The annuity industry is at a crossroads. LIMRA recently reported that first-quarter 2016 variable annuity sales were $26.6 billion, down 18% from the previous year. Early indications suggest that variable annuity sales have dropped at least another 10% or so in the second quarter. In fact, LIMRA is estimating that variable annuity sales will be off 15–20% in 2016 compared with 2015 and then another 25–30% in 2017.
In contrast, LIMRA reported that first-quarter sales of indexed annuities were up 35% to $15.7 billion, making them the growth engine for the industry. LIMRA reported that all of the top 10 indexed annuity carriers saw sales increases during the first quarter.
Yet in April, the Department of Labor (DOL) threw a giant roadblock in the way of the indexed annuity sales train. Much to the industry’s surprise, the DOL’s final fiduciary rule moved indexed annuities out of the less onerous fiduciary standard required by exemption 84-24 and into the new Best Interest Contract Exemption (BICE) along with variable annuities and other commissionable securities products. Many in the industry are of the opinion that the decline in variable annuity sales is mostly due to advisors’ uncertainty about the DOL rule. If that is indeed the case, then one must wonder if indexed annuity sales will soon suffer the same fate.
Personally, I’m not convinced that the drop in variable annuity sales is solely, or even mostly, due to the DOL rule. The fact of the matter is that variable annuity sales have been in a steady decline since 2011. Lessons learned during the 2007–09 financial crises, along with persistently low interest rates, have forced variable annuity companies to steadily scale back many of the overly generous living and death benefit features found in the contracts at the beginning of this decade.
On top of this, some companies chose to further reduce their exposure to the risk associated with both existing and new living benefits by offering buyouts, prohibiting additional deposits, eliminating popular investment options and/or requiring volatility management programs (which have generally performed poorly) on many of the remaining investment options. All of these changes precipitated the long sales decline. The DOL rule simply provided the knockout punch. How much further variable annuity sales will fall once the DOL rule goes into effect is anyone’s guess.
Many variable annuity companies initially decided to either double down on their indexed annuity business or enter the business for the first time so as to stay competitive in the annuity space while still adhering to the DOL requirements. The companies that already focus on indexed annuities also thought their future was very bright. While exemption 84-24 also requires a best interest standard for IRA recommendations, it does not require an actual contract and has significantly fewer disclosures than the BICE. The prevailing view was that 84-24 would require few, if any, changes in indexed annuity sales practices. While I would’ve debated that view, the DOL’s final rule made it a moot point.
So what happens now? In theory, the BICE allows advisors and their financial institution to maintain their current business model. As long as the financial institution executes the required contract, sets up the appropriate supervisory procedures and provides the necessary disclosures, products need not change in terms of features, costs or commissions. But let me stress again that this is likely only true in theory.
I think Michael Kitces of the Pinnacle Advisory Group (and holder of almost every financial designation on the planet) summed it up best in his April 11, 2016, post on the DOL rule when he wrote: “Financial services … companies claimed that they can offer … commission-based, and sometimes even proprietary products to consumers, while also receiving revenue-sharing agreements, and simultaneously still act in the client’s best interests as a fiduciary. And so the Department of Labor’s response became: ‘Fine. If and when consumers disagree, you’ll have a chance to prove it to the judge when the time comes.’”
The important thing to understand is that, while the BICE allows advisors and firms to continue to receive differential compensation, the greater the degree of differential compensation, the greater the challenge to prove the compensation had no impact on your recommendation. Therefore, the natural reaction will be to minimize the differential compensation. That means commissions across products may, over time, move to a narrower, and likely lower band. This could occur not only within the same asset class, but across asset classes as well.