for advertisements, but there is a group that doesn't believe it. They believe past returns are predictive of future returns. They are called actuaries and they usually have an office in the basement of an insurance company. Based on historic returns, actuaries believe they know the probabilities for returns for any future period such as five, ten, or twenty years. They and the insurance companies they work for count on the stock market repeating itself. Insurance companies take in premiums for policies, promise or guarantee a modest return to the policyholder, and invest a portion of the premiums in the stock market for its higher returns. The insurance company keeps the difference between the higher return it earns in the stock market and the modest, lower return it pays the policyholder.

With variable annuities, the policyholders can put their money into equity mutual funds within an insurance policy and participate in the return of the stock market. The insurance company usually offers some guaranteed income stream in the future. Of course, the actuaries and the insurance companies are counting on the stock and bond market delivering historic returns and are even hedging to insure it—except in one case.

In 2010, an insurance company in Ohio deviated from rigidly believing past returns would be predictive of future returns and brought out an annuity based on the dual beliefs the bull market was not sustainable and interest rates would increase. Both were wrong as we look back and aligned with the views of the common person on the street. The insurance company brought out its “Managed Volatility” variable annuity, with equity funds that did not have the objective of maximizing returns, but the objective of reducing volatility. Of course, returns are sacrificed to accomplish reduced volatility and the funds did not fully participate in the bull market. Yet, the annuities promised very impressive income streams out in the future. We can only presume that behind the scenes, the insurance company executives reasoned that they didn't need historic stock market returns to accumulate a lot of assets to generate adequate yields because interest rates would be much higher when the policy annuitized.

Think of how easy these policies were to sell. Investors didn't believe in the bull market and were still looking in their rearview mirrors at 2008 and early 2009. Reduced volatility was very appealing as was the impressive guaranteed income in the future. But, the bull market charged on and interest rates dropped. The insurance company executives should have listened to the actuaries and not overruled them with personal views of the stock market and interest rates. The equity funds did not accumulate enough assets to generate the promised income, especially at the lower interest rates. First, a little background before telling what happened.

ICON had managed three mutual funds inside that company's variable annuity since 2004. In 2010, they approached us and asked us, in a sense, to merge our balanced fund and our covered call fund together specifically for the Managed Volatility platform. The fund was then called Risk Managed Balanced and was a balanced fund (stocks and bonds) with options used to dampen the volatility of stocks. For many years it was the number one or number two performing fund on the platform and eventually got put into their model portfolio. On July 31, 2012, ICON presented to the variable annuity's mutual fund board of trustees. On one slide we showed that the stock market had gained 100.6% in 157 weeks off the March 9, 2009, low. We stated the market advance could continue at least a few more years and that “markets like this just don't come around very often.” We declared that in a market like this it is silly to invest to reduce volatility and that you should just “try to make as much money as you can.” With their view that the bull market was not for real, they probably dismissed our view just like they did the actuaries’ opinion.

Unable to deliver on their promised level of income, the insurance company called a phone meeting of their variable annuity sales staff and fired all of them in September 2018. They said they were stopping sales on variable annuities and stopping payments of trail commissions to financial advisors. They also held a call for managers of funds within the variable annuity. They explained what they were doing and most managers were silent, but ICON asked the question, “Do you have a plan for retaining assets?” The simple answer was, “No!” Then it hit us, unable to honor the income promised, they were hoping accounts would close and go away.

Financial advisors have tried suing the insurance company for defaulting on paying the trail commissions but so far have not been successful. Courts have ruled that the selling agreement was between the insurance company and the broker/dealer, not the advisor. Financial advisors may be barking up the wrong tree.

At the time, the insurance company was a mutual company, meaning it did not have shareholders like a typical corporation. In mutual companies, it is reasoned that the policyholders are the shareholders. The mutual structure is not unique to insurance. Many savings and loans and credit unions are mutual, where the depositors are the shareholders. Policyholders and depositors are very docile. They only care if the policy or deposit is being honored. They don't care about diversity in management, social issues, or how many jets the company owns. They vote for the board of directors by usually just reelecting the existing one. Here is the opening for the financial advisors and anyone else who felt hurt by the shutdown of the variable annuity.

People just don't buy insurance policies and variable annuities through unsolicited calls to the company. They are sold those policies by agents and financial advisors. These agents and advisors could have united and instructed their investors to nominate and elect a new slate of directors. As the old saying goes, “throw the bums out.” Then, that new board could have run the company the way they wanted, perhaps reinstating trail commissions.

Disbelief and denial in the bull market and the expectation for rising interest rates were powerful and gut level. They just felt right to many investors and executives, but they were wrong and in this case acting on them caused some damage.