The Compensation Conundrum: Why the DOL Got It Wrong

By Kim O'Brien InsuranceNewsNet

Late last spring, Timothy Hauser, a DOL deputy assistant secretary, and main architect of the fiduciary rule, told a gathering of mutual fund company representatives in Washington that the agency will consider making changes to the rule if problems arise during implementation.

That was good news. Like winter follows fall, problems follow massive rules that disrupt well-functioning, established markets.

Americans for Annuity Protection has had a number of meetings with key leaders at the DOL (the last meeting was even attended by a lawyer from the Solicitor General’s office). We are pleased to report that they appear to be listening as we point out the many problems and lack of clarity the rule presents.

AAP contends that it is much better to fix the problems now rather than wait for lawyers and the courts to do so. One of the biggest problems is the disparate and unfair treatment of commission-based compensation. We have spent many hours working to educate DOL staff about the consumer benefits of the commission-based compensation system, primarily to ensure that consumers won’t be paying more for their purchase of an annuity.

The rule unfairly puts annuities at a competitive disadvantage to other IRA products by singling them out because to their predominantly commission-based distribution system. Annuity commission compensation and distribution channels have been well-established by the regulatory structure governing its sales.

The rule ignores the fact that many consumers actually prefer to not write a check to their advisor for advice or pay them directly out of proceeds from their account value. Commissions, which are paid by the insurance company, compensate agents for the substantial investment of time and effort needed to analyze the products and provide the information necessary for their customers to make informed decisions.

Fixed annuity advisors must also comply with the more stringent NAIC Suitability Model (passed in 48 states and the D.C.) while variable annuity advisors must comply with the FINRA suitability requirements.

As one of the individuals who spent many hours working (and arguing) with the NAIC drafting committee, we are very cognizant of the more stringent fixed annuity requirements – product-specific training, carrier secondary review of each and every application before issuance, and replacement requirements - to name a few.

The law requires that in order to sell fixed annuities, advisors must not only be licensed by the states where they sell the annuity, must also be trained in each and every product they recommend BEFORE making a product recommendation.

The suitability requirements that an advisor must fulfill helps consumers assess which kind of annuity best fits their financial circumstances and risk tolerance, as well as to understand the various optional benefits they may wish to consider.

Annuity advisors perform a critical educational function, providing valuable information to retirement savers, who are often unfamiliar with annuities and may not understand the benefits of guaranteed income, protection and how annuities address financial risks. Advisors who sell annuities are also help consumers customize their annuity to best fit their particular needs and circumstances.

The primary alternative compensation arrangement is a fee for advice where a consumer pays an advisor to manage his or her money. For this ongoing service, consumers are charged, and are willing to pay, ongoing fees. The sale of an annuity, however, represents a one-time “buy and hold” transaction.

A fee-for-advice arrangement in an annuity purchase is incongruous with an annuity sale because there is no ongoing management of the annuity. The annuity is held and managed by the insurance company who is required to adhere to the consumer’s annuity contract.

Any additional advice or service (e.g., changing a beneficiary) could be handled by the advisor, but is just as easy to be handled by the insurance company. If the advisor does help after the sale, the assistance is incidental and typically a “one-off” situation. Asking all clients to pay an ongoing fee makes no sense and will cost consumers MORE.

Adopting a fee-for-advice compensation model for annuity transactions would be more expensive for many annuity buyers than a commission-based model, and would likely deprive many lower-income individuals of valuable financial education and assistance. Many advisories firms have minimum “assets under management” requirements that exclude the less wealthy.

Over time, the management of $100,000 in assets would generate much larger fees under a fee-based system than the one-time commission the insurance company would pay to an agent on a $100,000 fixed annuity.

For example:
1999 $    111,862 $       1,119 1995 $   107,703 $       1,077
2008 $    131,064 $       1,311 2004 $   149,331 $       1,493
Total Comp $     11,301     $     13,292

Customer Pays 47% MORE 55% MORE

*Assumes dividends reinvested and only 1 percent management fees deducted. Does not include other fees paid for mutual fund loads, brokerage commissions, other custodian fees and expenses for investing in exchange-traded funds.

Compare the above to a typical 10-year annuity compensation of 4-5 percent for a multi-year guarantee annuity or 6-7 percent for an indexed annuity or on average $4,500 and $6,500 respectively.

No one compensation structure is all good or all bad. Nor for that matter is one compensation type free from conflict. Level-fee advisors can just as easily have conflicts of interest as variable-fee advisors. Fee-only hourly advisors can create more “billable” hours than is warranted for the advice the consumer receives.

Fee-only asset under management can make money off the client when they, as managers, underperform. Commissioned advisors can push a product that pays higher commission when a lower commissioned product may work just as well.

Still, a April 2016 Wells Fargo/Gallup survey found that 9 in 10 consumers are satisfied with their 401(k) and, more importantly, most use personal financial advisors to help them allocate their 401(k) investments.

Similarly, the Insured Retirement Institute reports that 9 in 10 annuity owners say they are satisfied with their variable annuity-based investment. And, Jack Marrion, president of Advantage Compendium, reports that the 2014 customer complaint data from the NAIC shows OVER 99 percent of fixed annuity customers are satisfied with their purchase.

With these high levels of satisfaction, it would be difficult to make the case that compensation models in general and commission-based models specifically are a problem. Americans love choices and multiple compensation models offer just that.

Kim O’Brien is the vice chairman and CEO of Americans for Annuity Protection. She has 35 years of experience in the insurance industry. O’Brien served The National Association for Fixed Annuities (NAFA) for almost 12 years and led the organization to defeat the SEC’s Rule 151A.

Contact Kim at [email protected].