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."

So Shields predicts an increasing shift toward fee-based compensation from commission-based compensation. "The DOL fiduciary rule clearly favors fee-based compensation," he says, "and there will likely be an increase in the number of financial advisors who become investment-advisor representatives using no-load or low-load variable annuity products to avoid the complexity of using the Best Interest Contract Exemption."

Indeed, in February LPL chairman and chief executive Mark Casady announced that he expects a move to fee-based VAs as a result of the DOL rule. Reportedly, LPL will also continue to lower minimums on certain accounts -- some to as low as $5,000 -- for clients who can't afford fee-based accounts. Neither Casady nor another LPL spokesperson was available for comment by deadline time.

Casady also reportedly said that LPL is receiving an influx of advisors who seek to leave independent broker-dealers as a result of the DOL rule. The reason: Independent firms could be especially vulnerable to the new standard's harsh, critical eye because of their exposure to commission-based VAs.

"We've been preparing for a shift to fee-based annuity options for a number of years," says Ethan Young, director of annuity and insurance research at Commonwealth Financial Network, in Waltham Mass. "I don't see a huge impact to our advisors."

Price Wars Likely
Still, another potential fallout is a shift in favor of fixed annuities, which many -- but not all -- observers expect will remain exempt from the fiduciary standard. "I would anticipate there will be a greater focus on fixed annuities," says Billy Lanter, a fiduciary investment advisor at Unified Trust Company in Lexington, Ky. "Any time there’s a shift in regulation or compensation, there is also a shift in product sales."

Price wars also seem a likely possibility, he says. "With full fee disclosure, I would expect to see more competitive pricing between variable annuity issuers, which may ultimately lead to some fee compression," explains Lanter. "You may see pricing broken down into more riders/options that can be chosen while offering a lower cost for the 'basic' product."

But to what extent do these developments actually serve client's best interests?  "Typically, the recommendation to use fixed versus variable annuities comes down to the investment strategy that is right for the client, and fixed annuities do not provide the same investment solutions as the variable products," notes Shields, at Navigant. "So the implications of recommending a fixed annuity simply to avoid the disclosure requirements and commitments of the fiduciary rule should be carefully considered and discussed with compliance and legal counsel."

In other words, if VAs end up under a tougher standard, that doesn't mean they aren't the right product for certain clients. "I recommend a lot of VAs, particularly for clients looking for income and as part of their fixed-income space," says Michael Rosenberg, a managing partner at Livingston, N.J.-based Diversified Investment Strategies. The higher cost for these products may be justified to satisfy a specific need, such as the peace of mind of a guaranteed future income. "I explain thoroughly to clients the costs and fees associated, [and] the client must sign off his or her understanding," he says.

Yet Rosenberg acknowledges there are some bad apples.  "Unfortunately, I believe a few advisors sell high-cost products without explanation, or do not have the client's goals and objectives in mind," he says. "Savvy advisors who follow the Golden Rule of doing right by their clients will be fine [under the new regulations]."

In any case, Raymond James' Stolz suggests such a division may be short-lived.  "I just don’t see how we can tell our clients that we can work with them under one standard for Variable Annuities, but have a lower standard for all of the other types of annuities," he says.

Look For Innovation
If change is the one constant in life, so innovation in the annuities industry can almost be guaranteed -- especially in light of a changing regulatory environment.  "Realistically, I expect the same carriers to be representing the space with the same risk profile and profit expectations [after the DOL rule change]," says Judson Forner, vice president of investment marketing at ValMark Securities, in Akron, Ohio. "Products will evolve to include more indexed annuity strategies and advisory solutions with traditional income and death-benefit riders. The design of future solutions may seem abstract in comparison to products available today, as manufacturers look to deliver effective products within the new framework of what is allowable. Ultimately, while they may look and feel different, they will deliver similar value."

Others predict that L-share variable annuities, which are pricier than the more common B shares, could be eliminated as a result of the new regs. L-share VAs offer greater liquidity -- in the form of shorter surrender periods -- than B-share VAs, but they charge trailing mortality, expense and administration (MEA) fees of, on average, 1.65 percent -- which is significantly higher than the average B share's 1.15 percent MEA charge. That may be hard to justify in the new fiduciary environment. Two weeks ago, Commonwealth Financial Network eliminated L shares

"Traditional L-share products have been under pressure for some time and will continue to face significant headwinds," confirms Forner. "It is very possible that the L-share chassis is eliminated similar to B-share mutual funds, in the near future."

To be sure, there are also A- and C-share VAs -- a complicated alphabet soup that may soon be eliminated. "The problem is that the industry has designed these as different products with different names and different prospectuses and client literature," says Stolz. "That makes them difficult to present side by side. I just don’t see how this structure will be possible in a post-DOL world. So, yes, I believe this rule will eliminate the various share classes as we know them today."

He predicts it will come down to two types -- those with low surrender charges and those with none at all.

For the time being, though, the industry will have to wait and see what develops. That's not necessarily bad news. "This is very good for the industry and the profession," insists John Graves, an accredited investment fiduciary and owner of Ventura, Calif.-based The Renaissance Group. "The best advice [for advisors] is to become a fiduciary. Always act in the best interest of your client. Our profession should begin and end there. Advisors are fiduciaries; advisors are not salesmen."