Annuity products have long been the domain of annuity agents who earn substantial commissions, while the adoption of annuity products by fiduciary RIAs has been sluggish at best, ostensibly due to some combination of a dislike of available annuity products, and the lack of any commissions to incentivize their use. Yet now with the DoL fiduciary rule, there are new pressures coming that may compress annuity commissions... raising the question of whether annuity products will even survive in the long run without commission compensation to support them.
In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, we look at how the DoL fiduciary rule may impact annuity companies and annuity product design in the coming years, and whether it's really the beginning of the end of annuity products.
Yet a deeper look reveals that the changing incentives for annuity companies may not kill annuity products at all, and in fact may actually drive annuity products to get better in the future. After all, when an annuity company can't pay a hefty commission to incentivize agents to sell it, their own remaining choice is to actually design a good product, and then market and educate advisors on how to use it appropriate - in a manner that meets their own fiduciary requirements. In addition, annuity companies will also face new pressures to be more transparent and less "gimmicky" with their product design, as anything less will drive away fiduciary advisors who will fear they can't do sufficient due diligence to manage their own liability exposure.
Of course, the biggest caveat is that the new DoL fiduciary rules only apply to retirement accounts, which means non-qualified annuities won't face any of these pressures. Yet given that the concentration of retirement dollars that would buy annuities are held in retirement accounts, the opportunity for annuity companies is to figure out how to step up and create fiduciary-ready products... which in turn may only further increase the regulatory pressure on the SEC, FINRA, and state insurance regulators to improve the standards for non-qualified annuities to match the new fiduciary world for IRAs!
(Michael’s Note: The video below was recorded using Periscope, and announced via Twitter. If you want to participate in the next #OfficeHours live, please download the Periscope app on your mobile device, and follow @MichaelKitces on Twitter, so you get the announcement when the broadcast is starting, at/around 1PM EST every Tuesday! You can also submit your question in advance through our Contact page!)
#OfficeHours with @MichaelKitces Video Transcript
Welcome, everybody! Welcome to "Office Hours" with Michael Kitces!
We're here today to talk a bit about annuities, and what I believe is a collision course that has been set up between annuities that have a lot of high-commission activity associated with them, and the new Department of Labor fiduciary rule that got announced just a week or two ago (which is going to be kicking in a year from now).
DoL Fiduciary And Annuity Commissions
Under the new rule, the Department of Labor didn't specifically say, "no commissions". They said: "Commissions are okay, but your products are subject to fiduciary scrutiny."
So what realistically happens when a broker tries to sell an annuity, particularly one with a high upfront commission, but the recommendation is subject to a fiduciary standard that asks questions like: "Did you receive reasonable compensation for your services?"
Are people who are selling high-commission products going to be able to justify that compensation?
The prevailing view, including from folks like me, is that, no, they probably will not. The fact that the DOL didn't ban commissions doesn't mean commissions won't eventually go away under a fiduciary rule. All the DOL said was:
"We're not going ban commissions outright. You people who say you can do commissions and still meet a fiduciary duty, knock yourselves out. But be ready to justify it in court when you get sued, because someone's going to challenge you about it at some point!"
So the DOL didn't really grant that commissions are fiduciary. They simply said:
"People who sell products for commissions, while trying to meet a fiduciary duty, will have their day in court and their chance to make the case."
And when that day in court comes, I suspect a lot of commissions will begin to come down (if they haven't already). The commissions will either get eliminated, or at least come down (as I can envision a world where maybe small upfront commissions are allowed and then an ongoing trail). Those big upfront commissions and no trail, which encourages a lot of annuity churning, are very unlikely to survive any extended period of fiduciary scrutiny.
The Future Of Annuities After DoL Fiduciary
So the question is: If most annuities that get sold today have commissions, and the commissions incentivize the sales, and the commissions get squeezed out, does that mean basically annuities are going to go away?
I've seen a number of annuity companies that have been starting to reach out, and are asking questions like: "We're trying to figure out what on Earth this means for our products. Are all of our products going to go out of existence if we can't distribute them with commissions to encourage their sale?"
But here's the key thing. I think ultimately, what you're going find when we look back on this in 5 or 10 years, is that this was not the beginning of the end of annuities. This was the beginning of annuities actually getting a lot better.
Why It's So Hard To Find A Good No-Load Annuity Today
So why is DoL fiduciary good for annuities? Well, here's the strange and sad reality of how annuity product design plays out today.
When you want to design a high-quality annuity, then similar to designing high-quality investments, it's pretty straightforward. You're going to have to manage the costs and the expenses, or the expenses are such a drag that you can't really have a product that has a good risk/return trade-off, and a good long-term value.
But the challenge in the marketplace, particularly for annuities, is that the best products with the lowest cost are often NOT the ones that actually get sold in practice.
To some extent, that's because many of us who operate as advisers have a chip on our shoulder about annuities, and view all of them as bad, when the truth is not all of them are bad. Sure, many of them are mediocre high-cost products, and a lot of us came from that world where we saw a lot of those mediocre products. So I understand why a lot of us who are fiduciaries today are wary about annuities.
But what that means when you're an insurance or annuity company, trying to design a product... Imagine this world. I can make the best product out there, but all the fee-only advisers just think annuities are bad and won't sell any, or I can make a crappy product with high commissions and a really nice profit margin for myself, and as long as I load it up with enough commissions, a bajillion insurance agents sell the heck out of it. So if you're running this company, do you want the high-quality product that produces no sales and puts you out of business? Or do you want the low-quality product that a ton of people sell, and it makes your business successful?
That's the sad, perverse reality of how the annuity product design landscape has played out. I've watched this even over the span of my career. I started 16 years ago in the business, and I remember some of the early variable annuities with living benefit riders, and I remember some of the early equity index annuities. They were good contracts. They had very reasonable costs. They were rather transparent. They were pretty straightforward. There was not a lot of questionable fine print. You didn't need a complex calculation engine just to figure out how how to project the crazy combinations of spreads and participation rates and monthly resets that exist today. They were actually quite decent, high-quality products. And they got squeezed out of the marketplace. It started on the equity-indexed annuity side, and then migrated to the variable annuities side over time as well, particularly after the financial crisis.
So now when we look at the products that are in the marketplace today, they are higher cost, more complex, and more difficult to even vet. And a lot of us on the Periscope here know what happens when you take a product that's extremely opaque and complex out of the insurance industry. It tends to get loaded up with a lot of fees and expenses on the back end that no one can see because the thing is too darn opaque and complex to evaluate. The good products get squished out of existence.
I've spoken with a number of product designers at annuity companies over the years. And when I ask them why they can't make a product that is better, that's cleaner, that fiduciaries like us could feel more comfortable selling and sleep well at night, the refrain I always hear back is:
"Look, at the end of the day we've tried to design these products over time. We roll them out. Hardly anyone buys them. Hardly any advisors recommend them. The high commission stuff gets sold. And that's what keeps our company moving forward."
God Bless Capitalism. It's doing its thing. The companies have gone where the products are getting bought. But that's not necessarily where the best products are out there.
So we've been stuck in this trap where the high commission - or I should say the expensive products that give companies really fat margins - are the ones that give the annuity companies so much money they can incentivize with really high commissions which gets people who are attracted to the high commissions to sell them. While the high quality products with little marketing dollars don't get sold because there's no money to market them and no one's getting paid a commission to be incentivized.
And when we multiply that forward year after year, the good products have atrophied, the worse products got sold, and the marketplace has shifted. And I think that really is the environment we've seen over about the past 15 years or so, in both the equity-indexed annuity and the variable annuity space.
How DoL Fiduciary Changes Annuity Product Design
So here's what changes when DOL fiduciary comes about. Now suddenly, annuity companies can't rely on commissions alone to distribute their products. They have to come up with some other means, such as actually making a product that's good and then marketing it to fiduciary advisers! Because anybody who's advising on a retirement account going forward is going to be a fiduciary adviser. That's the scope of the DOL regulations.
So commissions will either get reigned in or eliminated completely. Companies won't just drive their sales based on the highest commission product. They'll have to actually make a good one, and then they'll actually have to figure out how to sell it, which means market it, educate advisers, show them why the product is actually good, and make the honest case for it. Because that's the only way that's going to be left to incentivize advisors to use the product, since commissions won't be much of an option anymore.
In other words, I think we've failed to appreciate in the industry how dramatically the incentives, not just for salespeople but for the product manufacturers themselves, are going to change after DOL fiduciary. The companies that create the products will suddenly have to change how they build and distribute products in a fiduciary world, where commissions are no longer the primary driver of sales. It has to actually be quality product design with bona fide marketing.
How Annuity Products Will Change After DoL Fiduciary
I think what you're going to see in the coming years... it will take a while for this to play out, but first you're going to start seeing annuity costs come down. You'll also start seeing the benefits get less gimmicky, because if you're a fiduciary, you don't want a gimmicky kind of product! You risk getting sued for misleading and false advertising!
And remember that sadly, the standard for getting sued for false advertising under suitability standards is really low. You can always say, "Well, on page 37 of the disclosure documents, it was disclosed that this thing might not do what I projected it to do." But You can't use that cop-out when you're a fiduciary! You have to actually demonstrate you did your due diligence and that another prudent expert would have recommended the same thing in the same client situation, and that your compensation was reasonable. There's no incentive to sell a gimmicky product in that environment. You sell the one that's actually good, and the one that's going to cover your own backside, too.
So I think we'll see annuity products start to become less gimmicky. Product illustrations will become more realistic, because no broker/dealer is going to want to encourage an annuity on their platform with all their brokers using aggressive or unrealistic sales illustrations that over-project the returns. Because the broker/dealer opens themselves up to a class action lawsuit for misleading sales projections if they allow aggressive sales illustrations! And transparency will start getting better on all the products, because the disclosure requirements associated with DOL fiduciary are going to drive at least some additional transparency.
In turn, this means we're going to get better clarity about how the annuity products are working under the hood, because that's what anybody doing fiduciary due diligence is going to be looking for. And that's what any attorney is going to be looking for when they say to an advisor they're suing "Justify to me how you knew this thing was the best if you didn't even understand how it worked under the hood?" Not being able to do due diligence on annuity products is going to get you sued, and you're going to lose, as a fiduciary, if you can't even do your own due diligence because the products aren't transparent.
Then you'll see surrender charges mostly vanish, because the truth of a surrender charge is it's nothing more than the penalty that the company looms over the client in order to recover the commissions that were paid upfront to the agent. It's no coincidence that contracts often have things like 7% surrender charges when they have 7% commissions. It's because literally, the annuity company pays the 7% commission upfront and then it recovers the 7% commission out of the expenses at 1% a year to make their money back, and the surrender charge ensures they can recover the rest if the client leaves early. That's why there's a seven-year, 7% surrender charge that steps down by 1%/year.
So at a point that you're not paying commissions upfront, you don't need the surrender charges either. They're basically built together. They go hand-in-hand. Or conversely, you might actually see a few products that have surrender charges, but the purpose of the surrender charge won't be to recover the commissions. The surrender charge will be a good trade-off for clients. For instance, a future annuity product might say "If you're willing to buy the version that has the five-year surrender charge, we'll give you a better yield. We'll give you a lower cost. We'll give you a better feature or benefit." Because it actually makes sense from the annuity company's perspective. If they can apply a surrender charge, and they know the money is going to stick around a little longer, they can invest it differently. It changes their time horizon.
For instance, imagine what you would do for clients, if they agree to a five-year lock-up to invest with you, versus the client that could fire you at any day. In many ways, we can actually invest a little bit more prudently and aggressively for clients when we know they're going to stick around for a period of time. And annuity companies, functionally, can do the same thing, particularly for the cost of how some guaranteed products come together, where low persistency, high turnover of the products are expensive for the annuity company too, and it drags it down the results for everyone. So surrender charges can actually be a good trade-off that you consider in the future, not something we try to avoid today.
Overall, I think what we're going to see is a huge wave of innovation for annuities when companies say, "Oh, crap. We can't compete on just the best-sounding gimmick paired with a high commission. We actually have to compete with the best feature, and then have it be something that's clear enough that we can teach fiduciaries what it is, how it works, why they should recommend it to their clients, and that they can do all the due diligence, so that they won't get sued as the intermediary for making a bad recommendation."
So the pressure now is on annuity companies. They must try to design an actually good annuity, and see what they can do. And that's just such a monumental shift in the annuity marketplace. That's why I titled this broadcast that DOL fiduciary isn't going to kill annuities. It can actually make them stronger.
This is the change in the incentive system that we needed for annuities. To actually allow them to function in something that's closer to a meritocracy. The good ones will be able to rise to the top, not the highest commission ones with the best payouts to the agent but not the best payout to the client!
So recognize the shift that's about to get underway. If you're a fiduciary right now that hasn't done annuities in the past, stay tuned. I think you're going to find that the products get a lot more interesting. Not right away. It's gonna take them probably two or three years for the dust to settle on all of this. Starting maybe some time in 2018 or 2019, you're going to see this shift really begin, and the new products to begin rolling out, not laden with opaque, low-transparency, high-commission stuff. Actual creative value that would be useful for our clients, that we can integrate in with the rest of their portfolio and holistic financial picture. Not to mention the opportunity to do a 1035 exchange out of existing higher-cost products, either while the client is alive, or even for the beneficiaries after death of the original annuity owner!
DoL Fiduciary For Qualified Vs Non-Qualified Annuities
Now the one warning, the one caveat, the one challenge of this shift in the annuity landscape that I think is going come over the next couple of years, is that the DOL's scope is only for IRAs. It's not for non-qualified taxable accounts. It's not for anyone that sells a non-qualified annuity. And the problem you're going to see is that while annuity products will start getting some better options for all those that operate as fiduciaries and sell into IRAs, there's also a temptation for some annuity companies to still keep producing the high-commission, low-quality, mediocre products and pump them to annuity agents that sell outside of IRAs. Because those who sell into non-qualified accounts, that sell non-qualified annuities, are not subject to any of this fiduciary scrutiny.
The refrain I'm worried we're gonna start hearing a couple of years from now are annuity agents saying, "Why would you contribute to an IRA at all when you can get tax-deferral and buy my non-qualified annuity with all these neat features and benefits?" Which will really be code for, "Don't put your money in an IRA where I can't sell this mediocre product. Buy it over here where I'm subject to a lower standard, and I can actually sell it to you without getting in trouble."
So I have to admit that while I think DoL fiduciary is going be a good thing for annuity landscape overall, because once we unleash the forces of better product design, it going to compound towards creating better and better products, you're also going to see two roads diverge in the coming years. The products in IRAs will get better and better, and get some really creative features and benefits, because if you're an annuity company, and you want to be sold in an IRA, you need a relevant retirement income guarantee or some other guarantee and benefit that has merit beyond just the tax-deferral wrapper.
But while we're going to see better products on the IRA side, we may continue to see the same product mediocrity we have today from a number of companies on the non-qualified side. And they're going to get further and further apart over the next maybe five years or so. Now eventually, I think that's going to drive regulators to act. We already have this weird untenable environment where, if you're working for a broker/dealer, you actually have a different legal standard for the client's IRA than the client's brokerage account, for the same client selling the same products and giving the same advice. Because one is subject to the DOL, and one is subject to FINRA, and the SEC is ultimately the overseer of FINRA and likely to push that. So at some point, I think we'll see a blending of the fiduciary standard across all types of accounts and all types of advisers. But even then, state insurance departments exist outside that regulatory screen. Fixed annuity agents, including those selling equity indexed annuities, exist outside of that environment as well. So unfortunately, I think there will continue to be a dark side for non-qualified annuities for many years to come. It's going to take a long time for our advisory regulatory environment to move out and capture all annuity agent sales practices.
Nonetheless, the contracts to be held in IRAs are going start getting good. I think they're gonna start getting really interesting. I think you're gonna see an explosion of options for annuities for fee-only advisers, because the push from the Department of Labor is that we all become level-fee fiduciaries, and that's where the product designers are going to have to go, if they want to capture or keep the IRA marketplace.
DoL Fiduciary Has Changed The Incentives For Annuity Companies
So stay tuned for this. I think it's one of the untold stories of DoL fiduciary, that not only is it changing maybe how advisers are compensated and regulated. It has changed the incentives for the companies that provide products to us. That's actually a very profound force that's going to take years to play out, but it means we might finally see some improvements in products because the incentives have changed. It's going to be more of a meritocracy and less of a, "What's the best commission we can load in this product? And how opaque and mediocre can we make it so we can scrape more money out, so that we can pay a bigger commission over to the agent?" Watch for this, going forward.
So I'm curious. Does anyone have any questions? Any thoughts about this from your end? Any of you actually operating as fiduciaries and doing annuity contracts right now? I don't see a lot of them out there these days, but there are a few, companies like Jefferson National, that have been doing investment-only variable annuities for a while. A nice option for a tax-deferral wrapper for a high-income client that doesn't have enough tax shelter dollars elsewhere, and needs a little bit of asset location. So we do see a couple products out there that are much lower cost and just function as annuity wrappers that adviser can use for tax deferral, and there are a couple that have retirement income guarantees as well, though not many. Again, the incentives to the companies haven't really been there, unfortunately.
All right. Well, I see no other questions then, so we'll go ahead and wrap up.
Thank you for joining us, "Office Hours," Michael Kitces, 1:00PM East Coast time every Tuesday. Hope this has been helpful, and we'll see you all next week. Take care!
So what do you think? Are you a fiduciary who recommends annuity products to clients today? Why or why not? Do you think DoL fiduciary has changed the incentives for annuity companies and their product designers in a meaningful way? Please share your thoughts in the comments below!
Dennis Markway says
Just imagine what kind of tool this could be for consumers as the DAC is removed? What will that mean for the designs, options, spreads and benefits in the next 10 years with that transformed capital position? Insurance companies can come out of this smelling like a rose (if they can continue to find distribution)
Kerry Pechter says
“If they continue to find distribution”. That’s the big question. Commissions have been high because intermediaries wouldn’t sell annuities without big incentives. Income annuities are irrevocable, and they involve deferred gratification, and an understanding of the value of longevity risk pooling. The purchase decision is complex, as well as the product.
Dennis Markway says
It will take immense cultural change and business model change for advisors to adapt to the fiduciary standards.
But, I don’t necessarily agree that commissions have been high because intermediaries wouldn’t sell them without it – there’s also a training and knowledge gap (many agents are only trained to sell certain products and “when all you have is a hammer, everything starts to look like a nail”). But, I certainly acknowledge the incentives (larger payouts, bonuses, trips, etc) have been a significant lure for many as it has been with non-traded REITS, loaded share classes, etc.
But, I firmly believe there is a prudent, fair and valuable use for annuities – it’s just a lot smaller space than the current market share. But if insurance companies redesign products without the overhang of deferred acquisition costs, surrender charges and all the other complexities, I think they have the potential to provide significantly enhanced value to consumers.
110% Transparency says
How do you ever get them–financial and insurance industries–to give up their short on hours long on pay jobs? They’ll need to actually earn their money rather than just collect it and will get paid less. Do you think that they’ll be able to handle that? Maybe that will weed out the sleazeballs.
Dennis Markway says
For many, it will require enormous changes that some will choose not to make (changes not only in compensation, but also increased responsibilities).
Besides the fact that in 99% of circumstances an annuity is a crap product to anyone capable of analyzing them mathematically…
Until the IRS allows fees to be taken out of annuity chassis without calling it a taxable distribution first, it will be a worse outcome for a client to pay fees separate from the annuity instead of attached to the commission structure of the annuity.
The commission trail’s implied deduction is worth far more to the client than the itemized deduction from a separate fee.
NQ annuities should be granted the same status as qualified accounts for investment fees. By extension so should HSA’s and 529 plans, but in those cases the opposite is true and you never want to bill the structure directly or through commission if you can help it. The itemized deduction is then worth more.
As of 4/27/2016, the 5 year yield to maturity for a A-rated corporate bond is 1.77%, and for a AAA-rated corporate bond, it’s 1.28%. This is before markups, commissions, or management fees.
A 5 year fixed interest deferred annuity, with 10% annual liquidity, surrender-free in 5 years, and no surrender charges on death or incapacity pays the owner a 2% compounded return.
How could an advisor in good conscience recommend investing in A to AAA rated corporate bonds, with a management fee or with a markup/commission, when the client can buy a 5 year fixed interest annuity? The only circumstance would be if it was non-qualified money and the client was going to access it before age 59 1/2.
Mathematically, how is that crap?
For a person who is looking at either longevity insurance or QLACs, or a lifetime income annuity, if he/she lives beyond the life expectancy of the pool upon which the actuaries base the payout, the person receives an excess return due to mortality credits. This is such basic math that it is now required material for CFA candidates to learn.
20 year AAA-rated corporate bonds currently yield 3.3%. 10 year AAA-rated corporates yield 2.38%. This is before markups/commissions or management fees. For a person who lives beyond life expectancy, it is not mathematically possible for the fixed income portion of the portfolio to replicate the same performance in a series of laddered AAA-rated corporate bonds, when compared to immediate or future income annuities with a AAA-rated life insurance company. In addition to the security of having a AAA-rated life insurance company, the owner has secondary guarantees from State Guarantee Associations that are more heavily funded than the bank secondary guarantee entity (FDIC).
So mathematically, how is that crap?
Most of the indexed annuities and variable annuities out there are crap, but the DOL rules will result in changes to how they are designed. Even now, some insurance companies are reducing their M&E charges to effectively be less than a typical wrap account fee.
110% Transparency says
Tony, didn’t the attorneys for the ratings agencies just say that their ratings were opinions? How can investors ever trust those ratings again after what happening in 2008? Have the compensation systems for those agencies changed? Did any executives at the rating agencies get fired? I don’t think that the ratings agencies have given investors any reason to think that things have changed at their place of work. I’ll never trust their ratings again.
The problems were with the ratings of CMOs, CDOs, etc. that had sub-prime debt in them and packaged with default insurance, not with insurance company and general corporate and municipal bond ratings.
Insurance company, corporate bond, and municipal bond ratings are still universally accepted for pricing risk and claims paying ability.
You need to do more research on this topic.
110% Transparency says
It’s how they–the ratings agencies–are compensated that would drive their behavior. I doubt that the type of product matters. I think that we muppet investors are better off not trusting the ratings agencies. Once a bad apple, always a bad apple. The best thing for us muppet investors is to always be skeptical. Trust no one in the financial disservices industry. Our LHEIS* is just too important.
*LHEIS = Lifelong Hard-Earned Irreplaceable Savings
Muppet investors can use esoteric acronyms too!
The issue with the rating agencies was not compensation. It was that the departments that rated complex and opaque collateralized debt and mortgage obligations of sub-prime paper did not fully understand what was in them.
It wasn’t a conspiracy to defraud investors by the ratings agencies.
It does matter. Whether ExxonMobil has AAA or A rated debt matters. Whether New York Life is AAA or AA rated matters.
Unsophisticated investors and consumers are definitely not better off if they choose to ignore insurance company financial strength and claims paying abilities.
It is dangerous and would be outright fraud and malpractice if a financial professional told a consumer that there is no financial strength difference between an AAA rated insurance company and a B rated insurance company.
This is one area where your distrust will hurt you.
If you buy long term care, property, liability, health, or longevity insurance company with no regard for financial strength ratings, it won’t go well for you.
That would be like a banker deciding that FICO (credit) scores don’t matter for borrowers because the information has not always been 100% accurate, and they start making prime car loans to borrowers with 500 credit scores at rates appropriate for 750+ credit scores.
110% Transparency says
The ratings agencies are paid to provide ratings. What were they rating AIG back in 2007-2008? What were they rating Citigroup back in 2007-2008? What were they rating Bank of America back in 2007-2008? Their ratings are only their opinions. That’s exactly what they said during the senate hearings. Consumers/customers/clients need to remember that and remember that the ratings agencies’ compensation system has not changed. They are paid to provide ratings. If the big banks don’t like the ratings they provide, they’ll take their business to the next ratings agency. Money talks bs walks.
You still don’t quite understand.
Large insurance companies are rated by AM Best, Moody’s, Fitch, and Standard & Poor’s. The insurance companies can’t just “shop ratings” that they don’t like.
AIG was incorrectly rated due to the actions of one smaller unit that over sold credit default coverage for subprime mortgage backed securities. The balance of AIG’s business was not what risked bringing the company down.
Citi and BofA did not go bankrupt. They actually got bigger. Their risks were mostly limited to subprime related mortgages.
Again, the departments of rating agencies that analyzed subprime CDOs and CMOs did not understand what was in them. Have you not watched the movie, “The Big Short”?
I’m not sure what you are trying to get at with the idea that ratings are “opinions.” That just means that they are not secondary guarantees. The Supreme Court decrees opinions. Oncologists and cardiologists operate based on their opinions. Accounting firms that audit public companies issue opinions on the correctness of financial statements.
Rating agency opinions are not a bunch of crap that they make up depending on how much an insurance company, municipality, or corporation are willing to pay. Rating agency opinions are based on facts, audits, research, academically validated studies, etc.
Accounting firms are not liable for the fraud of companies they audit. The accountants are charged to validate and give opinions, but they weren’t responsible for Enron or Worldcom. Likewise, rating agencies are similarly responsible.
110% Transparency says
Yes, I did see The Big Short; I watched it a couple of times. And, I read the book. I hope that many, many muppet investors see it more than once and read it more than once.
Re: Citibank. Think Meredith Whitney. Think Citibank assets. Think junk. Think stupid, incompetent, greedy executives. Think the same of Bank of America. How many OTC derivatives are they and their partners in crime exposed to now?
Think Kevin Yoder and the December 2014 CRomnibus: http://thinkprogress.org/economy/2014/12/12/3603194/dodd-frank-cromulent-phil-gramm/
Sorry fellas, but I don’t think that I am alone in my distrust of the ratings agencies or my distrust and dislike of anything Wall Street. Reform is too little too late. The greed gene is in full expression, and I’m not certain that anything is ever going to arrest it. Damage control isn’t going to work anymore; we shouldn’t want it to work. Investors must become hawks with eyes wide open. Investors must become highly skeptical of anything to do with Wall Street. Investors must have their Wall Street radar on 24/7/365. Our LHEIS is at stake. The financial disservices industry continues to bite the hand that feeds it. The incentives and compensation must change. If they don’t, we can expect the beast to continue biting the hand that feeds it. Soon there will be no hands left to bite. We’ll all be at Vanguard–the best of the worst.
Vanguard uses bond ratings in building their fixed income portfolios.
Do you allocate 100% of the fixed income portion of your portfolio to the Vanguard High Yield Corporate fund because it has had a higher return and you distrust all credit quality ratings?
When you buy life insurance, you just go by the lowest price, with no consideration for financial strength ratings?
When you buy long term care insurance, will you go by the lowest price, with no consideration for financial strength ratings?
I have run across people as distrustful as you. They put as much of their assets as possible in residential and commercial real estate. They buy life insurance for estate liquidity and equalization among heirs, and everything else they own is either real estate or small business interests. One client won’t even purchase fire insurance on his 10 rental properties because he thinks all insurance but life insurance is a scam. He won’t use real estate agents because he thinks all of them are crooks. He does all his transactions privately because he beleives title insurance and escrow companies are all crooks. He won’t go to doctors because…well, you get the theme here.
If you think owning stocks is such a scam, why do you own any at all?
Neither Michael or I, or anyone else is going to convince you that financial planning is a noble profession, that financial planning is much more than investment/product selection, or that indexed annuity sales people or Merrill Lynch brokers are not representative of the entire industry.
110% Transparency says
I’ve put all my money into bespoke tranche opportunities!!! LOL. They’re doing it again and again and again. Is anyone surprised? Behavior rewarded is behavior repeated. It’s Pavlov’s dogs.
Michael Kitces says
The companies you just listed are not insurance companies.
AIG has insurance subsidiaries. They were well rated in 2008. Which was accurate, because the insurance subsidiaries were secure, and segregated from the parent company that had financial issues.
And because insurance regulators require major insurance companies to be rated, the whole “get a rating you like or go to the next ratings agency” does NOT exist for insurance companies.
Again, you’re taking an issue for rating agencies pertaining to mortgage debt issued by investment banks, and are expanding it into insurance company ratings that are conducted differently, have different incentives, have different requirements, and operate in a different regulatory environment.
110% Transparency says
It’s called being willfully blind and thinking short term so that one can collect a big, big bonus. The culture must change. Without a change in culture the trust of the masses will not return. The financial disservices industry is reaping what it has sown. Funny thing is…they’re doing it again. Money and power corrupt. It’s a disease…a ever-mutating cancer. The T-cells have no balls.
Michael Kitces says
There’s a big difference between how ratings agencies handled collateralized mortgage obligations versus evaluating life insurance companies.
CMOs were somewhat opaque, the models were entirely new, and lacked robustness.
Insurance companies have been tracked and rated for a century, have fewer moving parts, and are radically more transparent for actuaries to assess and manage.
Simply put, the woes of rating agencies on mortgage bonds has absolutely no relationship to their ability to rate insurance companies. They were clearly terrible at the former, but are still quite good at the latter.
In addition, the perverse pay-to-play (or pay-to-rate) incentives for selling packaged mortgage bonds don’t exist in the same way for insurance company ratings, as they have a far different (and far more scrutinized) regulatory role when it comes to insurance.
110% Transparency says
Michael and Tony, it’s a culture thing for the whole of Wall Street. The ratings agencies sold their souls. They’re either honest or they are dishonest. They can either be trusted or they can not be trusted. The culture of Wall Street needs to change. I have my doubts that that will ever happen. I think that there are many, many others like me that have those same doubts.
The thing about annuities is that they are sold, not purchased. So annuity manufacturers still are mostly driven to gear product improvements in that direction — easier and more rewarding to sell, not better to buy and own.
110% Transparency says
From what I can tell, Brooke, the only thing that is purchased in the financial disservices industry are low-cost index funds, and unfortunately there are still way too few muppets who are asking RRs, IARs or RIAs to purchase them. And if muppets do ask, they get the big obfuscation game. Without an obfuscation meter, they are screwed. Get out the body cam for those face-to-face meetings and record all those phone calls. Muppets will never be able to protect themselves from the constantly mutating cancer that is the financial disservices industry and insurance industry.
Adam Obrecht says
Do you think the IRS will ever change the rules on fee payment to allow for advisory fees to be pulled from annuities with out causing taxation to the client?
110% Transparency says
Is that some kind of out-of-sight, out-of-mind fee collection system? Fees absolutely must be 110% transparent. IF YOU CAN’T MEASURE IT, YOU CAN’T CHANGE IT!!!
Open Architecture 2020 Group says
Here’s a different hypothetical future arbitration that all advisors should consider (especially the AUM fee segment): a plaintiff’s attorney asks why the fiduciary advisor committed to the best interest of the client at their point of retirement, but then failed to even mention the option of using mortality pooling to generate a predictable lifetime income stream without market risk. Immediate fixed annuities are already low commission (often 3%), and are even available with institutional pricing through Vanguard. Leading academics regularly write about mortality pooling to as an underutilized idea for many retirees (Robert Merton and Jeff Brown are two examples), and institutional pension plans regularly consider income annuities to de-risk. So for the RIA who bases their investment process on academic finance and institutional best practices, what will be the attorney’s defense where clients have suffered losses in stocks and bonds and weren’t able to at least consider the mortality pooling option? Chances are, the defense won’t be expensive pricing and complicated bells and whistles – immediate fixed annuities are already not like variable deferred products in either of those respects.
P.S. We don’t have an insurance/Annuity bias. Our think simply believes it’s in the retirees’ best interest to have all available tools their retirement advisor’s toolbox. You can visit our pro bono website if anyone’s interested. http://www.openarchitecture2020.com
I want to make sure I understand this. I transfer the title to my $1,000,000 to xyz insurer and it guarantees to pay me a fixed income for the remainder of my life. Additionally, I pay the intermediary (salesperson) 3% or $30,000 for his or her time. Only the recipient of the $30,000 would referred to this as “low commission”.
I have to say the financial industry is the sleaze. Here in central Florida I have attended three financial advisor dinners and they all basically sell annuities only. I imagine the commission s are quite high. The industry needs to cleanse itself
Reality Time says
No offense, but being a regular attendee of free dinner seminars might also be considered sleazy.
110% Transparency says
It needs to cleanse itself in industrial strength bleach.
Charlie Ryan says
Somehow AXA VAs got into the Howard Cty, MD school system 403b. These are 2.5% expense ratio index funds as far as I can tell; complete with surrender charges. What will happen to these? Will the law be retroactive? Why is it that many school system 403bs are insurance company offerings?
The k-12 403(b) investment plan is a true American scandal and has THRIVED IN THE 50 STATES SINCE 1960.
SHAME, SHAME ON THE NATIONAL EDUCATION ASSOCIATION AND THE AMERICAN FEDERATION OF TEACHERS. THESE TWO NATIONAL LOBBYING GROUPS HAVE BEEN IN A COMA FOR 56 YEARS. YET THEY CLAIM THEY ARE WORKING IN THE BEST INTERESTS OF THE AMERICAN TEACHER. THEY MAKE ME VOMIT!!!
Now let’s assume these investment plans come under the new Fiduciary Rule as enunciated by the DoL, (They do not because the k-12 403(b) is not covered by ERISA). But can we use the new Fiduciary Rule to light a fire under the nation’s school boards and teacher unions?
Of note: New York City Public Schools and its unions have, for the past 50 years, always practiced the Fiduciary Rule. With that said, the United Federation of Teachers, the bargaining agent for NYC teachers has never used its significant clout with its national affiliate, the American Federation of Teachers to assure that ALL of the nation’s teachers are treated in a Fiduciary manner.
JOEL L. FRANK
Posters here who make disparaging remarks about low compensation lifetime income annuities, must also sneer at traditional defined benefit pension plans as well. How very odd and peculiar.
Did you now that commission-generating investments are outlawed in Great Britain?
JOEL L. FRANK
Michael Kitces says
Did you know that the UK is also the world’s largest issuer of annuities, too? 🙂 (Though generally not the complex variable and equity-indexed versions we have here.)
Eric Bowser says
In most cases agents make less money on selling Fixed Index Annuities over the life of the contract than investment advisors do over the same period of time. The annuity is a commitment of X amount of years. The difference is the money comes upfront as a commission, but the bottom line is it is less than managing the money over the same time period. I would prefer to see better trail options on Fixed Index Annuities.
Reality Time says
Another well intended but misguided article on variable annuities. So hard to figure out where to begin hereafter watching the video clip and reading the article. I will make a few bullet points as a person who works for an annuity company. (No, I am not allowed to share the company I work for on this forum. This will also be my only post regarding this.) There has been a lot of noise out there with regards to the variable annuity business and what DOL means for it. It seems like there are hundreds of articles out there regarding the future of VA contracts. We shall see how each broker dealer handles the treatment of BICE.
1. Fee based variable annuities vs investment only variable annuity that pays a commission.
* Fee base VA = Rep charges between 1% to 1.5% on top of the fund charges of the annuity. (Some charge more by the way.)
* Investment only VA that pays a commission charges 1% to 1.25% out there. The ME&A pays the reps trails. Do the math.
There is virtually no difference in cost unless the fee base advisor wants to charge the client “less” than 1%. (I can tell you that is a very small percentage of fee based advisors out there.) Personally, I think fee based variable annuities will create situations where the overall costs will be “more” expensive than the baseline products being sold now if reps chose not to use BICE. The majority of wire reps charge 1.5% as their fee, and the majority of independent reps charge 1.25% as their fee. Most don’t breakpoint their fees unless the account is over a million bucks on their managed money side as well. (That is a fact.)
– Another issue with fee based annuities on the NQ side is where do you pay yourself as the advisor? If you take the fee out of the annuity, it is a taxable distribution. The only way for a fee based rep to pay themselves on a fee base annuity is to keep money outside of the contract in cash to get paid. While the commissioned based investment only variable annuities allow the client to be fully invested and basically have their fee taken out of the contract paid through the broker dealer. (A better way to own as the client being fully invested and easy for the advisor as well in my opinion). This is also the main reason why fee based annuities don’t sell a lot in the broker dealer community.
By the way, most (non annuity) managed money platforms that utilize active money management charge between 1.65% to as much as 3% “all in” out there depending who is being used between management fees, platform fees, ticket charges, custodial fees, and other layers of management. That is a different discussion in itself.
2. A fee base va with a standard death benefit costs around 30bps to 65bps of ME&A depending on the carrier or CDSC. Then the fee base rep charges 1% to 1.5% on top of that. (Or more as their fee)
A zero surrender VA with a standard death benefit typically charges around 1.65% of ME&A, and your classic 7 year CDSC products charge around 1.3% for ME&A
* A fee based VA with a standard death benefit could range between 1.3% to as much as 2.15% depending on the fee the rep charges the client. That doesn’t include extra rider costs.
* A commission based VA with a standard death benefit could ranges between 1.3% to 1.65%
Which one is cheaper again after the rep adds their fee to it?
3. With regards to your comments about the costs of living benefit riders: Yes, the costs are more expensive now. Anybody who looks at the rider costs pre-credit crisis was happy to pay lower costs because the 10 year was paying over 6% of interest back then. The 10 year rate has been floating around 1.7 to 1.9% the last year or so. Guess what happens to costs when that happens? They go up.
There are multiple flavors of living benefit riders and enhanced death benefit out there, for additional costs, by multiple carriers. The advisor needs to do their homework regarding the pros and cons to those additional features and benefits based on what they think is best for their client. This shouldn’t be anything new for the advisor as they should have always been working in this capacity from the start.
– Get that 10 year back up to the 6% to 10% range and you will see the costs of the riders go lower. Wake me up when we stop manipulating interest rates where that happens again. The low interest rate environment and hedging costs are why those riders are more expensive than they were back then.
The one place where you might see variable annuity products get better is with having lower costing subaccounts in them. Other than that, the actuaries that design the riders know what they are doing when it comes to calculating the cost of risk transfer. Those companies didn’t, are no longer around.
4. Yes, there are some dinosaurs out there who take their commission upfront. The vast majority of advisors who sell commission based variable annuities take trails on them. Those advisors who take the comp up front are only hurting themselves in the long run having to service the contracts while not getting paid as well.
Virtually every commission based variable annuity offers a 1% trail option on their contracts. In fact, I am not aware of any carrier that does not. There are commission options that range from upfront, to 25bps, to 50bps, to 75bps, to 1% on the trails of commission based annuities.
If a rep makes 7% on a 7 year annuity, it is the same (if not less with market performance) as a fee based rep who makes 1% a year over 7 years. This isn’t rocket science. I keep reading articles like this talking about “high” commissions, when in reality, it is the same or less over time than what most fee based reps charge their clients over the same period of time.
In addition, there are multiple commission options with trails that all pretty much equal the same amount of commission over that 7 year period.
5. Lastly, arbitration hasn’t gone away the last time I checked. The use of the best interest contract or going fee based isn’t going to change that.
Pardon the rant, or any typos above, but I wanted to clear the air a little bit with regards to the difference between commission based products and fee based variable annuities.
Good luck to everybody out here regarding DOL and how your broker dealer may react to the 1,000 pages of it.
Reality Time says
Michael – For the record, I generally enjoy reading your blog.
Please edit your post for grammar, usage, spelling, etc. It would then be much more of an easier read.
Reality Time says
Please save your high school English teacher post for somebody who actually values your opinion.
I read your post twice in an attempt to better comprehend it. Please forgive me for any sleight. I assure you that was not my intention.
Reality Time says
It’s a shame you are trying to give grammar lessons on an annuity thread as well. Good luck to you.
Can’t respond to your post above but thank you for making points 1-4. Reality
Michael Kitces says
The discussion here isn’t merely about whether a broker sells a variable annuity for an upfront commission versus a trail. It’s also about other channels adopting annuities as well, as product design changes. As you note, virtually all carriers have a 1% level trail option (along with other upfront commission options). However, VERY FEW offer a 0% trail option for RIAs who can and do charge clients separately for investment advice.
That obviously doesn’t mean the RIA advisor works for free – they may charge a similar 1% fee by other means. But it DOES materially change product distribution to design annuities that don’t pay the advisor internally and simply operate as a low-cost vehicle, which the advisor recommends, and charges separately for that advice. If you want a sense as to how that plays out, look at the explosive adoption of ETFs and total collapse of actively managed mutual funds amongst the RIA community. The RIA fee + ETF fee isn’t necessarily cheaper than a lot of actively managed mutual funds, but the RIA managing ETFs is causing severe disintermediation of active mutual fund managers (even aside from the impact of their not-always-stellar performance as well).
As for living benefit riders and interest rates, I would note that the 10-year was between 3.25% and 3.75% for much of 2003-2004, viewed by many as the heydey of the most appealing GMIB (and the then-still-relatively-new GMWB) riders. It’s not just a matter of interest rates “over 6% back then”. There was also the overall repricing of risk that happened after 2008. But again, there has still be ALMOST NO EXPANSION OF ANY OF THESE RIDERS TO THE RIA CHANNELS. Just a handful of companies offering any no-load (no upfront nor trail) option for RIAs. Because, again, there wasn’t much incentive to do so; the RIAs weren’t buying much, and the carriers weren’t doing much to sell to them, either. But again, the DoL rule has changed the landscape and the incentives.
And as for arbitration, it hasn’t gone away AT THE INDIVIDUAL ADVISOR LEVEL under DoL fiduciary and the best interest contract, but the BIC does require that financial institutions (who will sign the BIC directly with the client now) must leave themselves open to a class action lawsuit for failing to have policies and procedures in place to mitigate compensation conflicts of interest and ensure due diligence on products. And THAT lawsuit CANNOT be forced into arbitration. See https://www.kitces.com/blog/best-interests-contract-exemption-bice-and-dol-fiduciary-bic-requirements/ for further details.
Reality Time says
Hello Michael – I’m just responding to what you said regarding comp, and I’m simply saying the ME&A pays the comp just like an advisor charges a fee. Most fee based advisors charge “more” than 1% for their services as well. Agree with you regarding them getting paid for their services. It’s all the same. I’ve been in this business over 26 years, and am well aware that fee base and hybrid advisors sell passive lower cost ETFs on their platforms as well as actively managed funds. The fee based model is all about AUM and recurring revenue from it.
With regards to variable annuities, I think you will see virtually all of the variable annuity companies bring out fee based versions of their products before April of 2017. Those that don’t, will have a hard time surviving. If you look at product filings, you will already see a bunch of them being filed out there. In addition, there are many fee based annuities that already are available on the broker dealer level. However, the majority of those products will more than likely not be available on pure RIA platforms. I think you will see them available on regional, independent, and bank channel platforms. The same channels they cater to now that already provide extra back office eyes on suitability of their sales. Pure RIAs sell very little fee based annuities as it is now, and I do not see many players spending the money on getting their products set up on those platforms unless the needle moves where it makes sense. If you read my post above, you will notice that the extra 1% of ME&A will be taken off of those products that currently pay commissions. It’s a shell game regarding all in cost in my opinion. The design isn’t going to be that much different.
The 10 year note was over 5% in 2006 and 2007 before the credit crisis. In addition, other fixed income instruments were paying much more along with the back book of general accounts. VA sales with living benefit sales exploded after 2008. VA sales have been relatively flat on flows since then. 2003 and 2004 were not even close to being the heyday of living benefit sales. All you have to do is look at LIMRA sales “post” credit crisis and you see the flows are higher…2009 and 2010 for example. Yes, the sales rose after 9-11 and the tech bubble, but were not even close to sales after the credit crisis. There are also many va carriers that are completely out of the variable annuity business because of their gross mispricing of benefits during that interest rate period along with the costs of hedging. How many GMIB riders do you see still being sold by the way after all the mispricing, missed hedging, and reinsurers getting out of that game?
You are correct regarding how the BIC opens up the doors for more class action lawsuits on the institutional/broker dealer level. As I said before in my post, we shall see how each broker dealer creates, interprets, and decides if they are going to use the BIC or not. Those same institutions already receive class action lawsuits as it is without the BIC. I would also add that those broker dealers have become very stringent over the years with their current variable annuity suitability of sales with their back office. Talk to any current commissioned based seller of variable annuities and they will agree how difficult it is to sell them already with extra paper work, disclosures, and calls from the back office.
It’s an interesting game of chicken regarding which broker dealers will adopt BIC or not. They are well aware that reps could jump ship to another firm that adopts if they don’t, and they are also aware that the reps can say the hell with them and go pure RIA if they don’t adopt BIC.
In this very low interest rate environment why is it that the public-sector defined benefit pension plans immediate annuity rates have not changed?
Reality Time says
Please stay on topic when making posts to an article. It makes it enjoyable for the reader.
Your analysis is pretty much spot on. When in practice, I did some but they’ve gotten significantly worse over the years. There are still some decent value propositions out there but you are correct, the higher fee, higher commission ones get the attention. Hope some of the annuity haters reconsider. Frankly, some of the investment only or even DB only VA’s are cheaper than advisory accounts when index subs are used. Commissions on these (depending on the option chosen) pretty much pay advisors like advisory accounts. As a person who believes annuities can benefit risk averse investors, I see this as a positive consequence of the DOL rule. However, I still hate, hate, hate this quote: “We’re not going ban commissions outright. You people who say you can do commissions and still meet a fiduciary duty, knock yourselves out. But be ready to justify it in court when you get sued, because someone’s going to challenge you about it at some point” Sad!
lilli stern says
Can I sue the broker who sold me an annuity back in 2006 that benefited him more than me? He seemed to know very little about this product and never told me he was getting a whopping commission. He knew I had absolutely no knowledge of annuities or anything else in finances. I am stuck with this white elephant which is so complex I cannot find an affordable and honest financial advisor who will help me with this.