How Ohio National's move may lead to 'unscrupulous' broker behavior with annuities

If other insurers also start to terminate VA trail commissions, brokers might opt to take upfront sales commissions instead and start churning their clients' annuities

Oct 4, 2018 @ 11:34 am

By Greg Iacurci

Ohio National Financial Services Inc. recently told broker-dealers it would be terminating trailing commissions on some of its variable annuities, which has led experts to fear that the insurer's action will cause unscrupulous behavior among brokers.

Specifically, it will lead more brokers to elect upfront over trailing commissions and could lead to the churning of clients' variable annuities — both of which, depending on the circumstances, may be dubious practices, experts said.

"It's really going to create a problem from the perspective of people getting bad advice," said one LPL adviser, who requested anonymity.

InvestmentNewsreported Tuesday that Ohio National, which has roughly $25 billion of variable annuity assets on its books, told brokerage firms that it would be terminating their servicing agreements and cutting off brokers' trail commissions by mid-December.

The action, which pertains to VA contracts bought with a feature called a guaranteed minimum income benefit rider, is seemingly the first of its kind among insurers and led to an uproar among financial advisers and big broker-dealers such as LPL Financial.

'Back a Decade'

Brokers selling variable annuities to clients will likely view Ohio National's action as a signal that they should opt for upfront commissions rather than trailing commissions that are spread out over time, experts said. Brokers are now aware of the possibility that other insurers may shut off trailing compensation, too, and thus will be more inclined to take all the compensation in one fell swoop, experts said.

While upfront commissions aren't inherently bad, experts fear the lack of ongoing compensation would keep brokers from providing ongoing guidance on specifics such as the timing of withdrawals and the underlying investments — which could lead clients to make incorrect decisions and therefore mistakenly reduce their annuity benefit.

"Choosing a front-end commission, which most people agree has more of a conflict of interest on it, would be much more likely if the ongoing trail-based compensation — which aligns the client and the adviser's interests much better — is at risk," said Mark Cortazzo, senior partner at the advisory firm MACRO Consulting Group. "It would drive behavior that could set the industry back a decade."

In addition, brokers may feel pressured to exchange a client's Ohio National annuity for a separate product absent continued trails. Such an exchange, a practice known as "churning" when it's abused, would earn the broker another commission but would also likely disadvantage the client, experts said. That's because the benefits that accrue in a variable annuity's income rider don't transfer to another insurance company. The client would essentially be starting from scratch.

The Financial Industry Regulatory Authority Inc., the brokerage regulator, has cracked down on VA churning over the past few years.

"It's going to lead to some people — unscrupulous people — trying to replace these contracts, and they're good contracts that shouldn't be replaced," the LPL adviser said.

Meanwhile, Ohio National doesn't appear to be applying the policy universally — it's not disrupting the compensation arrangements for brokers who sold variable annuities through the insurer's own independent broker-dealer, the O.N. Equity Sales Co.

"There is no change in how you will be compensated for the in-force Ohio National annuity contracts you have written through ONESCO," said a previously unreported memo sent Tuesday to ONESCO brokers and obtained by InvestmentNews.

The memo, signed by Patrick H. McEvoy, the unit's chief executive and vice president of Ohio National's broker-dealer operations, said the policy applies to "the majority of all other" broker-dealers.

Even though most brokers will be losing trail commissions, Ohio National executives believe they will continue providing services to clients.

"We believe advisers do and will continue to act in the best interest of their clients regardless of how they choose their compensation structure," H. Douglas Cooke III, vice chairman and chief distribution officer at Ohio National, said in an emailed statement.

Advisers question that logic, saying brokers will naturally shy away from helping annuity clients — or at least providing the same level of service — if they're not compensated for it.

Some experts believe some of this broker behavior is precisely what the insurer is trying to encourage — product exchanges and client mistakes could allow the company to legally wriggle out of pricey obligations it made to consumers.

"That is what Ohio National wants," said Sheryl Moore, president and CEO of consulting firm Moore Market Intelligence. "Living benefit guarantees are expensive, hard on their reserves and they don't want it."

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