For clients to get the most from fee-based annuities, you need to dig into the numbers
August 29, 2017 by Robert Powell
Hardly a month goes by these days when an insurance firm doesn’t launch, or announce plans to launch a fee-based annuity.
In fact, the insurance industry introduced almost two dozen fee-based variable and indexed products in the last 12 months, according to Scott Stolz, president of Raymond James Insurance Group.
In recent weeks, companies including Brighthouse Financial—the annuity provider recently spun off by MetLife—Symetra, Pacific Life, Nationwide, and Allianz have joined the fee-based annuity fray that began in earnest when Jackson National Life Insurance launched its product in 2016. (Jefferson National launched what is regarded as the first generation fee-based product in 2005-06.)
Why the rush to market? Experts say these products are designed to comply with the Labor Department’s new fiduciary rule, which requires advisers to put their clients’ interest ahead of their own financial interests. In the past, advisers earned big commissions to sell annuities. With the new products, advisers will be able to charge a flat fee.
But should advisers cozy up to these new products?
At a high level, according to John Olsen, author of “John Olsen’s Guide to Annuities for the Consumer,” it depends on the specific provisions of the annuity and the nature of the advisory relationship. Generally speaking, he said, a commissionable annuity will be cheaper for the client than a flat fee if the adviser expects to work with the client for more than six years.
But there’s more to it, some of it in the fine print. Some early fee-based products didn’t come with living and guaranteed death benefits, which make certain guarantees if the holder dies, according to Stolz. Newer ones usually do, but they come with higher fees to cover the additional benefits.
Other benefits, such as upfront bonuses, generally only come with commissioned annuities. All told, advisers should make sure clients know what they’re getting.
At a minimum, experts said, advisers should become familiar with the pros and cons of fee-based annuities. The pros include the elimination of the perceived high commissions, according to a financial adviser and author Stan Haithcock, while cons can occur if there are fees for a fixed annuity rather than a variable one, which is actively managed.
“It’s hard for me to see the justification for charging an annual and ongoing fee for managing a fixed index annuity,” Haithcock said: They are comparable to certificates of deposit, he said, not ways to get market growth, and because the index option can usually be changed just once a year, there’s little reason for a fee.
“The industry disagrees with me on this, but this is a perfect example of trying to put a square peg in a round hole,” he said.
Variable annuities, meanwhile, should be fee-based, according to Haithcock.
“That’s a tough job, and charging a fee for that work makes sense,” he said. “And if you do that then manage the ‘heck’ out of it. Don’t just ‘set it and forget it.’”
Ultimately, Stolz said, advisers who offer both commissionable and fee-based products can boil the issue down to one question: Given two products with the same features, which is less expensive for the client over the expected life of the annuity? He offered four questions to help advisers get the clearest possible picture of the costs of variable annuities:
• How does a product’s contract costs, such as its mortality and expense charges, compare to the advisory fee? If the contract is 1% cheaper and the adviser charges a 1% fee, a policyholder would likely prefer a fee-based annuity because it will have lower, if any, surrender charges, which are paid if money is withdrawn before a certain time.
• Is there a difference in the costs of the underlying annuity subaccounts? If so, does that affect the answer to the first question? Some companies are bringing out fee-based variable annuities with lower cost sub-accounts or without the 12b-1 fees for marketing and distribution that some products include.
• How likely is it that the policyholder may need to access some of their principal to handle unplanned life costs? The more likely, the more attractive fee-based products with lower surrender charges should be.
• Is a living benefit, which guarantees certain benefits and terms in exchange for a fee, being added? If so, a commissionable product may be cheaper if a policyholder is expected to hold the product for a long time. How long? Consider doing a cost-benefit analysis. Since annuities don’t have front-end loads, the question is of comparing the size of the advisory fee to the cost of the contract.
Today, for instance, the average commissionable variable annuity has an annual cost of 1.3%, while fee-based variable annuities typically cost 0.3% to 0.6%. If you charge a 1% advisory fee and a fee-based annuity costs 0.3%, the product choice may not matter. But if your fees or expenses are higher, the commissionable product could be the better choice.
Stolz offers mostly the same questions for index annuities, with a few adjustments: Instead of costs when considering the first question, advisers should consider a product’s caps and rate guarantees; and the second question doesn’t apply.
Robert Powell is editor of Retirement Weekly, published by MarketWatch. Get a 30-day free trial to Retirement Weekly. Follow Bob’s tweets at RJPIII. Got questions about retirement? Get answers. Send Bob an email here.
