Why Fixed Indexed Annuities Are Riskier Without the Fiduciary Rule

Sales of a complex annuity product have soared, possibly because a federal regulation designed to protect consumers from unscrupulous sales practices was scrapped in June 2018.

Fixed indexed annuities or FIAs, also called equity indexed annuities or EIAs, are designed to protect retirees from losing money, but allow them to earn interest when the stock market does well. They can do this because they aren’t investments: FIAs are actually contracts that you can buy from an insurance company.

The federal regulation that would have protected consumers from buying this product if it wasn’t right for them was the Department of Labor’s fiduciary rule. A fiduciary is someone who is required to act in another person’s best financial interest.

If the fiduciary rule applied in the case of FIAs, the annuity salesperson would have had to act in, say, your mom’s best interest when inviting her to a free steak dinner where she could learn about these annuities and how they could help her in retirement.

Without the rule, the annuity salesperson can act in his or her own best interest and sell your mom a fixed income annuity just to earn a commission and a vacation. The FIA just has to be “suitable” for your mom. It only has to make sense given her financial circumstances and risk tolerance, even though it may not be the best investment for her particular situation.

It’s notoriously difficult to untangle correlation and causation, but here’s what we do know about the relationship between the fiduciary rule and fixed indexed annuity sales volume.

Sales of fixed indexed annuities peaked in the fourth quarter of 2015, with $16.1 billion sold, according to an Insured Retirement Institute press release using data from Beacon Research.

The fiduciary rule was issued early in the second quarter of 2016. After a slow first quarter, FIA sales were again $16.1 billion from April through June of 2016.

After the Fiduciary Rule was issued, insurers and brokers were uncertain about when and whether the rule would actually be implemented. The uncertainty was exacerbated by the change in presidential administrations from 2016 to 2017, but the industry still started making changes to accommodate the rule.

The Fiduciary Rule was ultimately killed on June 21, 2018.

In late October, the Wall Street Journal published an article noting that FIA sales were setting records, likely due to the fiduciary rule’s demise. In the second quarter of 2018, FIA sales totaled $17.65 billion, a 17% increase over the same time in 2017 and a 21% increase over the first quarter of 2018.

While other factors, such as interest rates, may have also impacted sales, the numbers support the theory espoused in the Journal. Indeed, it’s more than a theory: The industry itself apparently believed the fiduciary rule hurt its sales, as two key statements from IRI press releases indicate.

In a press release covering the 3Q 2017 results, the IRI stated, “An uncertain regulatory environment continued to disrupt annuity sales in the third quarter. . . . The ambiguity introduced into the marketplace by the partial implementation of the DOL fiduciary rule has interrupted consumers’ access to financial products that are critical to a financially secure retirement.”

Then, in its 4Q 2017 report published April 17, 2018, the IRI stated, “With the DOL fiduciary rule now vacated by the 5th Circuit Court of Appeals, we expect sales to continue building on these increases in 2018 as transaction friction abates.”

Interest rates may have also played a role in the recent spike in annuity sales. Rates started rising shortly before the fiduciary rule was issued. When interest rates go up, insurance companies can pay consumers more interest on annuities.

“Rising interest rates can improve the terms offered within the annuity contract, helping to support a higher guaranteed distribution rate or access to more upside potential from a fixed indexed annuity,” said Wade D. Pfau, Professor of Retirement Income at The American College of Financial Services. “As well, market volatility and recession fears can help to prompt people into using annuities as a form of protection.”

As Pfau alludes, the stock market took investors on a ride in the first half of 2018, which could have also influenced annuity sales. But as the table above shows, the relationship between increasing interest rates and increasing fixed indexed annuity sales is weak.

The DOL’s fiduciary rule could have been good for consumers considering the purchase of a fixed indexed annuity. The rule would have required annuity salespeople to disclose to the consumer the commission they were earning from selling an FIA and only recommend an FIA if it was in the consumer’s best interest.

FIAs may not be in many consumers’ best interest for several reasons.

1. High surrender charges. To purchase an annuity, which is a contract with an insurance company, you give an insurance company a bunch of money. If you want that money back any time during the first five to 10 years of the contract, you’ll typically have to pay a fee called a surrender charge. That fee might be 10% in the first year and it might decline by 1% per year thereafter.
2. Complex terms. How do I earn interest on my annuity? How does the insurance company decide how much interest I earn? Can they use a different method this year than they did last year? What’s the most I can earn? Are there fees that take away from my earnings? While these answers should all be spelled out in the marketing materials and, most importantly, the annuity contract, the terms may not be easy for the typical consumer to understand, and relying on the person selling it to you for answers is risky when that person doesn’t have to put your interests first.
3. Possibility of losing money. As discussed above, you can lose money from surrender charges if you take your money out early. The insurance company has to make up for its salespeople’s commissions somehow. And while you can’t lose money with a FIA because of poor stock market performance—a widely touted benefit of FIAs—you can lose money because if the stock market has low, flat, or negative returns for enough years, you won’t come out ahead. Fixed income annuities have what’s called a guaranteed minimum return, and these days, it is usually at least 87.5 percent of the premium paid at 1 to 3 percent interest.

The risks consumers take when they buy annuities really depend on the type of annuity, said Nahulan Ethirveerasingam, second vice president of annuity product management at Guardian, which sells variable annuities, fixed annuities and income annuities. Unlike fixed income annuities, variable annuities expose clients to both positive and negative market fluctuations. Fixed annuities (which are different from fixed income annuities) aren’t exposed to market fluctuations, but in exchange for providing a guaranteed interest amount, the client may need to have the money sit in the annuity for three-plus years.

“It’s not apples to apples, but consumers need to weigh the pros and cons of each product and should partner with a financial professional who can provide unbiased advice,” Ethirveerasingam said.

Fixed indexed annuity sales made up 55.3% of the fixed annuity market in the second quarter of 2018. So there’s a good chance you or someone you love will be pitched this product at some point. You should know what you’re getting into.

Annuity salespeople typically target retirees because retirees are the group most concerned about preserving their nest eggs and guaranteeing an income for the rest of their lives. Annuities can accomplish these goals, but they often do it in a convoluted and expensive way. The law does little to protect your parents against these complexities. So you’ll have to be their advocate.

If your mom insists on going to a sales dinner, go with her. If she’s already gone, let’s hope she hasn’t bought anything yet. If she hasn’t, you can take whatever information she’s gathered about the annuity a salesperson wants to sell her and get an unbiased financial professional's opinion of whether it’s a good product for her.

The fiduciary rule that would have required salespeople to provide advice in the customer’s best interest when retirement money was in play, as it often is with annuities, is dead. But alive and well are thousands of financial professionals who voluntarily abide by a fiduciary standard because they think it’s the right thing to do.

You can find these folks through the National Association of Personal Financial Advisors or through the Certified Financial Planner™ website, among other sources. You should check their regulatory histories through FINRA’s BrokerCheck and the SEC’s Investment Advisor Public Disclosure database before agreeing to meet with them to make sure they don’t have anything alarming in their disciplinary histories. Then you should get their take on any annuity you or a loved one is considering.

It wouldn’t be fair to categorically say that fixed indexed annuities are bad. But they’re only suitable for a small number of people who can really understand and afford them. Just as term life insurance is a simple, inexpensive form of life insurance, fixed annuities that are not indexed are a simpler, less expensive form of annuity.

Fixed indexed annuities do, indeed, allow you to participate in stock market returns in good years while avoiding losses in bad years. The question is whether the annuity’s costs will be higher than those good-year returns. That’s something that varies by annuity, because each product has different terms, and there are many different products out there. A single insurer might offer seven different types of fixed-indexed annuities, for example. There’s a lot to evaluate, and apples-to-apples comparisons may not be possible, as Ethirveerasingam notes.

Fixed indexed annuities can also offer income for life, which protects against outliving your assets. And they can provide a death benefit to your heirs so that you don’t have to worry about giving an insurance company a bunch of money, dying the next day, and not getting any benefit. But these features are often provided through riders, which cost extra.

Can annuity salespeople sell fixed indexed annuities more freely without the fiduciary rule? Yes.

Is that why their sales have recently spiked? Probably.

But most of us aren’t interested in an academic analysis of the market for a particular type of annuity. Most of us don’t even understand how a simple annuity works, let alone a more complicated one like an FIA.

The takeaway? FIAs are complicated. If someone is trying to sell one to you or someone you care about, consult a financial professional who won’t earn a commission if you buy one and see what they recommend.