Variable Annuity B Shares Gain at L Shares’ Expense

Sales of variable annuity B shares made up more than 75 percent of all variable annuity share sales classes in the third quarter of last year. This represents an increase of 6.7 percentage points compared with the year-ago period, according to Morningstar.

The big increase in B shares holds clues to the kind of fee structure preferred by financial advisors as variable annuity share classes come under more scrutiny from the Financial Industry Regulatory Authority. Adding to the scrutiny is the Department of Labor, which is putting the finishing touches on its proposed fiduciary rule.

“The DOL rule will have an impact on share classes, no question,” John McCarthy, Morningstar’s senior product manager, told InsuranceNewsNet.

“We think L shares will be hit harder in terms of sales compared with B shares because L share fees are a little higher. So anytime you get into a higher fee product, there's an inclination to move to a lower fee product,” McCarthy said.

FINRA regulators, in their 2015 Examination Priorities Letter, indicated they would look more closely at the marketing of L shares. With shorter surrender periods than B shares, L shares also come with higher costs.

For investors who hold a variable annuity investment over a long period, those L share costs add up.

L Shares Take it on the Chin

As a result, L shares got walloped. L shares tumbled 5.5 percentage points to 11.4 percent of variable annuity share class sales in the third quarter compared with the year-ago period, Morningstar’s data also show.

L shares typically have surrender periods of three to five years and their fee structure falls between the B shares and C shares, McCarthy said.

Top-selling carriers of variable annuity L shares are Jackson National, Lincoln Financial, AIG, Prudential and AEGON/Transamerica.

C shares were the only variable annuity share class other than B shares to notch gains in the 12-month period ending with the third quarter of 2015.

Sales of C shares rose 0.2 percentage points to 2 percent of all variable annuity share class sales in the 12-month period ending Sept. 30, compared with the year-ago period, according to Morningstar.

The variable annuity share data reflect individual variable annuity sales only, not group variable annuity sales.

C shares typically have the highest annual fees. But in exchange for a higher fee, the annuity company offers investors more liquidity. Investors are free to withdraw the money from their variable annuity at any time.

Most Share Classes Lose Ground

If B shares were the big winner and C shares finished a distant second in the third quarter, every other variable annuity share class lost ground. L shares were the biggest loser by far, Morningstar reported.

A shares dropped 0.1 percent to 1 percent of variable annuity sales in the third quarter. I shares slid 0.2 percent to finish the third quarter of 2015 at 4 percent of all variable annuity share class sales.

Bonus shares also dropped 0.2 percent to 1.9 percent of variable annuity share class sales. O shares dropped 0.9 percent, ending the third quarter at 4.4 percent of variable annuity share class sales.

B shares, which typically have a seven-year surrender period, charge a “back end” load. This is a commission when the annuity holder sells an investment.

Back end loads are designed to discourage withdrawals and differ from a “front end” load charged by A shares. Investors pay a front end load, or commission, when they buy the investment.

Because variable annuities should be used as a longer-term investment, and since the majority of variable annuities are sold with living benefit guarantees, A shares and B shares provide a more appropriate fee structure with longer surrender changes, McCarthy said.

In theory, investors shouldn’t be worried about a longer surrender charge because investors don’t need the liquidity.

DOL Rule to Affect Living Benefits

B share sales will likely be affected by the DOL rule as advisors, carriers and independent broker/dealers will have to display the impact of living benefits fees on the investment portfolio and the impact of fees on retirement income, McCarthy also said.

The top carriers with B share sales in the third quarter were Jackson National, AIG, Lincoln Financial, Axa Equitable and Prudential Financial.

New sales of variable annuities in the third quarter dropped 9.9 percent to $31.2 billion compared with the year-ago period. This was due to low interest rates and shrinking supply as carriers pulled back on variable annuity exposures, McCarthy said.

Every top-10 variable annuity carrier experienced a dip in variable annuity sales in the third quarter compared to the year-ago quarter, Morningstar also reported.

Low 10-year Treasury interest rates have made it difficult for annuity carriers to offer particularly attractive living benefits or to design variable annuities with radically different step ups and lifetime guarantees, McCarthy added.

InsuranceNewsNet Senior Writer Cyril Tuohy has covered the financial services industry for more than 15 years. Cyril may be reached at [email protected].

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