But unless fee-based advisors can decide how to best bill clients for holding such a safe, low-maintenance product, they ultimately may not recommend the category at all. And that would be a shame.
One of the most intriguing consequences of the Department of Labor’s fiduciary rule has been the introduction of so-called fee-based, or no-commission, versions of FIAs, among the best-selling annuities.
The fee-based versions differ from commission-paying FIAs in important ways. The cost of distribution (i.e., broker commissions) doesn’t get built into the product’s interest-crediting formulas. So they offer the end-client more attractive terms.
Fee-based FIAs also enable RIA (Registered Investment Advisor) firms to sell FIAs to IRA clients without having to comply with the DOL’s “best interest contract exemption,” or BICE, which more tightly regulates the commissioned-based sales of indexed annuities, variable annuities and mutual funds to IRA clients.
So no-fee FIAs, which offer participation in the stock market and other investments with no downside risk, offer a good deal for buyers and sellers – at least theoretically.
With brokers migrating from a commission-based sales model to fee-based advice model to avoid the BICE, banks and brokerages have asked life insurers to create more fee-based FIAs. Eight life insurers have so far offered up 15 products, according to looktowink.com, the indexed product data shop.
But, there is a problem.
Although these FIAs should be more appealing than ever to investors, sales have been negligible. In the second quarter of this year, sales were $22.48 million, or just 0.15% of total FIA sales in the quarter, says Sheryl Moore, CEO of Wink and Moore Market Intelligence.
Without commissions, brokers have no special incentive to sell no-commission FIAs. Many fee-based advisors levy a typical 1% managed account fee on the value of the FIA contract, but then fee-based FIAs cost as much or more as commission-based FIAs, eliminating their attraction to investors.
Moore, among other annuity marketing experts, is skeptical of the sales potential of fee-based FIAs. And charging a 1% managed account fee on a guaranteed, low-maintenance product like an FIA, in particular, doesn’t make sense to her.
“How can one justify an asset management fee on a product that has no market risk?” Moore says. “. . . This has me scratching my head.”
Some background is in order. Financial products aren’t like other products. If you buy a cashmere overcoat at Bergdorf Goodman and pay extra for the polite service, the prestige brand, and the store’s high-rent location, your overcoat isn’t less warm or well-tailored.
But when you pay extra for a financial product, then you’re getting a more or less flawed product. The amount you pay for distribution or service or advice obviously reduces its value.
Fee-based indexed annuities are a good example. These are indexed annuities that have no distribution costs—i.e., broker or agent commissions—baked into their crediting formulas. Fresh off the factory floor, so to speak, they have the potential, in up markets, to yield more than commission-based indexed annuities.
Insurance companies created these products in response to the DOL fiduciary rule. The rule made selling on commission to IRA clients more legally and administratively onerous. So many brokers and agents have migrated to a fee-based revenue model, where they earn a percentage of the assets they manage.
But will people actually buy a fee-only FIA, knowing that annual broker fees are ultimately higher than one-time commissions? So far, many financial advisors who sell these products are charging their usual managed account fee for the purchase of an FIA, and this is inappropriate.
For one thing, FIAs are guaranteed products, not securities. Investment management is really about managing the risks of securities, particularly stocks. That’s where professional expertise comes in. Since FIAs aren’t risky, their buyers should not be charged a management fee. In addition, the assets of the FIA fall under the aegis of the insurance firm that provides it, not at the brokerage firm. Fee-based advisors don’t charge a fee on other so-called general account products, such as single-premium immediate annuities. So why should they earn a fee on no-commission FIAs?
So how should the sale of no-fee FIAs be managed at the brokerage?
Brokers should either charge a small, one-time transactional fee on the sale or a much-reduced ongoing fee–as they might, for example, on a bond ladder. Sales reports already tell us that charging the full rate will not work. Financial advisors and brokers should make potential clients happy and set the stage for more FIA business – and more profitable business overall – and follow this path. This would also give modest annuity sales a shot in the arm.
In short, financial planning and advisory firms should do the right thing.
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