While the Department of Labor’s fiduciary rule, released last month, will likely cause recent declines in variable annuity sales to continue, experts believe the products could evolve to survive.

However, the old fee-and-commission models that enticed advisors to sell variable annuities to clients are likely to become extinct—since any insurance broker, agent, broker representative or financial advisor offering advice about retirement accounts will now be deemed to be fiduciaries. Others think commissions may not disappear but will fall dramatically just as sales loads have in the mutual fund world.

Companies offering no-load variable annuities see the playing field moving in their direction. “I think this is better for consumers,” says Mitch Caplan, CEO of Louisville, Ky.-based Jefferson National, a leading no-load variable annuity company. “Every day, power continues to migrate into the hands of clients and consumers, and it should continue to do so.”

Previously, the commission sale of variable annuities was exempt from fiduciary standards under ERISA, but the DOL’s rule will make it difficult for product manufacturers to compensate advisors for offering their products. The regulation could lead to fewer product manufacturers creating variable annuities, and fewer advisors offering the products to the clients because of the lower incentives.

Thus the fiduciary rule could pour cold water on an already smoldering variable annuity business. According to a recent LIMRA report, variable annuity sales in the first quarter of 2016 were down 18 percent year over year to their lowest levels since 2001. LIMRA estimates that VA sales will drop by a total of 15 to 20 percent for the year, and will drop another 25 to 30 percent in 2017.

“Most of the variable annuity world doesn’t fit in with the rule,” Caplan says. “The underlying features and functions are too expensive, and the cost of manufacturing and distributing most of these products is too high.”

Some variable annuities already eschew the traditional commission model. For example, Jefferson National’s “Monument Advisor” product carries a level, monthly fee in exchange for offering investors simple tax benefits.

Most variable annuities don’t comply with the rule’s requirement that compensation paid to advisors must be “reasonable.” While “reasonable compensation” isn’t specifically addressed in the DOL’s rule, in practice it means that advisors’ revenue should not vary depending on the types of products used within client accounts.

David Girmann, senior consultant with Cincinnati-based Strategy & Resources, says that many firms will move their business to other distribution channels to avoid compliance with the rule.

“I don’t think it will kill annuity sales,” Girmann says. “Unless the SEC follows suit with its own rules, we could see the shift of variable annuities to non-retirement-type products, which might be better in the long run. Today, 61 to 62 percent of all VA sales are in IRAs or plans.”

Most variable annuity manufacturers are going to have to take a close look at their business, says Girmann. Some will fight the rule, some will comply and some will exit the annuity business entirely to concentrate on their mutual fund and life insurance channels.

Caplan says the rule will do three things to the annuity industry in general: change the relationships within the vertical chain of manufacturers, distributors and advisors; put more focus on value and cost; and ultimately continue to prompt the migration of advisors from commission sales to fee advice business models.

“Everybody is trying to figure out what role they’re going to play,” Caplan says. “This is also part of another long-term movement where power is migrating from the hands of product manufacturers and distributors into the hands of the consumers and investors.”

Variable annuity manufacturers and distributors will have to decide whether to continue selling the products in the current environment, with their choices being company-specific, says Caplan. Many companies will leave the business entirely.

Others may choose a partial exit from manufacturing and distributing variable annuities, says Girmann. “The rule doesn’t touch in-force policies in a significant way, so you might see some companies choose to defend their current block of business and decide that’s profitable enough, [but] that they don’t want to participate in these markets any further.”

The companies who stick around will likely address the rule in different ways, says Caplan. “Some will focus on how they pay for distribution. Do they modify the way in which they compensate for distribution and move entirely to fee-only, or do they try to fit into the exemption that’s allowed? I think it depends on the individual manufacturer.”

Some insurance companies may follow MetLife’s lead and sell their distribution channels. Broker-dealers may decide it’s easier to become fiduciaries rather than find other ways to comply with the rule.

“Some migration to fee-only advice may be forced by the product manufacturers and not the distributors,” Caplan says. “On the other hand, some broker-dealers are going to say that it doesn’t matter if manufacturers build a solution; they’re not going to want to take on the risk of selling a commissioned product. I think you’ll see both.”

Still other firms will attempt to comply with the requirements of the Department of Labor’s best interest contract exemption. Under that rule, firms will have to disclose their fiduciary obligations, investment expenses and potential conflicts of interest to clients in a written contract.

Because the annuity sales would be bound by a written contract, clients would have the right to arbitrate individual complaints against an advisor, or to litigate their disputes as part of a class action.

While some industry watchdogs believe that the best interest contract exemption is too onerous for many annuity manufacturers and distributors to comply with, Girmann says that many firms will decide to adopt the contract and its requirements.

“I think the industry has become accustomed to more paperwork and regulation over time,” Girmann says. “The disclosure rules mean that if they’re moving money into an annuity, or out of another product, or replacing one annuity with another, they have to show how the new annuity is better for the client. The simple answers like offering more investment options are no longer sufficient. It has to be tailored to the client.”

Those disclosures should place fee pressure on products sold within annuities, says Caplan, as clients and advisors become aware of how investment expenses are used. Investors will expect annuity providers to offer lower-fee share classes within their products.

“Whether clients understand ‘fiduciary’ or not, what they do understand is cost,” Caplan says. “The power of technology has given them access to understanding what investment costs are, and how they can lower costs to improve returns. The whole fee structure and institutional share classes are going to be the next thing that people focus on.”

Currently, around 4 percent of annuities are sold in institutional share classes, says Girmann, and there are only around 20 carriers offering I-shares within their products.

The movement toward lower costs means that different types of funds are going to show up within annuities, too, says Tony D’Amico, CEO of the Fidato Group, a Strongsville, Ohio-based hybrid RIA. “They’re going to have difficulty justifying higher up-front costs, so we’re going to see a lot more use of index funds and ETFs.”

Annuities might also shift to products with few up-front costs and trailing fees and commissions, says Girmann, and the average product hold time within annuities will probably increase. Surrender fees, charges for withdrawing or abandoning an annuity—typically charged within a certain period after its purchase—will also be decreased or eliminated.

While D’Amico argues that product manufacturers will begin to eliminate riders and living benefits in order to offer a lower-cost product, Girmann argues that the add-ons could be used to justify variable annuities’ higher costs and commissions.

“Firms are going to try to differentiate themselves to find ways to charge additional fees or to justify the additional fees they already charge,” Girmann says. “Commissioned products still make sense. They’re just going to have to be positioned properly. A client that isn’t going to make a lot of changes and who will hold onto a product long-term might be better off paying an up-front commission, which over the long term might be lower than an ongoing fee.”

The highest cost annuities likely won’t survive past the DOL rule’s effective date in April 2017, says D’Amico, because advisors likely won’t be able to justify the expense clients would pay for the tax benefits.

As a result, the relationship between advisors, clients and annuities will change, says Caplan.

“If you make products clearer, simpler and more transparent, they begin to become more commoditized and fungible,” Caplan says. “They migrate from products that are sold to products that are bought. Since they don’t have to be sold, that generally means that they can drop a lot of the commission structure, and everyone will be impacted along the way.”

Variable annuities will be limited in their utility, says D’Amico, because distributors will no longer be able to easily market them to low and middle-income investors who aren’t currently maxing out their retirement accounts.

“In the future, the only place where variable annuities will be able to be justified is for clients in the higher tax brackets or with very large portfolios,” D’Amico says. “Advisors are going to have to do a tax analysis specific to their client to determine if the cost of an annuity is worth the benefit it provides. If someone is strictly focused on selling a client, they’re not going to do that level of work.”

There may also still be a market for variable annuities among the extremely risk averse, says Girmann. “People still love guarantees. The fear of loss is much greater than the joy of a gain. We’re seeing investors who don’t ever want to lose money. They hate the idea of losing something. Those kinds of investors may be willing to take less of an upside by investing through a variable annuity product that protects on the downside. Especially in the younger generations, millennials don’t want to risk their nest eggs. They’re in cash or fixed income right now.”