Many providers of fixed indexed annuities and advisers who sell them were caught off guard when the Labor Department
failed to exempt them from a fiduciary standard under the department's new rule.
As advisers now weigh how to make recommendations of indexed annuities without running afoul of the rule, they can look to specific text of the regulation to glimpse what factors the Department of Labor would consider as part of a prudent recommendation.
Importantly, the “rigorous approach” required would likely be similar for other insurance products and investments in the DOL's eyes, Fred Reish, chairman of the financial services ERISA team and retirement income team at law firm Drinker Biddle & Reath, wrote in a recent blog
post.
The fiduciary rule,
released in its final form April 6, requires that advisers and brokers act in clients' best interest when giving investment advice on retirement accounts.
According to the DOL, “assessing the prudence of a particular indexed annuity requires the understanding" of:
• surrender terms and charges;
• interest rate caps;
• the particular market index or indexes to which the annuity is linked;
• the scope of any downside risk;
• associated administrative and other charges;
• the insurer's authority to revise terms and charges over the life of the investment;
• the specific methodology used to compute the index-linked interest rate;
• and any optional benefits that may be offered, such as living benefits and death benefits.
The DOL continued to say: “In operation, the index-linked interest rate can be affected by participation rates; spread, margin or asset fees; interest rate caps; the particular method for determining the change in the relevant index over the annuity's period (annual, high water mark, or point-to-point); and the method for calculating interest earned during the annuity's term (e.g., simple or compounded interest).”
Based on precedence of the Employee Retirement Income Security Act of 1974, “an adviser would also need to evaluate the financial stability of the insurance company and its ability to make the annuity payments (e.g., 20 or 30 years from now),” according to Mr. Reish.
STALLED GROWTH?
Fixed indexed annuities have been on a growth tear in recent years — 2015 was
a record year, with annuity sales hitting nearly $55 billion, a 13% increase over the year prior. It was also the eighth consecutive year of growth for fixed indexed annuities.
The story has been the opposite for variable annuities. Although sales are around 2.5 times those of fixed indexed annuities, VA sales are on a multi-year decline.
Many anticipated the DOL rule
would depress VA sales even further, at the same time bolstering sales of fixed indexed annuities. Some VA carriers had thought FIAs could serve as a sort of pivot product that could capture flows that otherwise would have gone to VAs.
That's because VAs were expected to be subject to the best interest contract exemption, or BICE, under the DOL's proposed fiduciary rule, exposing firms and advisers to additional compliance and litigation risk. FIAs, however, were expected to retain an exemption from this requirement, known at Prohibited Transaction Exemption.
The final rule ultimately positioned both variable and fixed indexed annuities within the BICE.
John Matovina, chief executive of American Equity Investment Life Holding Co., highlighted the uncertain sales environment for indexed annuities during the company's first-quarter earnings call.
“The unexpected change in the treatment of fixed-indexed annuities in the final rule, and the related prohibited transaction exemptions do cast a cloud over our future growth rate,” Mr. Matovina
said. American Equity derives roughly 95% of earnings from indexed annuities.
HOMEWORK DONE?
Although it's not surprising the Labor Department ultimately changed tack with respect to indexed annuities, the points the DOL made regarding prudent recommendations of the product shows they didn't conduct thorough due diligence ahead of their decision, according to Sheryl Moore, president and chief executive of Moore Market Intelligence, who tracks data on indexed annuities.
For one, the examples of index crediting methods are a bit outdated, Ms. Moore said. Insurers haven't used the “high water mark” crediting method for several years, she added.
“I'm disappointed the DOL doesn't seem to know what they're talking about,” she said. “Did you guys even do your homework?”
A DOL spokesman declined to comment.
