Labor Department proposal could change commissions from controversial retirement savings vehicle

By Anna Prior
Published on Feb 8, 2016 on The Wall Street Journal

Variable annuities—which are controversial but widely used for retirement saving—are about to face one of their stiffest tests thanks to a Labor Department proposal.

The proposed rule, expected to be finalized as soon as next month, would hold advisers working with retirement savings to a “fiduciary” standard. That approach means an adviser must work in the best interest of a client, and it generally requires advisers and firms to avoid conflicts of interest, which could include commissions and other sales-based compensation.

If the rule becomes final with minimal changes from the most recent published proposal, industry watchers and analysts say variable-annuity issuers might need to shift from paying sellers upfront commissions—which average around 8% according to a 2014 estimate from Conning Inc.—to a business model based on investors paying lower, ongoing fees.

Among the insurers that issue these complex retirement-savings vehicles are Lincoln National Corp., MetLife Inc., Prudential Financial Inc. and Prudential PLC’s Jackson National Life Insurance Co. The rule also will affect the brokerages and individual financial advisers that sell variable annuities.

“We think it’ll throw a wet blanket over the entire industry, certainly for the first year,” said Jules Gaudreau, an independent insurance adviser and president of the National Association of Insurance and Financial Advisors, a trade group.

With a variable annuity, a buyer gets a retirement nest egg invested in mutual-fund-like accounts with a lifetime income feature. The annuities often are purchased with an add-on “rider” that guarantees a minimum paycheck for life with protection against stock-market losses.

Fans of these annuities describe the product as being like a personal pension plan.

Variable-annuity sales totaled nearly $98 billion in the first nine months of 2015, according to researcher Morningstar Inc., roughly in line with their average over the last five years.

More than half of that involves retirement accounts and so would potentially be affected by the rule. It is possible that insurers and brokerages also would choose to apply new compensation arrangements to annuities sold outside of retirement accounts.

Despite this popularity, variable-annuity critics have railed against their complexities and annual fees that can top 3%. Critics also note that consumers pay the seller’s commissions indirectly through the ongoing charges and through surrender charges due if they drop a contract within several years of purchase.

Variable annuities with guaranteed lifetime benefits “are extremely complicated products already and are, frankly, oversold,” said Scott Witt, a New Berlin, Wis., insurance adviser who is unusual in charging fees to investors and not accepting commissions.

Some say the high commissions lead advisers and insurance agents to sell to some people who may not be best served by such an investment, and regulators have issued consumer advisories.

The near-term earnings impact on insurers isn’t expected to be huge. A scenario involving a 25% drop in variable-annuity sales would result in a 2% annual per-share earnings hit at Lincoln Financial Group, estimates Keefe, Bruyette & Woods analyst Ryan Krueger. He puts the impact at about 1% annually for Prudential and MetLife.

Speaking to analysts last week, Lincoln Financial Group President and Chief Executive Dennis Glass said that roughly 30% of the company’s sales in the fourth quarter came from products that would be affected by the Labor Department’s rule, assuming no changes are made to the proposal. He said the firm has been working to curb its reliance on sales of variable annuities.

If sales are disrupted, Mr. Glass said Lincoln will be able to use share buybacks “to blunt much of the [earnings-per-share] impact over the next several years.”

Prudential has said that it benefits from a diversified business model; MetLife is divesting operations including its U.S. variable-annuity business. Jackson National, meanwhile, has “multiple contingency plans in place” depending on the rule and various interpretations of the rule from brokerages, said Alison Reed, executive vice president of operations for the firm’s distribution arm.

There likely also is to be a legal challenge from the financial-services industry once the final rule is in place.

Even so, the fiduciary-duty rule is a “huge” deal for the annuity industry, in part because some individual sellers might avoid these products rather than accept a combination of lower upfront compensation and greater responsibility, said Joseph Belth, professor emeritus of insurance at Indiana University.

“It would revolutionize the annuity business,” with investors benefiting from higher standards for advisers, he said.

Commissions had long been the norm in the insurance industry because most of the adviser’s work is done upfront in the sales process. Annuities are intended as long-term investments and because of the product guarantees, buyers typically require less ongoing advice, said Jackson National’s Ms. Reed.

While the Labor Department’s latest proposal would technically allow advisers to continue to collect commissions, the insurance and brokerage industries have generally said that the requirements to do so are ambiguous and unworkable. Before any sales discussion, for instance, an investor would have to be given detailed information about the seller’s compensation and would have to sign a contract spelling out the adviser’s obligation. Trade groups including the American Council of Life Insurers have lobbied for variable annuities to be subject to what they see as more workable rules for other annuities without mutual-fund-like investments.

Spencer, Wis.-based independent adviser Juli McNeely said she’ll be in a bind if the Labor Department makes it unworkable for her to sell variable annuities with commissions, given that vast majority of the products today are commission-based. She might turn to other types of annuities as alternatives, she said, while waiting to see if insurers roll out more variable annuities with the commissions stripped out.

Says Conning insurance analyst Scott Hawkins: “Eventually, the insurers will find ways to be innovative and alter their products and services for the new environment.”

Contact us today for an examination of your portfolio – our “Financial Fresh Look”!

You can start your examination by filling out and submitting the Data Gathering form below.  The Expense Sheet is optional.