Potential Changes to Fixed Annuity Product Designs After Implementation of the DOL Fiduciary Rule
August 16, 2016 by Harry Stout
The life insurance industry is now contemplating what it must do to implement the final DOL fiduciary rule (“the rule”). The April 10, 2017 date is known, circled on most calendars and the race is on to comply with the 1,023 page rule by that date.
Most organizations are doing their planning, assuming there will be no possible changes by regulators or from the outstanding lawsuits that have been filed looking to change or halt the rule. These organizations are hoping that changes will be made to make implementation much easier but as I have heard many experienced business people say, “Hope is not a plan to be implemented.”
As I look at the implementation effort, I see many key issues surfacing for the industry. In this article, I will address how fixed annuity product designs could be impacted. While the process of developing, filing and gaining regulatory approval for new product types will be difficult to complete by the effective date, I believe many new and innovative product introductions will take place in the first 36 months of doing business under the rule.
Forces Driving Product Change
There are many provisions in the rule that will impact the design of products sold for consumers with qualified funds. Here are the major forces that I see driving product changes. They are:
- The need for simpler index annuity product designs to aid presentation and understandability by consumers and financial professionals.
- Lower agent and marketing organization compensation to better meet the “reasonable (but not defined) compensation” requirement. While many carriers believe their existing level of compensation to be reasonable, I have learned that as scrutiny comes to costs and expenses, they have a tendency to be reduced over time in response to that scrutiny regardless of how reasonable they were to begin with. Over time, I see commissions decreasing for all product types with more and more financial professionals moving to level fee arrangements even though these arrangements can cost the consumer more in the long run. Level fee arrangements are perceived as producing less of a “conflict of interest” than heaped commission arrangements.
- Simpler product interest crediting strategies to aid in consumer and financial professional understandability of index products. In recent years, the annuity industry has introduced many creative indexing methodologies. While they were intended to improve returns or create a marketing advantage, they have been unnecessarily complex and difficult to understand by both consumers and financial professionals. In light of the rule, look for indexing methodologies to become simpler, easy-to-use and easier to understand.
- The need for increased consumer benefits to create carrier differentiation. We will likely see life insurer carriers add new consumer benefits to their products to create differentiation from their competition. This is because it will be difficult, if not impossible, for a carrier to differentiate the quality of its product through compensation or service as most product specific incentives have been eliminated and the playing field leveled by the rule’s provisions. I think you will see some real innovation in this area over time.
Emerging Product Types and Designs
The forces described above are paving the way for five product designs or product types to likely gain popularity in the first 36 months post implementation. They are:
- No commission or wrap annuities sold with simpler indexing methods. Financial professionals who charge for their services based on fees or hourly rates will sell these products. These products will have very short surrender charge periods (likely three to four years) without income or other riders that have become commonplace in the market. The current low interest rate environment will make development of short duration index products very difficult or almost impossible for all but the largest carriers.
- New lower commission products designed to clearly meet the “reasonableness test,” with shorter surrender charge period lengths (five to seven years) and lower percentages (maximum 7% in any year) and simpler indexing methods. As financial professionals will need to more clearly explain every indexing strategy to consumers, simpler indexing strategies will make this requirement easier to comply with. As surrender charge periods are reduced, the amount of compensation that the products are able to afford will decline.
- Existing products may continue to be sold, but likely only those with shorter five to seven-year surrender charge periods, sold with lower compensation and simpler indexing strategies for the reasons described above.
- Increased use of Multiple Year Guaranteed Annuity products, with multiple guarantee periods sold under PTE 84-24. These products are fully guaranteed and can be used to create a laddering of maturities to address potential increasing interest rates. As they can be sold outside the need for the Best Interest Contract, I think sales of this product type will substantially increase.
- Income annuities will also grow in applicability as financial professionals begin to use them more to meet client needs under the PTE 84-24 granted to these products as part of the rule. Again these products have definite consumer benefits, are fully guaranteed and provide the lifetime or long-term payment streams consumers are looking to obtain from their hard-earned retirement savings.
Summary
Overall, my view on potential fixed annuity product designs focuses on creating products that are simpler, easier to explain, have simpler indexing strategies and are as fully guaranteed as possible. These changes will be consistent with the new rule, provide products that can be sold under the Best Interest Contract Exemption but that are well positioned to meet consumer needs for the stability, income protections and guaranteed returns that are the hallmark of fixed annuity products. It will be an interesting first few years, but I think the industry will find new and innovative ways to succeed and prosper under the rule.
