Is it in the best interest of a mutual fund investor to pay a broker a 1 percent annual fee on invested assets of $100,000 in a retirement account?
Or is a 4.5 percent up front commission and .25 percent annual trail commission on $100,000 variable annuity with a lifetime income rider in the best interest of the client?
For annuitants in a variable annuity held for 30 years or more — which would be the case if annuitants don’t want to outlive their income — the upfront commission model is by far the better deal as far as annuity contract holders are concerned.
Surrender fees, other charges and hidden incentives aside, insurance advisors stand to take home a lot less using a commission-based model than they do using a fee-based model. That is, as long as the investment term lasts beyond the break-even point of four to six years.
Under an illustration provided by Lincoln National, a big seller of variable annuities, a 1 percent annual fee on a $100,000 investment would cost the investor $30,000 over a 30-year lifespan while the cost of a $100,000 variable annuity would come to $11,750 over the same period.
Variable annuity investors who surrender their annuity within the first four or five years end up paying more — $4,500 in this example — than mutual fund investors hit with a 1 percent fee — $1,000 in this same example.
Holding Periods a Critical Variable
Consumers and other low-volume “transactors” with buy-and-hold strategies “can’t jump to the conclusion that commissions are not in your best interest,” said Will Fuller, president of Annuity Solutions with Lincoln Financial Distributors and Lincoln Financial Network. They are Lincoln National broker-dealers.
“You just simply can’t get there when you take into account the horizing of the investment,” Fuller said in conference call with analysts.
The analysis of commission-based and level-fee comparisons were provided by Lincoln National last year during the public comment period and reiterated in a presentation with analysts last month.
Under a fee-based model, small retirement investors with $40,000 or $50,000 in a rollover individual retirement account will end up paying more in relative terms than the $10 million retirement account holder, said 401k expert Anthony J. Domino Jr.
“The concept of paying upfront once versus annually is more a function not of what product you buy but on how long you keep the client,” said Domino, a managing principal at Associated Benefit Consultants and a registered representative and financial adviser at Park Avenue Securities in Rye Brook, N.Y.
Comparisons between how much financial advisors collect in fees and how much agents and advisors receive in commission help explain why some insurance wholesalers have announced they will continue to sell commission-based products.
Even under tougher standards promulgated by the Department of Labor, which kick in beginning next April, the value of commission-based products remains an important differentiator depending on the client’s individual circumstances, the Lincoln National executive said.
“Our issue was there was consumer value in commissions; there’s consumer value in fees,” Fuller said.
The commission and the fee model can both lay claim to serving the best interest of a client, but the commission model comes with a twist, courtesy of the DOL’s new fiduciary rule.
To sell variable annuities and fixed indexed annuities with a commission in the future, agents will need to comply with an exemption to the Labor Department fiduciary rule’s Best Interest Contract. The Best Interest Contract Exemption means more onerous disclosures and a signed document between agent and client.
Since the publication of the DOL rule and the BIC, insurance company distributors have begun discussing standardizing compensation so that agents selling similar retirement products get paid through similar commission schedules.
Most distributors intend to use the BIC, Fuller said, “because every method of compensation is held to the same standard.” Indeed, Lincoln’s approach is to standardize commissions by each distinct product category.
“Large institutions have standardized comp by product category,” he said.
“Levelized commissions,” have already been in place for a long time, but that any additional sort of compensation will soon be “rationalized across the entire industry,” Principal Financial Group President Daniel J. Houston said earlier this year.
But with insurance companies having a significant voice in commission structures, will working under the exemption and agents earning commissions remain a favored route for product structures? Or will insurance companies gravitate toward fee-based products?
Insurers need to “be prepared” to offer distributors product designs for both fee- and commission-based annuities, said Scott Stolz, senior vice president at Raymond James, at LIMRA’s Retirement Industry Conference in May.
Along with that, there’s no question that insurers will have to offer more specific, simplified and straightforward pricing models, Stolz added.
InsuranceNewsNet Senior Writer Cyril Tuohy has covered the financial services industry for more than 15 years. Cyril may be reached at firstname.lastname@example.org.
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