Fee-based products attract attention

Feb 3, 2013 @ 12:01 am

By Andrew Osterland

Variable annuities have always been a tough sell to registered investment advisers. They're complicated, they're costly and they're usually sold on a commission basis.

“I never felt comfortable with variable annuities,” said David D'Amico, president of Braver Wealth Management LLC, an RIA based in Needham, Mass. “I always felt there was something lurking in the contract that would surprise me. It was difficult to get over the negatives.”

Mr. D'Amico, however, has been warming up to the idea. With low interest rates and volatile capital markets undermining the economics of writing traditional variable annuities, insurance companies are coming up with new products specifically tailored to fee-based advisers such as Mr. D'Amico. While a number of companies — ING Groep NV, Genworth Financial Inc., John Hancock Financial Services Inc. and Sun Life Financial Inc. among them — have exited the traditional VA business, and others have scaled back offerings, fee-based products for RIAs are on the rise.

“A lot of insurance companies are treading water until interest rates increase,” said John McCarthy, a senior product manager for Morningstar Inc. who tracks the insurance industry. “Four or five years ago, the RIA market wasn't a top priority for the industry. It is now.”†

The number of fee-based variable annuities (also referred to as I shares) offered in the market has risen to 61 today, from 34 in late 2011, according to Morningstar. Sales in the third quarter last year totaled $1.059 billion, versus $910 million in the year-earlier quarter. That's no industry sales bonanza, but it is solid growth, considering that total VA sales in the quarter were down 4.9%.

STRIPPED-DOWN VERSION

Fee-based variable annuities are stripped-down versions of their traditional cousins. There are no complicated guarantees, no hard- to-understand living benefits, no upfront loads or surrender charges. What's left is the core attribute of a variable annuity: its tax deferral benefit.

“RIAs have held variable annuities in disdain,” said Laurence Greenberg, president of Jefferson National. “But this is a different version of the variable annuity. We don't sell the products to advisers; we simply explain the benefits of tax deferral to them.”

Jefferson launched its Monument Advisor annuity in 2006. It charges a flat fee of $20 per month, and investors are responsible for the underlying fund fees. It offers no living benefits and only an optional return-of-premium death benefit, which it reinsures through other carriers.

A big draw for advisers is the number of investment options on the fee-based platforms. Because the insurers aren't holding the risk associated with guaranteeing income streams or future benefits, they can offer a wider range of investment choices to advisers. Jefferson, for example, has 390 funds in the Monument Advisor annuity, including 70 alternative investment options.

“These newer structures are a lot more flexible,” Mr. D'Amico said. “It's like managing assets the way advisers always have.”

Like all variable annuities, the fee-based versions offer tax-free growth for the assets and the ability to withdraw from the account later in life when an individual's tax rates are lower. For investors who have maxed out their 401(k) and/or individual retirement account contribution limits, VAs offer another vehicle for tax-free investment growth.

VOLATILE MARKETS

“I like the low fees and the large selection of investments, but the big benefit is the compounding of money without the consequences of taxes,” said Steve Blumenthal, CEO of Capital Management Group Inc.

That benefit is all the more appealing given the volatile markets. It allows advisers to use more-active investment strategies that they otherwise might not in a taxable account. “You can build tax-inefficient strategies in these variable annuities and not worry about the tax implications,” Mr. D'Amico said. “They're a great place to shelter assets.”

With taxes already rising for high-income earners and the possibility of further hikes, the demand for tax-free growth will only increase — one reason why companies are launching new products and filling out their investment platforms.

"RETIREMENT CHALLENGE'

“It's the perfect storm in terms of the retirement challenge. We have historically low interest rates, volatility and an impending rise in tax rates,” said Doug Wolff, president of Security Benefit Life, which introduced its Elite Designs fee-based variable annuity last April. It has a base mortality-and-expense fee of 20 basis points, a subaccount administration fee of another 25 basis points and no withdrawal or surrender fees. The standard death benefit is the contract value, and 27% of the contracts sold so far include an optional return-of-premium death benefit for 35 basis points. Advisers charge their fee on top of that.

“We see a lot of potential in a marketplace that hasn't historically embraced annuities,” Mr. Wolff said.

How big that potential is remains to be seen. While product sales growth has been impressive, it's related to a small base. Ninety percent of VA sales still carry some form of guarantee and are sold on a commission basis, according to Morningstar. The market share of fee-based products rose to just 3.1% of total industry sales in the third quarter of 2012, from 2.4% one year earlier.

While more large carriers such as Lincoln National Corp. and Nationwide Mutual Insurance Co. are entering the market, some are still waiting for stronger evidence that RIAs want the products.

“With tax deferral being on everyone's mind, the market could really develop, and we hope that it does,” said Greg Cicotte, president of Jackson National Life Insurance Co., the second-largest seller of variable annuities in the industry as of the third quarter of last year. He said he's not yet willing to make the marketing and technology investment needed to launch a fee-based product.

CHANGING TIDE

“We're watching the market closely,” he said, “and we're prepared to enter if volumes get big enough to warrant it.”

If Mr. D'Amico's change of heart on the idea is any indication, the volumes will be there. “I think I'm typical of most RIAs who wanted nothing to do with variable annuities in the past,” he said. “If you're not looking at these products now, you're not exercising your fiduciary duty.”

aosterland@investmentnews.com Twitter: @aoreport

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