Recently, Fisher Investments’ CEO and founder Ken Fisher was interviewed in ThinkAdvisor about his view of annuities—and in particular, why he has a particularly low opinion of variable annuities, whereby the annuity owner invests his or her premiums in mutual fund-like subaccounts before converting the account to a guaranteed income stream at retirement.
Ken’s public stance on this is relatively uncommon in the industry. Many strategic retirement planning professionals know and understand these products’ extreme limitations—namely, that they are ultra-high fee, low returning and generally sold as a means of providing the investor the impossible: growth with capital preservation. Yet few step right out and say it publicly.
Now then, part of the interview delves into various ongoing efforts by the likes of the Department of Labor (DOL) and other regulatory bodies to enact a uniform Fiduciary Standard across the financial services industry. Currently, only Registered Investment Advisers (like Fisher Investments) are held to the Fiduciary Standard, an SEC rule requiring the adviser to put clients’ interests before their own and disclose any known conflicts of interest. Other financial professionals, including brokers and insurance salespeople, are held to the suitability standard, which says products pitched to people must not be unsuitable for their investment situation.
The effort to install a blanket Fiduciary Standard has been underway in the bowels of government for years—2010’s Dodd-Frank Wall Street Reform Act mandated the SEC to study installing one for all financial professionals. When they dragged their feet, the Department of Labor put forward its own proposal to install a Fiduciary Standard for all financial professionals advising retirement accounts. That rule, currently under further consideration, comment and study, is the one Ken specifically refers to. Ken suggested a hard and fast Fiduciary rule, if enacted, would largely gut the variable annuity industry. But he went on to note lobbying efforts by the insurance and brokerage industries will prevent a hard and fast fiduciary standard from covering all relationships, permitting the sale of the variable annuities. Let’s put a finer point on this issue and expand.
While some professionals in the business will no doubt disagree, it seems to us variable annuities are sold far more frequently than they actually should be. This is why the vast majority never reach annuitization (the point when the owner turns the contract into a stream of guaranteed income). They are much more often surrendered early—cashed in. With high fees, limited investment options and overall complexity, illiquidity and a lack of flexibility, we generally think the number of client situations where this is the right investment product are very, very small.
Usually, these products are sold by folks held to the Suitability Standard, with many wagging an accusatory finger at the Fiduciary Standard’s “client interests first” rule. Yet there is a caveat to this. Annuities have a special regulatory niche carved into the Fiduciary Standard called the “84-24 rule” that allows RIAs to sell them—variable annuities aren’t covered by the Fiduciary Standard, no matter whether your adviser is or not. (Fisher Investments chooses not to do so for all the reasons Ken covers in the ThinkAdvisor piece.) The DOL’s proposal could close this exemption for variable annuities and expand the rule to cover anyone dealing with a retirement account.
Yet even this may not mean the end of variable annuities. It could just mean more paperwork. For example, the SEC has long cautioned investors against buying deferred annuities inside qualified retirement accounts, like IRAs, because it doubles up on tax deferral. Yet they are still sold this way, just with an additional piece of paperwork that says the investor is buying the contract for reasons other than tax deferral—they like the “guarantee” or some other bell or whistle. Hence, there is precedent for insurers to create additional paperwork stating that the buyer is aware of the embedded fees and limitations and was apprised of these by the selling agent/broker/adviser/etc. It’s a highly profitable business for insurers, and we are betting they would get creative if their lobbying doesn’t succeed.
Indeed, insurers already have gotten creative. Several firms offer RIA-targeted suites of variable annuities intended to overcome RIAs’ objections. (Here are a couple of examples.) And how do they intend to meet this? In general, it isn’t by slashing costs, but as a recent LifeHealthPro article suggested, by “justifying the higher cost structure.” They wrote:
Higher costs are a big issue for RIAs, who have a well-earned reputation for being hypersensitive to fees. Many RIAs may focus on a total return type of analysis, utilizing tools and materials that they have in place today for evaluating investment options. If insurers are to drive growth through the RIA channel, they must be ready and willing to justify the higher costs of contractual guarantees by clearly demonstrating the superior client outcomes when it comes to either the income benefits, death benefits or tax benefits. In some circumstances, companies may need to sharpen the pencil on management and administrative expense fees in order to gain acceptance. For example, the combination of a balanced-risk fund and a growth-of-dividends fund is likely to be discussed as a retirement income solution with lower total fees than a typical RIA-channel VA, once the latter’s management and administration fees, mortality expense charges and rider fees are taken into account. An insurer should educate and enable RIAs regarding the cost-value propositions to increase the likelihood of VA sales.
The boldface is ours. Ultimately, Ken’s main point—that investors have to look out for their own interests when approaching variable annuities—is likely to be true no matter what the DOL, SEC or any other regulator eventually does, short of outlawing the product altogether. The rule your adviser is subject to simply doesn’t protect you from sub-par advice and poor product recommendations.
Variable annuities are a matter of values. They are against ours, pure and simple. We think they should be against yours, too.