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Changes Coming to the Structure of Variable Annuity Fees

As we anxiously await the final Department of Labor rule that could change the annuity industry, people are speculating about what will happen with variable annuities in particular. Insurance News Net’s Cyril Tuohy discussed the possibility of an increase in wrap variable annuities in the recent article “DOL May Encourage Move to Wrap Variable Annuity Fee Structure.” A variable annuity with a wrap structure has no surrender fees and very low expenses. The catch is that the fees paid to the financial advisor will likely have to come out of a separate pool of money between the client and advisor. This is because advisory fees paid from a non-qualified variable annuity will be taxed as a distribution. Advisors don’t want to take the fee directly from the variable annuity to save their clients the tax burden.

Life insurance company and annuity executives have been talking about what will happen with variable annuity fees for months. Many products will have to be restructured so that they can accommodate a fee-based model for all of the advisors that choose to follow that path with the anticipated DOL rule change. Most fee-based advisors don’t currently sell variable annuities, something that will change if the expected rule becomes reality. Their biggest objection is that there are fewer investment options and what they perceive as higher fees associated with variable annuities. These wrap variable annuities are sold to fee-based advisors and have no surrender charges. They function like a C-share variable annuity, but since the insurance company isn’t paying commission, the administrative and mortality expenses are significantly less. Most clients who buy C-share variable annuities are using a 1035 exchange to move from an old variable annuity into a new one. A lot of advisors sell variable annuities because they like the up-front commission structure, so this is going to undergo a transformation as well.

One of Morningstar’s variable annuity experts said that variable annuity B shares will perhaps be impacted most by the DOL rule. Advisors will have to demonstrate how the living benefit fees impact the portfolio and how the fees impact retirement income. These products usually have a seven year surrender charge and make up around three-fourths of total variable annuity sales. Jackson National, AIG, Lincoln Financial, AXA Equitable and Prudential Financial were the top five sellers of B-share variable annuities during the third quarter of last year. New variable annuity sales were down almost 10% during the third quarter of 2015 to $31.2 billion. This is because of low interest rates and less supply as many insurance carriers cut back on variable annuity products. They haven’t been able to offer very attractive living benefits, step ups or lifetime guarantees because of the low rates.

Advisors will be held to a new fiduciary standard with the DOL rule, which might introduce a new class of wrap variable annuity products to the market. The annuity market, particularly variable annuities, will see a lot of changes as advisors work to follow the new standards and keep their clients happy as well.

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