With fiduciary rule out of the way, VA sales may improve, but won’t return to previous peak

Sales of variable annuities, which have been slumping for years, are expected to see some improvement now that the Labor Department’s fiduciary rule has been vacated by an Appellate Court, and the agency has extended a temporary enforcement policy that will give sellers of investments wider compliance latitude.

“The DOL’s announcement of a new temporary fiduciary rule enforcement policy will not change our expectations for a rise in variable annuity sales in 2018,” said Laura Bazer, vice president and senior credit officer at Moody’s Investors Service.

This week, Labor published a Field Assistance Bulletin, saying it will not pursue prohibited transaction claims against advisers and firms that have implemented compliance regimens around the fiduciary rule, so long as they are demonstrating a good faith effort to serve clients’ best interests. The Department intends to provide future guidance, it said, and potential new prohibited transaction relief for fiduciaries.

Labor’s fiduciary rule, which was promulgated under the Obama administration in April 2016 and was partially implemented in June 2017, folded variable annuities and fixed indexed annuities into the regulation’s Best Interest Contract Exemption.

Under that prohibited transaction exemption, broker-dealers would have to submit to extensive warranty and disclosure requirements to sell any investment or insurance product for commission compensation to qualified retirement accounts.

It also included a private right-of-action provision, which prohibited firms from writing class-action waivers into contracts with investors.

In March, the U.S. Court of Appeals for the Fifth Circuit issued a split decision vacating the fiduciary rule. The court was expected to issue a mandate on Monday effectuating the decision, but has yet to do so.

Bazer said the delay in issuing the mandate is likely an administrative matter. She expects the 5th Circuit to issue a document soon.

But even with the fiduciary rule out of the way, sales of variable annuities will continue to face headwinds. “We don’t think sales will shoot back up to prior levels, for a variety of reasons,” Bazer told BenefitsPRO.

Sales of variable annuities were $95.6 billion in 2017, according to the LIMRA Secure Retirement Institute.

That marked the first time in 20 years that sales dropped below the $100 billion threshold. In 2011, VA sales peaked at $158 billion.

While a steady decline in sales was seen before the fiduciary rule, the controversial regulation, which sought to address conflicts of interest in investment sales, clearly weighed on the variable annuity market.

Sales to IRAs, which were regulated under the fiduciary rule, dropped 16 percent in 2017, according to LIMRA. The most pronounced quarterly drop was seen after the fiduciary rule’s impartial conduct standards were implemented last June. In the third quarter of last year, sales to IRAs dropped 24 percent.

For the year, VA sales to non-qualified accounts, which were not regulated by the fiduciary rule, actually increased 4 percent, while sales to non-qualified accounts fell only 3 percent during the third quarter.

VAs struggle in a fee-conscious marketplace

The fiduciary rule’s private right of action was designed as the regulation’s main enforcement mechanism.

The Trump Labor Department issued guidance last year saying it would not enforce that aspect of the rule. But the provision still exposed annuity providers, distributors, and sellers to private-party class claims.

Annuity sales should see a bump with the threat of class-action lawsuits removed, Bazer said.

As the ultimate fate of the fiduciary rule came into question with the surprise election of President Trump, its strongest proponents hung their hat on the prospect that the rule would raise consumer consciousness of a fiduciary standard of care.

But more than any awareness the years-long battle over the fiduciary rule may have imparted on the investor public, the larger trend of passive investing has accounted for the most pressure on variable annuity sales. “This has been the biggest market trend,” Bazer noted; she expects investor interest in passive investing to continue to hamper sales.

As Labor’s rule is taken off the books, regulators at the state level are crafting new fiduciary standards. And the Securities and Exchange Commission has proposed a best interest standard for dually-registered broker-dealers. Those efforts will create continued uncertainty in the annuity market and potentially crimp sales.

“Given new regulatory proposals from the SEC and New York State, and investors’ reduced appetite for products with higher fees, variable annuity sales will not return to previous peak levels, even with an end to the DOL rule,” Bazer said.

The life insurance companies that Moody’s rates have been adjusting to slower VA sales. Most are well diversified in other annuity products, life insurance, the pension risk transfer business, and pension products.

“They have a tool box full of products they sell,” Bazer added. “When one product doesn’t sell, another will.”