The fact that the Department of Labor’s fiduciary rule has gone through the budget process means that it will likely be finalized this year. A lot will change for advisors selling annuities as well as for those designing new products. In the Think Advisor article “How Annuities Will Be Transformed by DOL Fiduciary Rule,” Scott Stoltz discussed the future of annuities after this new fiduciary rule takes effect.
He said that advisors will now have two different choices for making IRA recommendations to their clients. The first option is to serve as a fiduciary under ERISA without conflicts. Any conflict of interest between an advisor and client is eliminated with this option, including the payment of commissions. Advisors will charge a flat fee, an hourly rate, or a flat percentage of the assets under management. The other option is to serve as an ERISA fiduciary with conflicts that will be under the umbrella of the Best Interests Contract Exemption (BICE). The BICE exemption was introduced by the DOL to try and have a compensation model that is similar to those in existence currently. Under this structure, commissions are allowed but they have to be “reasonable”, disclosed up front, and not have any bearing on what recommendations are issued. It also includes a long list of different disclosures about all of the costs involved and any compensation that will be paid out. Advisors also have to have a contract with each client confirming that their recommendations are not at all biased. If there are any violations of this contract, the advisor and firm could have a claim against them.
The DOL argues that financial advisors should have to have the client’s best interest at heart in a similar manner to what doctors and lawyers promise to do. We all know that doctors and lawyers aren’t always perfect and that they have to spend a lot of time considering potential liability when making recommendations. Financial advisors will now have to spend more time considering potential liability as well. Mr. Stoltz thinks that most advisors will take the more conservative option and choose to serve as an ERISA fiduciary. Choosing that option puts more restrictions on advisors, but it also more clearly explains what is allowed and what is not. The BICE model doesn’t require as much change to advisors’ current plans, but there is a lot of uncertainty that comes with choosing to follow the BICE model. “Reasonable” can be interpreted in many different ways.
In addition to how this DOL fiduciary rule will effect advisors, it’s important to consider how it will change annuity products and innovation. There will definitely be a greater need for annuity products that don’t pay commissions, or fee-based annuities. Those advisors who opt for the ERISA fiduciary role will only be able to sell fee-based annuity products. Even advisors who take the other route will likely want to sell some fee-based annuities too because they will have to be able to defend any commission charged and prove that it is reasonable. It’s not likely that commission-based annuities will disappear, but the product structure will most likely change. Instead of up-front commissions of 5%, that number will probably be closer to 1-3%. Mr. Stoltz thinks that the commission structure will look more like a fee-based account charge. Since up-front commissions will be lower, high surrender charges and long surrender periods will be unnecessary going forward.
There are three products that this author mentions as the likely future of annuities. The first annuity would be made for both advisor options as a fee-based annuity account that is low-cost, no commission, and has no surrender charges. The second annuity would be similar to the first, but would have a low surrender charge to offer better pricing to consumers. It would also be modeled for both the ERISA and BICE options. The third product would only be for the BICE structure. It would cost a little bit more and have a low surrender charge but a longer surrender period. Fee-based accounts haven’t had much success to date, but are likely to become more popular as higher commission alternatives disappear. Mr. Stoltz thinks that there will be a large decline in annuity sales while advisors and insurance companies adjust to these fiduciary rule changes.
Advisors often complain that they have to charge higher commissions because of the additional paperwork and regulation that they have to deal with. As annuities become simpler, this additional paperwork should ease and some of this suitability paperwork may become unnecessary. There is a great need for guaranteed income right now, so hopefully the DOL, FINRA and the annuity industry can work together to ensure that the right annuity products are available to those who need them. While the new DOL rule might be a pain to advisors and insurers at the beginning, it should ensure that the industry remains fair and that annuities function for everyone involved in their sale.