DOL rule: Expect changes to products, distribution & compensation

With the Department of Labor's much anticipated conflict-of-interest or fiduciary standards now finalized, industry stakeholders are offering varying assessments on the regulatory impact. Among the prognosticators: Fitch Ratings.

The international credit ratings agency stated in a comment letter issued shortly before publication of the finalized regulations that it expects changes to product offerings, distribution strategies and compensation structures. The new rules, Fitch asserts, will also lead to increased operational costs for insurers and advisors endeavoring to comply with the new standard.

To gain greater insight into Fitch's assessment, LifeHealthPro Senior Editor Warren S. Hersch spoke with Doug Meyer, the organization's managing director for life insurance. As the interview took place before the regulations were finalized, it did not touch on fixed index annuities, which the best interest contract standards now also encompass.

The inclusion of fixed index annuity writers in the BIC, Fitch wrote in a subsequent April 7 comment letter, will be "more onerous" for FIA writers than for VA writers, who have already devoted "considerable time and effort." The April 7 letter adds that the lower-than-anticipated burden for VA writers should diminish the negative impact on VA sales relative to initial expectations."

"However, Fitch believes that, over the longer term, both FIA and VA writers will be able to adapt to the new standards due to the relative attractiveness of these products in a low interest rate environment," Fitch states in the comment. "Additionally, the longer phase-in period [of the regulations] may lessen the disruption to the sales process that was [earlier] envisioned and may dampen the impact of the unexpected inclusion of FIAs."

These caveats aside, Fitch's view of the final regulations' broader impact dovetails with its earlier assessment. The following are excerpts of the LifeHealthPro interview.

Warren S. Hersch: Your comment letter tags the DOL fiduciary proposal as credit-neutral for life insurers in the short run, but potentially credit-negative long-term. Why the diverging forecasts?

Doug Meyer: Near-term, we foresee a decline in sales of variable annuity products over some period of time. That could negatively or positively impact the credit profiles of individual VA carriers — hence the credit-neutral rating. The broader application of the fiduciary standard — not just in respect to variable annuities, but also other insurance and retirement products — is a greater concern for us, which is why see the long-term impact as credit-negative.

Hersch: The report suggests that the regulations could drive changes in product offerings. So should we expect, for example, a revamping of variable annuities to provide more of a fee-like compensation structure, along the lines of, say, Jefferson National's Monument Advisor, which comes with a flat monthly fee?

Meyer: Yes, but I should add that fee-based variable annuities have gained much traction in the industry to date. Fee-based annuities still represents a very small segment of the market — less than 5 percent of sales.

Hersch: Why is that?

Meyer: These products provide in effect a levelized commission, and thus an ongoing stream of income, as opposed to a larger, up-front commission on the sale. For many advisors, levelized comp is still not an attractive option.

Hersch: I understand the commission-based agent or advisor has historically not found the flat commission or fee attractive. But to the extent that the DOL's fiduciary drive more advisors to go fee-based, then perhaps there might be an uptick in these products, yes?

Meyer: It's reasonable to expect that the share of sales by fee-based advisors will go up, but I don't think that would necessarily offset the potential reduction of commission-based sales.

Hersch: Duly noted. The Fitch memo also references expected changes in industry distribution strategies. Can you elaborate as to what you foresee?

Meyer: There could more direct-to-consumer robo-advisor solutions, such as we're now seeing from Vanguard, Betterment, Wealthfront and other investment firms. By managing client portfolios using computer algorithms, these companies can cut portfolio management costs and pass the savings on to consumers. But I think a shift to these solutions will be challenging because of product complexity and issues surrounding the fiduciary standard's best interest contract requirements.

Hersch: It seems that the DOL rule will lead, in different ways, to both increased complexity and simplicity. Transactions in the qualified retirement plan space will be more complex to the extent there are increased reporting, compliance and disclosure requirements. But the rule might also result in a simplification of retirement products, with fewer being promoted to plan participants. Do you agree?

Meyer: As to products, I think that's speculation. Variable annuities could be made simpler, but complex guarantees — living benefit guarantees — remain big drivers of VA sales. Transitioning to a simpler product chassis while retaining these guarantees and sales could be a challenge.

Hersch: It will be challenging, that is, to restructure the product to maintain the living benefits while shifting to a fee-based compensation structure, correct?

Meyers: Yes, to the extent that such variable annuities need an advisor to close the sale. I think that's clear. If they're developed, new products with simplified guarantees would likely appeal most to younger consumers.

Hersch: Your memo also describes the likely increase in the risk of litigation to insurance agents and insurance companies, which may in turn increase compliance costs. Why do you envision increased litigation?

Meyer: A high standard of care translates to a bigger minefield of regulations that advisors will have to navigate to remain in compliance. As the chance of being judged non-compliant increases, so does the risk of litigation for acting in contravention of those rules. And to the extent that there is the potential for increased litigation, advisors can also expect to pay more for errors and omissions or E&O insurance.

Hersch: Let's turn to the insurers. In recent months, MetLife sold its Premier Client Group — a retail distribution arm with some 4,000 advisors — to MassMutual. And American International Group sold its broker-dealer operation to Lightyear Capital LLC. Both life insurers cited the then pending DOL rule as a factor in the unit sales. Do you expect other carriers to undertake similar moves? And if so, should we expect a greater separation of distribution from manufacturing?

Meyer: Other players that don't enjoy the economies of scale of MetLife and AIG probably also need to rethink their distribution strategies. I think it's reasonable to expect that smaller insurers will try to rationalize their distribution channels. Some will reconfigure their channels to be more efficient and better align with the regulations; others will purse sales and spin-offs.

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