High Noon In Annuity City

You might say it's nearly High Noon in Annuity City.

By the end of the first quarter of 2016, the U.S. Department of Labor will announce new rules to modify -- and likely expand -- the definition of "fiduciary responsibility" under the Employee Retirement Income Security Act of 1974 (ERISA), affecting countless retirement products, including annuities and, perhaps especially, variable annuities (VAs).  

Specifically, the Prohibited Transaction Exemption 84-24, which has exempted VAs from fiduciary standards, will almost certainly be altered or even revoked while new compliance burdens are placed on all fiduciaries. Though details remain to be seen, as of this writing, the primary aim is to address potential conflicts of interest.

"The intention is wonderful, but I’m concerned about the unintended consequences," says Mark Cortazzo, senior partner at Parsippany, N.J.-based MACRO Consulting Group. "The greatest risk is limiting client choices."

His fear is based on the idea that pressures on fee disclosure could slant the market toward the cheapest, most stripped-down products. "If the determination between good and bad is based on the absolute standard of cost," observes Cortazzo, "then products with protection or other creative solutions could have so much liability that advisors don’t even present them as options to their clients. You’re almost assumed guilty until you prove your innocence."

Protections on annuities typically come as riders, of course, such as income guarantees, which add to the costs. But reducing riders, and therefore costs, isn't necessarily best for all clients. "An income guarantee on a variable annuity is insurance," says Cortazzo. "As with all insurance, there is a low probability of utilization … It's a bad deal for most, but a good deal for some because you are pooling risk. Ten years from now, you may look back and decide the income guarantee was not worth it because you didn’t use it. It doesn’t mean it wasn’t the best decision at the time, however."

Watching Commissions
The devil, as they say, is in the details. "Transparency is always a good thing," says Scott Stolz, senior vice president of Private Client Group Investment Products at Raymond James in St. Petersburg, Fla. "Our concern is about the steps required to achieve this goal. … Given that the DOL’s rule is measured in the hundreds of pages, no one should be surprised that the industry is concerned that the cost of complying will exceed the benefits."

To comply, most advisors will likely eliminate commissions from retirement products, explains Stolz. Instead, they will rely on an hourly rate, a flat fee, or a percentage of assets under management. The assumption is that brokers who collect commissions on retirement accounts often put their own interests ahead of their clients'.

Alternatively, advisors may choose to continue using existing compensation models, including charging commissions, if they scrupulously abide by the Best Interest Contract Exemption, which means guaranteeing full disclosure on costs and fees and essentially signing a contract with each client promising non-bias.  

"If advisors wants to recommend products that pay commissions, trails or have revenue-sharing elements to them, they will need to enter into a contract with the investor asserting that, in addition to the disclosure of the fees involved, they have identified and developed policies and procedures to handle conflicts of interest, and will commit to putting the clients’ interest before those of the firm or themselves," says John Shields, a Boston-based director in the financial services practice at Chicago-headquartered Navigant Consulting. "This puts the financial advisors and their broker-dealers in a very difficult situation."