Obama-era fiduciary rule made variable annuities cheaper, study finds
Clients have found better-performing and less expensive products in the variable annuity marketplace, thanks in part to the Obama-era fiduciary rule, a new academic study argues.
The study, written by three finance and economics professors at Harvard Business School and New York University, takes a fresh look at some of the most hotly disputed topics in wealth management, with striking and controversial results.
After tracking sales during the time when the Labor Department partially implemented its original fiduciary rule in 2017, the researchers say the results indicate that clients “on average, benefited” in their variable annuities. Expenses fell by 20 basis points and risk-adjusted returns climbed 92 bps, according to the study.
Differences in fees, commissions and subaccounts among VA products have “important value implications” for advisors and clients, Mark Egan, Shan Ge and Johnny Tang said in an email interview. Egan also co-authored a February 2019 study on financial advisor misconduct.
“On average, brokers are more likely to sell annuities that have lower expenses, which is good for investors, but are also more likely to sell high commission annuities,” the professors said. “What is a bit more surprising is how much heterogeneity there is in broker/investor incentives (i.e. commissions and expenses) across annuities.”
In all, they examined product characteristics and sales data between 2005 and mid-2019 from Morningstar and regulatory filings. Expenses ranged between 0.25% and 4.20% of assets per year, with an average of 2.24%. The mean disclosed upfront commission was 6.09% of premium payments, with a spectrum from zero all the way to 16%.
VAs sold by captive brokers employed by the issuer firms cost roughly 25 bps less than the products sold by non-captive representatives, also known as independent advisors, according to the study. The data “suggests that captive brokers place a higher weight on their clients' incentives relative to non-captive brokers,” according to the study.
And, for the year marked by partial implementation of the rule, sales of VAs with the highest expenses tumbled by 43% more than the drop in sales of low-expense products. The effects of the rule “were persistent even though the rule was ultimately vacated,” the researchers say.
“We find that in anticipation of the DoL rule, variable annuity sales became more sensitive to expenses,” Egan, Ge and Tang say. “This appears to be driven by the behavior of both brokers and insurers, as brokers changed which annuities they sold, and insurers increased the availability of low-expense and low-commission products.”
The conclusions ring true to advocates of the rule issued by the Obama Administration in 2016.
“Big picture it documents that the Obama-era fiduciary rule saved investors billions and totally debunks the industry argument that it limited access to small investors,” portfolio manager and pensions whistleblower Chris Tobe said in an email.
The fiduciary rule’s critics take issue with the working paper’s conclusions. Sheryl Moore, CEO of annuity market research firm Wink, wrote a blog on the firm’s website with a list of the ways that the “flawed study” fell short in her opinion.
For one, she views the comparisons between captive and non-captive reps as “apples to oranges” because independent advisors don’t get employee benefits or office space from their home offices, she says. In addition, issuers use “really extreme” numbers in VA prospectuses that don’t reflect the actual commissions tied to the products, Moore says.
“It definitely looks like to me that they're trying to sway it negatively and that they went into this research paper with a bias,” Moore says.
To the Insured Retirement Institute, a trade and advocacy group for the retirement income industry, there are three main problems with the study’s findings, according to Frank O'Connor, IRI’s vice president of research and outreach.
Assessing costs and returns alone fails to take into account the value of the protection embedded in the products, O’Connor says. In addition, clients who buy lower-cost products as part of an overall portfolio will be paying substantially more than the underlying price of the VA. O’Connor also questions the assertion that the rule is “directly responsible” for lower prices.
“That contention is not really borne out by what we observed over that period of time stretching before the DoL rule was proposed,” he says. “Why didn't VA sales rebound strongly after the rule was vacated? It was really more these seismic shifts in the overall environment.”
Since an appeals court vacated the Obama-era rule in 2018, the Labor Department has issued a proposed replacement that has been met with sharp criticism from investor advocates. The SEC, meanwhile, has faced similarly stinging criticism for its Regulation Best Interest. Egan, Ge and Tang say they plan to work on a follow-up paper about subsequent regulations.