An Actuary’s Take on the New DOL’s Fiduciary Rule
Last month, the U.S. Department of Labor finalized the much-discussed Fiduciary Rule for retirement plans. The new rules cover Defined Contribution plans, such as 401(k)s and IRAs.
For the retirement advisory community, this rule will cover much of the scope of their practice. There will undoubtedly be lawsuits challenging the rule, but for now, the new rule is scheduled to go into effect later this year.
There have been ample articles written about the new DOL rule from legal and regulatory perspectives. But I’d like to add a few comments of my own from an actuarial viewpoint.
In particular, I want to clear up several persistent misconceptions that have been promulgated by both regulators and financial commentators as the new rule has been developed and debated.
As an actuary, I have helped develop life and annuity products and understand how they are designed and priced. Our regulators have clearly been influenced by a strong anti-annuity lobby. But for financial advisors who want to do right by their clients, it’s essential to separate fact from fiction. My comments are not an indictment on managed money, but they do shed light on the important role annuities play for many American savers.
Misconception 1: An annuity is inherently more expensive to the consumer than a fee-based managed account.
From an actuarial perspective, both fees and commissions can be a cost-effective way for consumers to access financial products and advice.
But during this debate, we consistently heard that charging a fee to manage funds (regardless of the size of that fee) is more virtuous than taking a commission by selling an annuity.
Well, let’s do the math. A typical annual managed account fee is anywhere from 1% to 1.5% of the account value. (Remember, our clients need to understand the total cost of all forms of fees charged to manage their funds, from asset allocation model fees to administrative fees.) A typical fixed indexed annuity commission is around 7%, which is paid one time, assuming a 10-year surrender charge period.
The managed account will charge anywhere from 10% to 15% of the account over the same ten years versus the annuity’s 7%. (I have ignored changes in the managed account’s balance over the ten-year period, which could result in even higher dollar fees.)
So why are regulators arguing a managed fee is better for consumers when it could cost the client nearly twice as much?
It’s important for everyone in our industry—from regulators and advisors down to clients themselves—to understand the true cost of any financial strategy they consider. However, we often see regulators making assumptions without evaluating the math behind them.
Misconception 2: A longer surrender charge period is inherently bad for the consumer.
Having priced annuity products for longer than I want to admit, I always feel that this is a very misunderstood part of product pricing.
From an actuarial perspective, the longer the company can reasonably expect to hold the funds from the annuity premium, the more flexibility the actuary has in pricing in more favorable product features—features that clients enjoy, such as higher caps and more generous ancillary benefits like LTC doublers.
As with many financial products, there will always be a trade-off between the ease of accessing funds and the value that those funds can generate. It’s important that consumers choose the right approach based on real knowledge and not just fear-mongering.
Misconception 3: A managed account can address income risk as adequately as an annuity.
This is where the insurance industry adds so much value to retirement planning. Let’s look at guaranteed lifetime income riders.
Income risk is related to several factors, including sequence of return risk (what kind of market will our clients retire into?); longevity risk (how long will their savings need to last? For many of our clients, it’s far longer than the average American); and medical costs risk (how much of their savings will be spent on the medical costs of aging?).
Many American savers are greatly concerned about these risks - essentially, the risk of outliving their retirement assets.
A retirement approach relying purely on managed funds must address these risks by potentially limiting annual distributions, reallocating investments to safer, lower-yielding fixed-income assets, and finding monies for additional out-of-pocket medical costs elsewhere.
Even with these adjustments, a managed account, of course, cannot absolutely guarantee that our clients won’t outlive their funds.
And that’s where an FIA with a guaranteed income rider can add big value. These products can help cover core annual income needs, mitigate sequence of returns risk, ensure clients don’t outlive their assets, and even sometimes offer additional benefits for long-term care.
Yet, the DOL rule implicitly “looks down” on this asset class simply because a commission is paid rather than a fee being charged.
That certainly doesn’t keep the client’s best interest in mind, as the rule intends to do.
I am sure the insurance industry will have many comments on this rule, but I rarely see these three issues being clearly and passionately promoted to our elected leaders and regulators.
Advisors shouldn't be on the defensive just because they use annuities as part of their client’s overall retirement strategy. In fact, you could argue that any advisor who refuses to evaluate annuities for their clients is not living up to their fiduciary standard. How is an advisor putting the best interests of their clients ahead of their own if they refuse to use one of the most effective tools available to address longevity risk?
Clearly, there is a very appropriate role for annuities while still maintaining a fiduciary standard.
One thing is clear: In today’s regulatory environment, it’s more important than ever to clearly and appropriately document the reason behind the financial decisions you recommend to a client.
At Stonewood Financial, many of our client reports were designed with this need in mind. If you haven’t seen a sample already, I’d recommend you start with our Annuity Alpha report, which dovetails into this DOL conversation perfectly.
It will be several months before the legal dust settles, and we know what the final DOL rule will be going forward. In the meantime, let’s all commit to putting the needs of our clients first - no matter what product or approach that entails.
