Annuity guru Moshe Milevsky contends that, concerning annuities, the Department of Labor’s fiduciary standard rule’s overriding emphasis on fees is deeply flawed.
All in all, he says, the rule—which will see the first phase of implementation in April 2017—cries out for the expertise of financial economists.
In an interview with ThinkAdvisor, Milevsky, finance professor at Toronto’s Schulich School of Business at York University and a leading annuities consultant to the financial services industry, discussed his views on the controversial rule, which holds advisors and insurance agents to a fiduciary standard for advice regarding retirement accounts.
Milevsky’s short-term forecast for the annuity industry: pessimistic.
Long-term outlook? Upbeat. What with widespread confusion about the rule and industry lawsuits seeking to halt it, the professor anticipates two years of uncertainty, if not turmoil, before homeostasis returns to the annuity space.
Following are highlights from ThinkAdvisor’s interview with Milevsky:
What affect will the DOL’s fiduciary standard rule have on the annuity industry?
There is absolutely no doubt in my mind that it will have a very big impact. It’s already having impact. Variable annuity sales have declined quite dramatically in the last year, partially due to uncertainty about the rule. Indexed and fixed annuity sales have increased, partially because [advisors and agents] thought they wouldn’t be covered by the rule.
But if indexed annuities are considered to be part of it and require a BIC [Best Interest Contract Exception], I think they’ll decline too.
Do you expect companies to introduce variable annuities with only a basic asset management fee and no commission?
Could be. Commissions will have to change. Commissions will become illegal if you’re a fiduciary unless you have a BIC in place.
What do you predict for annuities in the near-term?
Next year is looking bad. It’s going to be shaky, especially with uncertainty about the implementation of the rule and the presidential election. If Trump gets in, I really don’t know what will happen to a rule like this – but I don’t think Thomas Perez will still be running the DOL. [Twenty-eighteen] will probably be a bit better than next year. Projecting beyond, I think there’ll be a growing recognition: “When I’m 90 years old, I want my annuity.”
What’s the current mood of people in the annuity industry?
You sense the uncertainty in their morale. There’s a feeling of gloom, especially in the variable annuity [space]—that “this is going to make life more difficult for us for the next year or two.”
Could the rule bring better annuity design and more transparency?
I wish it would go in that direction. But what worries me is that it will just make prospectuses longer and create a lot more paperwork for everyone—and [clients] won’t necessarily pay more attention to what they’re signing.
How do you suggest the rule could be improved?
There has to be a little bit more financial economic thinking. I’d love to have more of a transparent cost-benefit analysis done by financial economists of what products belong in what categories. The notion that something is an insurance contract versus a security was driven purely by lawyers. I look at some of this and say, “Really! That’s surprising!”
What else do you find objectionable?
There’s an extreme emphasis on fees—that fees are obviously bad, and the lower the better. No, not necessarily. But if you charge too much in fees, you’re going to be running afoul of the rule.
Fees, of course, have long been an issue with VAs.
Variable annuities have suffered as a result of the emphasis on fees: their fees are clear and observable, and they seem high. With a variable annuity, fees are quite explicit. Once you read the contract, you see it’s 3%, or possibly 4%. On the other hand, with indexed annuities and fixed indexed annuities, it seems like there are no fees because there’s no explicit line anywhere saying, “Your fee is 2%.” So, because these fees are implicit and very, very difficult to discern, you think you’re not paying them.
But are there any “hidden” fees in annuities?
Almost every single fixed index annuity I’ve seen does not include a dividend. So right off the top, you’re not getting the 1% to 2%, or possibly 3%, dividend yield that you’d get if you held the underlying index. I’m sorry—if you’re not giving me a dividend, that’s a fee because you’ve taken away that 2% or 3%. Why isn’t this explicitly called a fee? If people were told they were losing that, the variable annuity wouldn’t look so bad relative to the fixed indexed annuity. This is just one example of [the rule’s] obscured thinking and total emphasis on fees.
What’s your opinion of the industry lawsuits that seek to kill the rule?
There’s a big debate as to what “reasonable compensation” is for selling an annuity. We all know that annuities are more complicated than index funds. Explaining to a client how an annuity works takes more time than explaining an index fund. So, obviously, an annuity should pay the advisor more. Anyone who thinks that everybody should get paid the same, regardless of how complex the product is, doesn’t understand how incentives work. So I have sympathy for that.
What about the suits themselves?
I sympathize with what NAFA [National Association for Fixed Annuities] is arguing: Why are certain things inside the regulation and certain things out? What requires a BIC? An indexed annuity is in, whereas a deferred income annuity, or a fixed income annuity or longevity insurance is out! It’s a little odd to me that when you buy an annuity that guarantees you $100 a month in 20 years, you don’t need the BIC, but when you buy an annuity that guarantees you between $90 and $130 a month, you do need it.
Why the distinction, do you think?
The DOL is saying that if you sell the product that dominates the income annuity or dominates the deferred income annuity, it’s better in terms of payout and you’re subject to all this regulation. Well, that discourages you from doing it, which then encourages you to sell the inferior product. To a financial economist that makes no sense.
Under the rule, advisors must explain the product they’re recommending for retirement accounts and why it’s in the client’s best interest. What responsibility does that place on those who sell annuities?
The burden of education is much higher now. It’s not enough to be able to explain the annuity to the person who’s buying it; you have to be able to explain it to yourself. It’s no longer about convincing someone to buy something; it’s about convincing yourself that you understand what makes it tick. That takes [up] time.
What else must be explained?
Not only why 30% of the client’s nest egg was put into a particular variable annuity, for example, but why you chose this certain company’s product and not another company’s. That requires you to really understand all the competitors. Again, this takes time.
In a previous interview, you told me that “to condemn annuities as a category is like saying, ‘Money is evil;’ you’ve got to narrow it down.” Please elaborate.
The word, “annuity,” is almost meaningless at this point. It’s like saying “fund.” What sort of fund? What kind of annuity? The word “annuity” is very broad, and the jargon can be confusing. We need a bit more clarity.
What do you recommend?
I try not to use the word, “annuity,” when I’m describing them. I like to say “personal pension.”
Why is “annuity” immediately off-putting to so many investors?
Part of it is that a large segment of writers have tarnished them. And FINRA, the NASD, the NYSE have always said that some of the biggest complaints they’ve had were about annuities. There were some pretty big bad apples that contaminated a lot of barrels. I think the situation has improved. We don’t see the outrageous commission structures anymore. There’s more transparency. Still, [a negative connotation] persists.
Why is it important for people to own annuities today?
We’re in a volatile world. With the decline in [providing] defined benefit pensions, it’s important to [substitute that] guaranteed lifetime income with some other form of guarantee. Guarantees become more valuable to people that are moving into retirement. The vast majority of what you’re buying with an annuity is risk management.
Is relying on an annuity enough?
It’s not the only thing you should be eating. There are many other things that should be on our plate in the morning besides granola.
People are living longer, but this is often accompanied by varying degrees of cognitive decline. Why should one have an annuity in place earlier rather than later?
People need to establish a [specific] plan for what will trigger turning on the [annuity’s] income. It’s either a certain age that they reach or a horrible market. So, if, say, the market goes down 20%, I want the income to start because it’s a living benefit and I have a guarantee. If an insurance company is guaranteeing me 5% for life, and my [investment] account has just collapsed 20%, turn on the income.
Do you personally own an annuity?
When I was 45 [four years ago], I purchased some annuities and [established] that I’d like to turn on the income in 20 or 30 years. I don’t want to be in my late 80s or 90s and have to start thinking, “Is this the optimal time, or should I have more exposure to equities?” The last thing I want to be doing at that age is running simulations. At 97, I’m not going to call Wade Pfau and Michael Kitces: “So, guys, what do out think? I’m 97. What’s a sustainable withdrawal rate?”
Tell me about your Portfolio Longevity Extension Corp.
I help endowments and individuals measure the longevity of their portfolios. I run analyses and tell them things they can do to extend the longevity. Annuities are part of that, but there are many other instruments that can help.
Sounds like you’re acting almost as a financial advisor.
Absolutely not. It’s all about education. In fact, with the DOL rule, “advice” is the [verboten] “A-word” for me. It’s now even more important for me never to use the word “advice” in a conversation.
Final thoughts about annuities long-term?
I certainly think that annuities will be in the news for the foreseeable future. It’s not a product that’s going to disappear. Annuities are how people will be paying for their retirement. I want 100% of my income to come from annuities and pensions. I want annuity income forever.
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