How Annuities Will Be Transformed by DOL Fiduciary Rule

Now that I have discussed how I see advisors responding to the proposed new DOL rule, let’s turn to the treatment of annuity contracts by advisors in reaction to the rule. Given the relatively long duration an annuity could and should be held, I could make an argument that a 7% up-front commission is reasonable. After all, if the policyholder owns the annuity for 10 years or more, that essentially equates to 0.70% per year or less. Over the long run, even a commission of this size could be the cheapest option for the policyholder.

However, each financial institution, and selling advisor, will have to ask themselves whether or not they want to potentially defend such a commission. Advisors and their firms will quickly conclude that it will be easier to defend a 6% up-front commission than a 7% up-front commission. It will be far easier still to defend a 2–3% commission, even if it comes with an annual trail.

Putting it all together, a few conclusions regarding future annuity product designs come to mind. First, there will be a need for annuities that pay zero commissions and can be sold in a fee-based account. For those advisors that take the ERISA fiduciary route, this will be their only option for selling annuities. Many advisors that decide to utilize the BICE will also likely choose to reduce their potential liability by recommending annuities that do not pay commissions.

There is no language in the BICE suggesting that you cannot utilize a fee-based account structure as a means to comply with its requirements. Rather than worry about whether or not a commission is reasonable, especially when commissions differ from product to product, many advisors will likely turn to a fee-based account structure and eliminate that particular uncertainty altogether.

Second, while I’m not predicting an end to commission-based annuities, I do believe that the commission structure will change. I think the days of 5%-plus up-front commission options will soon be behind us. These will likely be replaced by commission options of 1–3% up-front with an annual trail. In other words, a commission structure that looks a lot like a fee-based account charge.

The commission compression will also lead to changes in the surrender charge schedules. Once the larger up-front commission options are eliminated, there is no longer a need for initial surrender charges of 7–10%, nor do they need to last as long. Annuity companies will likely introduce three different annuity designs:

• A low-cost option that pays zero commissions with no surrender charges designed for fee-based accounts under both ERISA and the BICE.

• A low-cost option that pays zero commissions and has low surrender charges for a limited amount of time designed for accounts under ERISA and BICE. The addition of a minimal surrender charge will allow for better consumer pricing, and would therefore be positioned as an option for policyholders who are willing to accept this minimal potential charge.

• A slightly higher-cost option that pays some commission and has a low, but longer, surrender charge period that is designed to be used only with the BICE.

If I’m correct, this could also be a welcoming end to multiple variable annuity share classes that each sit on a unique product chassis.

Up to this point, the industry has had little success getting advisors to offer annuities in fee-based accounts. While many have tried, few would consider those efforts a success. Jefferson National, with its $20 per month design, has had the most success and it took them eight years to achieve $2 billion in total sales through advisors. The industry is understandably concerned about what might happen to sales should my predictions become reality.

At the same time, all of the no-load or low-load annuities introduced to date have had to compete with a commissionable alternative to the same product. Take away that alternative and fee-based options will have more success. Still, I suspect the industry will see at least a 50% drop in sales while advisors adjust to the new model.

Easing Compliance

Many advisors will say that the higher commission is necessary to compensate for the time taken to work through the significant amount of compliance paperwork and regulation that exists at financial institutions. However, I would argue that the majority of this paperwork is a direct result of the current commission structure. FINRA is so focused on ensuring the annuity is not being recommended because of the commissions that they have forced firms to create a seemingly endless stream of hurdles for virtually every sale.

My expectation is that in a world where the new product designs I have proposed exist, most of the current suitability paperwork would become unnecessary. In this world, annuities should not attract any more compliance oversight than any other product. Hopefully, FINRA shares my view. If not, we could very well experience a decline in sales in excess of even the 50% I previously contemplated. Given the great need for guaranteed lifetime income, I would think this would be a situation the DOL hopes to avoid.

Scott Stolz is Senior Vice President, Private Client Group Investment Products, Raymond James.

– Related on ThinkAdvisor:

• Why Ken Fisher Hates Annuities
• Why Ken Fisher Is Wrong on Annuities: Milevsky, Finke
• What Annuities Can (and Can’t) Do for Retirees
• The New Variables in Variable Annuities
• Indexed Annuity Providers’ Latest Twist: Uncapped Index Crediting