As a result, Morningstar is advocating that policymakers should facilitate the greater use of certain types of annuities, particularly GIPs, through specific policy measures aimed at retirement accounts,” the company said.
Currently, there are three barriers to the integration of annuity products in retirement plans. These are the liability risks under ERISA that plan sponsors face when providing annuities to employees; the fact that no federal guarantee exists for annuities; and the lack of a uniform federal investment advice standard for annuities, Morningstar said.
“When employers choose annuity benefit providers for their 401(k), 403(b), or other sponsored plan, they expose themselves to litigation risk. An annuitant who becomes dissatisfied by an annuity provider’s failure to fulfill its contractual obligations in an ERISA plan could bring suit against the employer by claiming that the employer’s selection of that annuity provider was imprudent,” Morningstar said.
Annuities have “unusually high fees,” Morningstar conceded. That may additionally “invite litigation from potential annuity purchasers who find that the employer offered high-cost plans in lieu of lower-cost plans of comparable quality and financial reliability,” the firm said.
Despite the recent introduction of legislation to address liability for an underwriter’s solvency, “it should be noted that employer concern about the fiduciary responsibilities involved in selecting an annuity provider for retirement plans is not a new issue and has historically presented a significant challenge to government regulators,” Morningstar noted.
The ratings and data firm also argued that the fact that annuities are regulated and guaranteed by state governments rather than the federal government may be adding to investors’ reticence that they’ll be left holding the bag if an insurer defaults.
Lack of uniform investment advice on annuities also stands in the way of investors and employers getting more comfortable with the contracts. “Given the lack of standardization in how annuity information is presented, these disparities in standards for advice present a land mine for retail investors,” Morningstar said.
There are more complications as well. Right now, investors face different standards depending on the type of account an annuity is purchased in, the type of financial professional the contract is purchased from and the type of annuity being bought.
For instance, variable annuities, but not fixed annuities or SPIAs, would be covered by the Securities and Exchange Commission’s investment advice rule Regulation Best Interest.
The murkiness of regulation governing annuities is potentially offputting to investors. For example “individuals purchasing a VA from a securities broker in what is deemed to be a one-off transaction have the protection of Reg BI, but do not have the protection of the DOL [fiduciary[ standard and are unlikely to have any protection if purchasing an annuity product other than a variable annuity, except for that under state law,” Morningstar noted.
Because many investors come to a securities or insurance broker “for a one-time purchase of an annuity, creating a significant opportunity to avoid the DOL fiduciary standard by key participants in this market. DOL regulations could cover all advice provided in retirement accounts, including employer-sponsored plans and IRAs, regardless of the annuity product in which the portfolio is being invested,” the firm argued.