In the continuing evolution of the investment industry, one consistent trend has been the gradual reduction in fees, expenses–and commissions–that investors pay for most investment products. There are exceptions, for example, hedge funds; and fees and commissions for variable annuities have in general crept up, not down. But that may be about to change.
While many advisors and their clients believe that variable annuities are important investments under the right circumstances, “the perception exists that variable annuities are just too expensive relative to the benefits that are received, and the commissions are too high relative to other investments,” says Scott Stolz, president of the insurance and annuity general agency at St. Petersburg, Florida-based Raymond James. “As long as that perception existed, variable annuities (VAs) would always remain under a cloud.”
“The industry needed to begin to change the pricing structure of the products,” Stolz argues. Raymond James executives wondered if they could reduce costs to clients by requiring all of the VA products sold by the firm’s advisors to meet a set of fee and structure criteria. Only those products that met the standards would be available through the Raymond James rep force. Although the firm does much more volume in mutual funds than in insurance products, Stolz says VAs account for about 85% of Raymond James’s insurance business. He expects the firms’ advisors to sell about $3 billion in VAs in 2006–2.5% to 3% of the overall VA marketplace. That makes Raymond James a significant distributor for a lot of insurance firms. “No company really wants to walk away from $150 to $200 million in sales each year,” Stolz asserts, “I think we were just big enough to pull this thing off.”
When the broker/dealer first approached its VA vendors with the radical notion of reducing commissions and changing the way VAs are structured, the firm was offering products from 18 insurance companies, and each company offered three or four distinct products–different share classes, fees, and options structures–each with its own prospectus and application–or around a hundred permutations in total. It was nearly impossible for clients to compare all of them. “We don’t have a menu of 100 products anymore,” and that, it seems, is better for everybody, from compliance to customers. Stolz says the initial reaction from the insurance companies was: “‘Hey, this could be a really good thing for us.’” They were struggling to stay competitive and had to keep raising commissions.
Raymond James developed a set of criteria: limit fees and surrender charges to clients, streamline share classes, and limit commissions paid during the first seven years of the contract. Stolz emphasizes that the firm made it very clear that these were not to be proprietary products–the lower-cost VA products should be made available to all broker/dealers.
“We’re delivering to the clients the same benefits and features that they’ve got today but because we have been willing to take less commission for the product, that allows the insurance companies to charge lower fees to the customer.” Of 18 insurance companies that offered VAs through the B/D before, nine had the revised products ready by July 31, and the rest are in the process of revising their products to comply.
What does this mean in material terms? Stolz says that typical annual mortality and expense charges amount to 1.4% per year; Raymond James asked providers to reduce that to 1.15%, or 25 basis points per year, (most of the companies went to 1.15%, but a couple went to 1%). While combined up-front and trail commissions typically equaled 8% over the first seven years, Raymond James mandated no more than 7% over the first seven years. “So the insurance companies that were paying, say, 7% or 7.5% are now paying 5% plus [25 bps] every year, so they’re paying about 2% to 2.5% less up front, a little bit less overall, and they’re kind of spreading that out. It’s that savings that’s allowed them to reduce the mortality and expense charge.” The trail continues beyond seven years “because we said the surrender charge on the product could not exceed seven years; after the seven years the client can get out of the contract anytime at no cost.”
Instead of the four traditional share classes of VAs–including the traditional VA with a seven-year surrender charge (a B share); or the same annuity with three- or four-year surrender charge (L shares), in which clients pay 25 to 40 basis points per year for that additional liquidity; bonus shares, which look like a B share but the client gets a “bonus” of, say, 5% when they purchase, but then pays more each year in commissions; or the most expensive of all, C shares, in which there’s no surrender charge (total liquidity) but clients pay heftier commissions up front, Raymond James told the insurance firms they could “offer a shorter surrender charge period, and can offer a bonus, but instead of it being a distinct product, it needs to be a rider on your main B share product.”
Now, if a Raymond James client wants a shorter surrender charge period than seven years, he checks the box on the application, and it states which option he’s picking, and what he’s paying for that shortened period. Similarly if he wants a bonus, he checks a different box, and “it says, specifically, here is what they’re going to pay” for that bonus option. Stolz’s view is that “there is less confusion for the customer as to what they are paying for the extra liquidity and/or the bonus.”
While advisors may not be thrilled, at first blush, with the slight cut in pay that comes with this revamp of a very popular product, this was not about “making a bad product good, because the product as it exists today is good,” Stolz argues, “we believe as a firm that ultimately if the costs of the product come down we, as an industry, will sell more just like when mutual funds went from 8.5% up-front sales charges to where they are today–that’s part of what made mutual fund sales explode.”