Annuities’ Future
November 4, 2016 by Ben Mattlin
Unless you’ve been living under a rock, you know the Department of Labor (DOL) issued new standards for retirement products last April. Included among the items subject to a higher fiduciary standard are variable annuities (VAs) and fixed-indexed annuities (FIAs). But what exactly that means isn’t entirely clear. Yet.
Whether you believe the new regs will save the industry from unscrupulous practices or destroy it with unnecessary and overly complex rules, one fact appears indisputable: The industry and the products will have to adjust to fit the new regulations. As insurance companies scramble to redesign their annuities for this post-DOL world, how can advisors prepare themselves for what’s likely to be a complex transition?
Multifaceted Pressure
In late September, Nationwide acquired Jefferson National, a provider of low-fee variable annuities, and said the DOL Rule was the deal primary impetus for the deal. “There will be pressure to transform what annuities are, but annuities aren’t going to disappear,” says Larry Greenberg, president of Louisville, Ky.-based Jefferson National, in an interview shortly before the transaction was announced.
That pressure, he says, is multifaceted. “There is intense regulatory scrutiny, a lot of public distrust of financial services companies in general, and a strong focus on educating consumers to think about the price of financial products, their value and costs,” Greenberg explains. These distinct but overlapping factors are generating a move toward products that “will be lower cost, represent stronger value and be more transparent.”
Lower Commissions
To most observers, though, the new breed of products will probably also carry lower commissions—possibly even NO commissions—and favor more fee-based contracts. That’s because, under the new rules, VAs, FIAs and other equity-based products and services sold on commission will require a best interest contract exemption (BICE) for every client. That’s a legally binding guarantee of non-bias as well as full disclosure on all costs and fees.
Several FIA providers have already announced plans to issue new fee-based products to get around the BICE regulation, and in late-september Jackson National Life Insurance Co. released its first fee-based VA. “I see commissions getting reduced, which is fine by me,” says Andrew Murdoch, president of Somerset Wealth Strategies, in Portland, Ore. As a result, he says, “insurance carriers’ sales will be down, some advisors will be forced to leave the business as they will not survive, and clients will lose advisors that do not make it or are newer to the business.”
Murdoch is in the camp that thinks these reforms are for the good. To be clear, though, he isn’t sounding the death knell of annuities. “They will always have a place in a portfolio,” he says, “but [the DOL ruling] will eliminate some people’s overselling the benefits, which is a problem now.”
Eliminating Bad Actors
Eliminating the bad actors—those who make false promises to clients or issue recommendations solely based on the commissions they receive—will of course be good for the industry. And after all, that’s partly the point of the new regulatory scrutiny. Yet the repercussions of these changes could catch many well-intentioned and scrupulous advisors by surprise.
One recent FUSE Research Network survey found that two-thirds of advisors don’t believe the new regs will have any impact—either positive or negative—on the use of VAs. A few even believe the rules will lead to greater use of the products. “[Those] advisors will be surprised, unless they do not use annuities,” says Murdoch.
Duane Thompson, a senior policy analyst at Pittsburgh-headquartered fi360, a fiduciary training firm and the credentialing body for the Accredited Investment Fiduciary and the Accredited Investment Fiduciary Analyst designations, puts it this way: “They are in an unfortunate state of denial.”
Thompson adds, however, that many others are on the opposite end of the spectrum. There’s “a tremendous amount of uncertainty and concern from firms that rely heavily on commission and third-party revenue. They—and all of us—are anxiously awaiting additional regulatory guidance promised by the DOL,” he says.
Echoing others, Thompson anticipates a “significant transformation from a sales-oriented business model to a client-centric fiduciary culture.” He says this transformation could take years to accomplish. But he, too, believes that equity-linked annuities will continue in some shape or form, as retiring baby boomers seek sources of income that can appreciate over time.
Lack Of Clarity
Part of the frustration lies in the fact that, under the Employee Retirement Income Security Act (ERISA), it’s not certain what kind or degree of advisor compensation is considered “reasonable.” “It’s likely commissions will get slashed, but we won’t have the answer on how much for perhaps years,” says Thompson. Clearer definitions may only emerge after lawsuits and enforcement actions, but the end result, he says, will probably be “more streamlined and fiduciary-friendly annuity products without the bells-and-whistles add-ons that make these products complex.”
In the meantime, Thompson’s advice to advisors is: “Don’t be resistant to change, whether you’re commission-based or fee-only.” He adds that paying attention to academic research on the role of annuity products in a retirement portfolio would be a good way for some advisors to bone up on their fiduciary responsibilities. Many academics tend to like annuities as a source of retirement income due to their predictability.
Putting Annuities in Context
To Greenberg at Jefferson National, this transition is just the latest step in a broad-based movement that’s been going on for decades. “Even the big wirehouses have moved their businesses to a fee-based model where they’re managing money for clients in fee-based accounts,” he says. “Insurance products are the last bastion of commissions, and now that’s starting to change.”
Taking the long view, the annuities markets should be able to work out the kinks over time. But it may get worse before it gets better. “The annuity industry will go through a couple of transition years after the full implementation of DOL, but I predict sales will ultimately increase because carriers will have to focus on simplicity and transparency, which means that consumers will better understand their choices and subsequently buy more,” says Stan “The Annuity Man” Haithcock, in Ponte Vedra Beach, Fla.
He doesn’t think that will take too long. “The financial advisory industry always adapts quickly, regardless of what is thrown at them,” he says.
He further points out that the word “annuities” applies to many different types of products, which may contribute to the confusion. When viewed more as a type of insurance contract than an investment vehicle, the practical benefits become more obvious.
“The demographic tidal wave of baby boomers and retirees wanting contractual guarantees will still continue,” says Haithcock, citing income annuities, deferred annuities and qualified longevity annuity contracts (QLACs) among the products that “will always fill a need.” Most of these already offer a “pro-client design,” he says.
On the other hand, many FIAs and VAs will have to be redesigned to get away from their current sales models, many of which are “based on how much the agent army can sell,” says Haithcock. These are the products that “will see the most drastic product-design changes, which is a good thing,” he says.
When the dust settles, Haithcock predicts “advisors will use more of these transfer-of-risk contractual strategies for the non-correlated part of a portfolio.”
The Aftermath
Not everyone is so sure. “Right now, fee-only advisors don’t have a financial incentive to recommend annuities to clients who may need them,” says Michael Guillemette, assistant professor of personal financial planning at the University of Missouri. “In some circumstances, an annuity with a fee, but no commission, may help clients who are in the decumulation phase—as well as help annuity companies sell more product.”
But the post-DOL world could also help secure annuities’ place in retirement planning. “We expect guaranteed lifetime income products to become more mainstream,” says Will Fuller, president, Annuity Solutions, Lincoln Financial Distributors and Lincoln Financial Network. “As advisors move clients from accumulation to distribution, it is critical they recognize the need for guaranteed lifetime income that can never go down and that you can’t outlive.”
The guarantees inherent in these annuity contracts are even more crucial today as people live longer and traditional pensions can no longer be counted on. “The objective of qualified plans is to ultimately provide retirement income,” notes Fuller. “Given this great need, how can a solution that guarantees lifetime income—that an annuity provides—not be in the best interest of today’s clients?”
Lincoln isn’t scrapping commissions altogether, however. “We believe in choice,” he says. “If a client has an income need and the solution that best fits their need is an annuity, we will be prepared to offer commission- and fee-based options.”
One clear casualty of regulatory scrutiny appears to be the L share. For higher fees and an ongoing trailing commission, L shares offer a shorter surrender period than traditional B share annuities—there’s a period of four or five years before they can be sold, as opposed to a B-share annuity’s typical seven-year wait. Last August, both Jackson National Life Insurance Co. and Pruco Life Insurance Co., an annuity unit of Prudential Financial, announced they were ending sales of L-share VAs.
“Those types of offerings are going to eventually disappear,” says Haithcock. He doesn’t mind, noting that those who truly have their clients’ best interests at heart won’t miss the L shares either.
But don’t expect Lincoln to make such an announcement anytime soon. “If the market continues to see the need for this type of solution, we will continue to manufacture and distribute them,” says Fuller.
Savvy advisors had better stay tuned.
