By Anna Prior
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."
Write to Anna Prior at anna.prior@wsj.com
(END) Dow Jones Newswires
February 08, 2016 18:40 ET (23:40 GMT)
Copyright (c) 2016 Dow Jones & Company, Inc.
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