Defunct DOL Rule Helped with VA Transparency and Outcomes: Research

By Miriam Rozen August 5, 2020

The fee transparency obligations imposed by the Department of Labor’s previous fiduciary rule on brokers that handled retirement accounts dimmed the popularity of variable annuity products, but also improved investment outcomes.

That’s according to a 62-page report, “Conflicting Interests and the Effect of Fiduciary Duty — Evidence from Variable Annuities.” The report, published in July, was written by Mark Egan, an assistant professor of finance at the Harvard Business School; Shan Ge, an assistant professor of finance at New York University; and Johnny Tang, a doctoral student in economics at Harvard University. The report was published by the National Bureau of Economic Research.

More than $2 trillion in assets are invested in VAs in the U.S., according to the authors. Insurers typically pay brokers a commission for selling variable annuities that ranges from 0% to more than 10% of investors’ premium payments, they note.

“Brokers earn higher commissions for selling inferior annuities, in terms of higher expenses," the authors wrote. The higher commissions also net more investor complaints, they added. "Our results indicate that variable annuity sales are roughly six times more sensitive to brokers’ financial interests than investors’,” they wrote in the report.

After the previous DOL fiduciary rule was proposed in 2016, the authors said, the sales of high-expense VAs fell by 52% as sales became more sensitive to expenses and insurers increased the relative availability of low-expense products. And based on the author’s structural model estimates, “investor welfare improved as a result of the fiduciary rule under conservative assumptions.”

VAs “generally have higher fees” so they are “on average are worse for investors,” Egan tells FA-IQ.  

The market responses “in anticipation of” the previous DOL fiduciary rule were “pretty sharp,” and “tell us something about whether or not a rule like this would have [an] impact on the behavior of brokers. It looks like it clearly did and clearly lowered the average fee paid by investors,” Egan says.

The previous DOL fiduciary rule, which would have required retirement account brokers to act as fiduciaries, was ordered vacated by the U.S. Court of Appeals for the Fifth Circuit in 2018.

The varied VA commissions create scenarios “that incentivize brokers to sell products that are not desirable for investors,” the co-authors wrote. “[O]n average, brokers are incentivized to sell higher-expense products and products with worse investment options, as measured by the variety and performance of the investment options.”

Based on their VA pricing review, the authors wrote that a 1% increase in expense ratios is associated with a 1.61% increase in brokerage commissions. They also found that high-fee, high-commission VA products were linked to higher numbers of investor complaints and related allegations of broker misconduct.

While it was pending, the previous DOL fiduciary rule was responsible for increasing the annual risk-adjusted returns of investors by up to 86 basis points, the co-authors wrote.  

Total VA sales dropped 20% to $25.5 billion in the second quarter of this year compared with the same period in 2019, according to Secure Retirement Institute, which is part of the research organization Limra, as reported by FA-IQ sister publication Life Annuity Specialist. That is the lowest quarterly level of variable annuity sales since 1996, according to the SRI data, which was based on a survey of issuers.

Not so fast

Todd Giesing, an SRI senior research director for annuity research, pushes back on the conclusions of the NBER-published report.

The previous DOL rule was not the only reason the sales of VAs slipped around that time, Giesing says.

“There were numerous factors during this timeline,” he says. The main reason was declining interest rates, which make “it more difficult for the insurance companies to provide value in the variable annuity business,” he says.

Moreover, VAs already passed their peak year in 2008 — long before the DOL rule was initiated — when sales hit $165 billion and they made up 70% of total annuity sales, Giesing says.

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