Did the DoL fiduciary rule really make variable annuities cheaper?

Department of Labor exterior by Bloomberg
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This piece is in response to an article that appeared in Financial Planning Sept. 24.

Did sales of "expensive" variable annuities fall as a result of the now-vacated Department of Labor’s fiduciary rule, as claimed by professors in a study published in July?

The professors from Harvard Business School and New York University do make a pretty compelling argument. After all, total industry variable annuity sales are down roughly 30% since 2015, the year the Labor Department’s rule was proposed.

Additionally, L share variable annuities — one of the most expensive product designs — no longer exist. We’ve also seen more advisory variable annuities come into the market over the last several years.

But is this all a result of a proposed fiduciary standard?

Let’s start with industry sales. According to the study, “… the Labor Department fiduciary rule had a large impact on broker and insurer behavior. After the proposal, variable annuity sales declined by 19%. The decline in annuity sales was primarily driven by a decline in high-expense variable annuity sales. Sales of high-expense annuities fell by 43% more than low-expense annuities.”

According to the LIMRA Secure Retirement Institute, industry sales were $158 billion in 2011, the second-highest total ever, after which they started a slow, steady decline to $134 billion in 2015. Then there was a significant decline to just $106 billion in 2016. Sales have been basically flat every year since.

Bad timing

Given that the fiduciary rule was proposed in April 2015, it’s understandable that the study would credit the rule with much of that decline. However, most industry changes prompted by the rule did not occur until the summer of 2017. The reality is that industry variable annuity sales started their steady decline years before the rule was introduced, and reached current levels more than a year before manufacturers and distributors implemented changes to comply with the rule.

If you dig further into SRI sales data, you’ll see that as recently as 2014, variable annuities with living benefits outsold variable annuities without living benefits by a factor of 2 to 1. However, when 10-year Treasuries dipped below 2% for the second time in January 2015, virtually every variable annuity company implemented a second round of benefit reductions on their living benefits. Many advisors simply determined that these benefits were no longer worth the cost.

Sales of variable annuities with living benefits declined by 30% from 2015 to 2016, and then another 20% in 2017, while variable annuity sales without living benefits remained unchanged. If the Labor Department rule was responsible for the decline in industry sales, all similarly priced variable annuities would be impacted, not just variable annuities with living benefits.


What about the claim that the Labor Department rule caused advisors to shun “high-expense variable annuities” in favor of “low-expense variable annuities”?

This is harder to analyze because the study does not list which specific products fell into “high-expense” and “low-expense” categories. It merely stated that “ High-expense variable annuities are defined as those with expense ratios that are in the top quartile of all variable annuities offered as of 2013 Q1. Low-expense variable annuities are defined as those with expense ratios that are in the bottom quartile of all variable annuities offered as of 2013 Q1.”

The fact that they used the first quarter of 2013 is instructive. According to Morningstar, during the first quarter of 2013, L share variable annuities made up 22% of total variable annuity sales. As a refresher, L shares typically came with a 4-year surrender charge rather than the 7-to-10-year charge that is on the more common B share variable annuities.

In exchange for offering a shorter surrender charge period, insurance companies had to charge a higher mortality and expense (M&E) fee — typically 1.60% to 1.70%. By the end of 2016, sales had fallen to just 2.4% of total industry sales. Clearly, this product design would fall into the “high-expense” category.

But this change was not a result of the Labor Department rule. Remember, the industry didn’t implement those changes until 2017. This change was a result of enforcement actions by FINRA.

Essentially, FINRA took issue with the fact that clients were paying higher fees for a shorter surrender charge on a variable annuity that also had a lifetime withdrawal benefit. At 22% of total sales, L share sales would have been $32 billion in 2013. However, they would have been only $2.5 billion in 2016. This drop of approximately $30 billion would fully explain the significant drop in “high-expense” variable annuities that the study cited.

Advisory annuities in the mix

The final piece of this puzzle is advisory variable annuities and structured annuities. Given that Figure 4(a) in the study shows a distribution of variable annuity commissions from 0% to 16%, I have to conclude that the study included advisory annuities in the analysis. Clearly, these would fall into the “low-expense” category. While advisory annuities still make up a small percentage of total variable annuity sales, they would be much higher today than back in 2013.

I would argue that these products should have been excluded from the study altogether. Yes, they are “low-expense”, but the owner pays an advisory fee on top of any contract and sub-account fee. It would be impossible to factor that cost into the analysis. And it’s entirely possible that the client would actually pay more in the long run for that solution. In fact, that is the very basis of the industry’s primary argument against the Labor Department’s rule.

Given that most structured annuities (also referred to as Registered Indexed Linked Annuities or RILAs) are filed as variable annuities, I have to assume these contracts were included in the study. If they were, since they are spread products, they would have to fall into the “low-expense” category. They have no extra contract charges or sub-account fees. While they might be filed as a variable annuity, they are totally different products that fit a very different need. Sales of this product type were virtually non-existent in 2013, but according to SRI, 2019 sales were over $17 billion. Including these products in the analysis would have a major impact on any conclusions reached. However, the growth in this product line results from its goal of maximizing the upside while protecting against loss rather than from any impacts of the Labor Department rule.

Closing argument

The authors of the study are right about one thing: There are more “low-expense” variable annuities sold today than seven years ago. Both structured and advisory annuities capture a much larger market share. Fewer variable annuities are being sold with living benefits, thereby eliminating the need for full-feature, more expensive product designs.

The demise of the L share variable annuity has also had a major impact on the product mix within the industry. But at best, the fiduciary rule was a tipping point for these changes rather than the cause. The few distributors that had not already eliminated L shares from their platforms as a result of FINRA’s enforcements chose to do so once the Department of Labor’s rule became effective. Advisors had increasingly been moving clients out of brokerage accounts to advisory accounts well before the Labor Department rule was introduced. The rule, as well as Regulation Best Interest, simply accelerated that existing trend.

Scott Stolz, CFP, RICP, is president of Raymond James Insurance Group, where he manages the due diligence, product positioning, sales, and operational functions for annuities and life insurance distributed through the firm's more than 8,200 financial advisors.

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Annuities Variable annuities Fiduciary Rule DoL Retirement planning