In the wake of the final Department of Labor (DOL) fiduciary rule, advisors and insurance carriers alike have been compelled to reevaluate sales practices surrounding annuity sales—especially with respect to variable and fixed indexed annuities. While these types of annuities remain permissible under the DOL rule, an advisor must now ensure that the recommended product is in the client’s best interests, including with respect to the advisor’s compensation, which must be “reasonable.” The concept of reasonable compensation is not clearly defined by the rule, but when it comes to variable products, a commission-based product is unlikely to remain viable. 

Enter the fee-based variable annuities that insurance carriers are already beginning to revamp—potentially signaling a comeback for the long-suffering product class.

Fee-Based Annuity Products

Generally, a fee-based variable annuity charges an ongoing asset-based fee instead of providing the advisor with a traditional commission.  Because these fees are typically “level,” firms that sell them are not required to deal with all of the onerous requirements of the DOL’s best interests contract exemption, or BICE.

The availability of a streamlined version of the exemption for level-fee advisors makes selling fee-based products more attractive for advisory firms, which can be held liable for advisors who, as DOL fiduciaries, sell products that are not in the client’s best interests. While level fee advisors must acknowledge their fiduciary status in writing and adhere to the generally applicable best interests standard, they are not required to execute the formal contract that is otherwise required to satisfy the best interest contract exemption.

Historically, advisors have been compensated for the sale of variable annuity products on a commission basis, which is believed to motivate advisors to recommend products because of their high commission value, rather than because they are in the client’s best interests. This structure generates concern both that the advisor’s compensation may not be reasonable and that the advisor may not be able to satisfy the stringent requirements of the best interest contract exemption.

New Developments in Fee-Based Variable Annuities

Many recently announced fee-based variable annuity products have sought to lower overall fees and penalties that clients may be held responsible for, developing features that can make the product more valuable to the client (also providing justification for the reasonableness of the fee). For example, some of these products provide for very short surrender charge periods, an option that adds value because it limits the period of time during which the client is locked into the product.

In one product that offers a three-year surrender charge period, early surrender charges are limited to 2% in the first two years, and 1% in the third year.  Further, these surrender charges only apply to the contract’s earnings or 10% of purchase payments. Many expect that the trend of fee-based annuities with short (or no) surrender periods and low surrender charges will continue as fees must be disclosed and the client’s best interests must be taken into account.

Further, these products offer various living and death benefit riders that can serve to increase the value of the contract to the client.

These types of features can make variable annuities more attractive to clients than they have been in recent years due to poor performance and insurance carriers who have attempted to modify guarantees that were attached to the products.

Conclusion

The DOL fiduciary rule has provided an impetus for change in much of the financial planning world — and the variable annuity marketplace is one area that may be evolving in such a way that the new fee-based products may actually add value for clients who are interested in variable products.

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