Variable and fixed-indexed annuities feel sting of DOL fiduciary rule

Those who thought fixed indexed annuities would be a benefactor of the Labor Department’s fiduciary rule may want to think again.
The Department of Labor dealt a bit of a surprise blow to fixed indexed annuities in the final iteration of its rule, issued Wednesday, by lumping the annuities into a more complex and costly regulatory regime than they have presently, representing an about-face from the department’s original proposal.
The DOL had earmarked variable annuities for this enhanced compliance regime under its proposed rule, and experts largely agreed the impact on qualified VAs would be profound, with a likely negative impact on sales and the embrace of new product types and compensation arrangements.
The final rule will probably lead to the same or a slightly better outcome for variable annuities, experts said, and it now looks like a similar fate awaits fixed indexed annuities. Many insurers had been banking on fixed indexed annuities as a sort of fallback option that could capture some flows that may have otherwise gone to VAs.
“Indexed annuities were variable-annuity carriers’ Plan B. Now, they’re having to come up with Plan C,” said Sheryl Moore, president and chief executive of Moore Market Intelligence.
Prior to the Labor Department’s rule, which raises investment advice standards for retirement accounts, variable and fixed indexed annuities had an exemption under something called “Prohibited Transaction Exemption (PTE) 84-24,” allowing the sale of these products in retirement accounts even if variable compensation such as commissions were received by an adviser.
Now, variable annuities and fixed indexed annuities have lost that exemption, and advisers and insurers must satisfy conditions of the Best Interest Contract Exemption (BICE) in order to sell such products in qualified accounts. Many feel that exposes stakeholders to additional litigation and compliance risk.
“The final rule has made it very clear fixed indexed annuities are now under the BICE, and I know many of the annuity carriers were counting on that being 84-24, business-as-usual,” said Chris Joline, a principal at PwC.
“What we initially thought was many VA carriers would go into fixed indexed annuities because it would be simpler to handle those, and they have many of the same characteristics,” Mr. Joline added. “Now, we don’t see that as being as likely.”
MetLife Inc. for example, recently entered into a long-term distribution deal with Massachusetts Mutual Life Insurance Co. for fixed indexed annuities, whereby MetLife, one of the top players in the VA market, would develop a FIA for distribution by MassMutual advisers. Both firms don’t currently have any proprietary fixed indexed annuities.
Fixed rate annuities such as immediate annuities retain their 84-24 exemption, though. Indexed and variable annuities are being treated differently from standard fixed annuities because they are “often quite complex and subject to significant conflicts of interest at the point of sale [and] should be sold under the more stringent conditions of the Best Interest Contract Exemption,” according to the text of the final rule.
Indexed annuities have been on a sales tear the last several years, achieving their best year on record in 2015. Many thought they wouldn’t be subject to the BICE in the final rule.
“We most recently heard from industry players that it wasn’t expected,” stated a note from Keefe, Bruyette & Woods Inc. “Indexed annuities are a high commission product like VAs, and 60-65% of industry sales are within qualified retirement plans. We expect indexed annuity sales to be negatively impacted as result.”
The stock of American Equity Investment Life, 95% of whose earnings come from fixed indexed annuities, according to KBW, was down around 15% as of 4 p.m. Wednesday.
Cathy Weatherford, president and chief executive of the Insured Retirement Institute, said the trade organization wasn’t surprised that the DOL moved fixed indexed annuities out of PTE 84-24, due to conversations the group had with DOL officials about the proposed rule. Those conversations hinted at “simpler” annuities such as immediate annuities being the ones to ultimately retain the original exemption.
However, the final rule did “loosen” some of the BICE requirements from the proposed rule, which could make it a bit easier for life insurers and distributors to comply with the BICE, and sales of VAs may not be as bad as originally projected, according to Laura Bazer, vice president and senior credit officer at Moody’s.
“I would say variable annuity sales will be impacted, but possibly not as much as people thought,” Ms. Bazer said. “But we’ll have to see, and it will depend on the specifics of the company selling the product.”
As an example of looser rules, the BICE doesn’t have to be signed until an account is opened, disclosures were reduced and the exemption has been clarified to ensure there’s no bias against sale of proprietary products. Further, the implementation deadline was lengthened to a year.
“I do think that any relief in BICE, including the extension, will help with VA sales attrition attributed to advisers abandoning the solutions in the short term,” said Judson Forner, vice president of investment marketing at ValMark Securities Inc., an independent broker-dealer. “I also think that the longer distributors have to comply and the lighter the BICE formalities are, the more advisers will choose to consider and potentially utilize that door.”
Lee Covington, general counsel at IRI, said it’s too early to tell what the impact on annuity sales will be. “It’s a very complicated provision, and language really matters,” he said.
That said, even though the DOL eliminated some of the BICE “complexities,” advisers and carriers will have to go through many of the same steps as under the proposed rule to comply, and the litigation risk is still present, Mr. Joline said.
Because using fee- rather than commission-based annuities is one way to escape the necessity of complying with the BICE, many had forecast product development headed toward the fee-based arena to meet the demand of advisers embracing this type of model. That dynamic is likely still in play, Mr. Joline said.
“I think that still has the same chance of happening,” he said. “Product redesign may have to be triggered.”