Analysis: Fee-only annuities try to overcome bad rep

WASHINGTON Mon Jun 13, 2011 5:21pm EDT

WASHINGTON (Reuters) - For decades, variable annuities have had a bad rap, dissed as fee-laden, overly expensive and "not bought but sold" to unsophisticated investors by commission-hungry brokers.

That was enough to turn off fee-only advisers who under a fiduciary standard of care must find the lowest-cost, best financial products for their clients.

But now, as more advisers are moving to fee-only, fiduciary practices, insurance companies such as Allianz Life Financial Services, AXA Equitable Life Insurance Company, Lincoln National Life Insurance Co.(LNC.N), Prudential's (PRU.N) Prudential Annuities and Sun Life Financial (SLF.TO) are creating new products to attract them.

They're responding to a post-crash emphasis on retirement security that has made more investors willing to pay for guarantees. Variable annuities also offer a way to defer taxes, a big appeal to the affluent clients that tend to use fee-only advisers.

A variable annuity is essentially an insurance policy wrapped around a mutual fund portfolio. Money earned within the annuity is tax-deferred. Annuities also have death benefits that can be converted into a lifetime-guaranteed retirement income stream.

Traditionally, all those bells and whistles carried a stiff price tag--three percent or more of the amount invested in the annuity. Additionally, heavy surrender charges could shave one percent to seven percent off investors' balances if an annuity was sold within seven years of purchase.

SKEPTICISM

"Isn't it interesting that not once in my career of 27 years, have I recommended a variable annuity to a client?" says Bethesda, Maryland, adviser Mary Malgoire, a pioneer of the fee-only advisory industry.

But John Ritter, a board member of the National Association of Personal Financial Advisors, the primary professional association of fee-only advisers, says no-load annuity companies are beginning to show up at conventions of planners who blanch at the word commissions.

"At our last convention, there was a lot more interest in variable annuities, and a lot more willingness and openness to exploring them," he said.

To be sure, "no-load" annuities are a drop in the bucket of the overall variable annuity market. In the first quarter of 2011, they attracted $986.7 million, or 2.6 percent of the $38.7 billion in total variable annuity sales, according to Morningstar.

"These products have not performed to the level that maybe would have been expected," says Marco Chmura, manager of Morningstar's variable annuity data operations.

No-load variable annuities sales, however, have momentum. They are on track this year to grow 22 percent over 2010, which would come close to the record sales figure of 2007.

LONG GESTATION

"We've been thinking about this space for a number of years, but it took us around 15 to 18 months of development," said

Robert DeChellis, president of Allianz Life Financial Services. "We didn't just take our existing chassis and strip it down."

Allianz is one of several insurance companies that are offering commission-free annuities through LPL Financial, a broker dealer that offers trading services and other support to independent brokers and financial advisers.

LPL launched its variable annuity platform in February in response to an increased demand from financial advisers and their clients, said John Moninger, LPL's executive vice president of advisory and brokerage solutions.

It's too early to declare the program a success but initial results are promising, he said. At least half of the sales on the commission-free platform are being made by advisers who never previously sold a variable annuity. What's more, the average amount being invested is about twice that of the industry's average variable annuity sale, according to Moninger.

Some traditional no-load investment companies, including Fidelity Investments and Vanguard Investments, have been offering variable annuities directly to investors and fee-only advisers. Jefferson National Life Insurance Company, for its part, introduced a fee-only variable annuity in 2006 and is projecting record 2011 sales of $250 million, about one-fourth of total sales since introduction.

HIGH FEES

No-commission annuities are not necessarily cheaper than those carrying commissions because mutual funds stuffed inside the annuity can have higher-than-average management fees. The insurance protections also can cost as much as 1.4 percent of the annuity contract, says Laurence Greenberg, president of Jefferson National.

Even if an investor in a high tax bracket could save through the deferral feature, the savings that Greenberg estimates of 0.85 percent wouldn't compensate for the 1.4 percent cost, he says.

Jefferson substitutes a flat $20 a month fee in place of a percentage of mortality and expense charges, making the annual contract charge around 0.12 percent for a typical $200,000 contract.

The complex of fees is why many fee-only advisers recommend variable annuities irregularly and with care. Ritter, for example, isolates them for clients who want to trade out of a more expensive annuity without incurring tax bills or for those who have exhausted many of the other tax-advantaged methods of saving and investing.

Some savvy investors are beginning to shift highly taxed investments, including real estate and corporate bonds, into a tax-deferred annuity while leaving stocks in taxable accounts that can produce offsetting losses or lower-rate capital gains, suggests Bing Waldert, an analyst at consulting firm Cerulli Associates.

Robert Fragasso, a Pittsburgh adviser who works primarily on a fee basis, says he would like to see a completely separate no-load annuity wrapper so clients could have insurance coverage and leave the underlying portfolio completely open for him to manage. He concedes that it could take some time to convince the annuity-selling insurance industry that such a plan would be good for them.

There's one more change annuities manufacturers might consider.

"When you describe the annuity's purpose to advisers, they all want it," says Moninger. "But when you actually say the word 'annuity' they immediately retreat."

Perhaps the new, improved variable annuities are ripe for a new, improved, name.

(Reporting by Linda Stern; Editing by Lauren Young)

(This article has been modified to correct the spelling of Robert Fragasso in paragraph 24 in the story that originally ran on June 9th)

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