Despite the extended delay of the Department of Labor fiduciary rule, insurance carriers have wasted no time in introducing a line of annuity products designed to fit within the rule’s constraints.
Thus far, fee-based annuities have seemed like the product of choice for advisors who wish to continue to sell variable and fixed indexed annuity products under the fiduciary rule, so that carriers have been rolling out new variations on the products for months. Despite this, each situation is different (as always), and advisors must be cautious to avoid taking a one-size-fits-all approach to selling fee-based annuity products—weighing the costs and benefits of these newly emerging products can be critical to ensuring that the client’s needs are met while avoiding unpleasant surprises down the road.
Fee-Based Annuities: The Appeal
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-interest contract exemption.
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 interests 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 interests contract exemption.
Does the Product Fit?
While fee-based annuities may allow advisors to more easily sell annuities without running afoul of the fiduciary rule, it is still important to examine the details of the individual product in order to ensure it will help the client meet his or her financial goals. Because these products charge an ongoing fee, they can potentially be more expensive for clients in the long run.
Some carriers have sought to make their fee-based annuity products more attractive by providing living and death benefit riders that can serve to increase the value of the contract to the client (and can, in some circumstances, justify a higher overall price for the client who values these features). However, for some clients, a commission-based product which guarantees living benefits may be cheaper because the client will hold the product for many years.
Further, other products may provide for very short surrender charge periods, an option that adds value for the client because it limits the period of time during which he or she is locked into the product. For clients who anticipate the possibility of accessing the annuity investment early, the higher price of the fee-based annuity may be justifiable.
The client should also look to the costs of the underlying sub-accounts of a variable annuity product, which can influence the value of the product. If the product is an indexed annuity, the various caps, spreads and interest rate guarantees should be examined to determine the value offered by the product.
Advisors should be aware that fee-based annuities really aren’t any different from other types of financial products in that the need to examine the individual product and compare it to the client’s goals remains — meaning that a one-size-fits-all approach does not apply simply because the annuity is fee-based.