A Chill Regulatory Wind Dampens
Variable Annuity Sales
Andrew Singer

GIVEN MARKET uncertainties, it’s been a tough year for bank-sold variable annuities (VAs). There’s been some "retrenching," notes Mark Tully, senior vice president of annuity distribution and sales for The Phoenix Companies (Hartford, CT). Other factors, like the war in Iraq, the 2004 U.S. presidential election, oil prices, and interest rates may also have had an impact. Overall, there were "plenty of reasons to sit on the sidelines," says Tully.

The year started out strong, but things began to decline in April, observes Lynn Abbott, vice president of national sales and strategic alliances, American Express Financial Group (Amex), Minneapolis, Minnesota. Variable annuity sales decreased along with other investment products, including fixed annuities. "Sales are just down in all broker/dealers."

The market and interest rates have been up and down since May, Abbott says. "The election plays a role, too." Earlier, there were three bad years and one good year ("that no one knew [about] at the time," says Abbott). Then some ups and downs. "People are just not investing."

"Sales are down," confirms consultant Kenneth Kehrer, whose June 2004 industry figures showed a 28-percent decline compared with VA production in June 2003. Is it because markets are down, he asks, or is it because of the "drumbeat of bad publicity and the pressure of regulators to ‘get’ variable annuities?"

AmSouth fined

This last factor—increased regulatory scrutiny—could well be the ‘gorilla in the room’ when it comes to bank-sold VAs. Is it really a big deal? "Very," answers Kehrer, "because variable annuities are so important to banks." They contribute more revenues to the typical broker/dealer than do mutual funds. If regulators succeed in forcing commissions down, and there’s some talk of this, it’s conceivable they could reduce by half the 20 percent of bank broker/dealer revenues that VAs provide—a substantial hit. They could also force fewer sales, suppressing revenues further. Banks also worry about getting caught up in an AmSouth situation, suggests Kehrer.

State regulators recently fined AmSouth Investment Services, a subsidiary of AmSouth Bank (Birmingham, AL), $225,000 "for failure to adequately protect investors in two states." According to Mississippi Secretary of State Eric Clark in a press release dated March 26, 2004, "Most of the problems we found [were] related to variable annuities and their unsuitability for most investors."

Sales are off. Is it because markets are down—or because of the 'drumbeat of bad publicity' and the pressure of regulators to 'get' variable annuities?

Initial complaints focused on an AmSouth broker based in Starkville, Mississippi. "Elderly and unsophisticated clients were persuaded to put their savings into variable annuities that were unsuitable for them," reported USA Today (July 12, 2004). Among other things, the AmSouth broker reportedly had clients move funds that were already parked in IRAs into variable annuities.

Regulators are particularly attentive now to exchanges involving VAs. "An estimated 60 percent of variable-annuity gross sales came from exchanges last year [2003], compared with about 15 percent in 1996, according to Financial Research Corporation in Boston. The concern is that brokers are pushing these exchanges to generate more commissions for themselves," reported the Wall Street Journal On-line (April 5, 2004). The article continued:

This is partly why the National Association of Securities Dealers continues to investigate improper sales of variable annuities, which combine mutual-fund-like investments with a life-insurance component. Since 2001, the NASD has taken about 80 disciplinary actions against firms. The regulatory body has warned investors, in at least two investor alerts over the past three years, to be especially careful during market downturns because exchanges may be ‘the only way a salesperson can generate additional business.’

"So it’s a very big thing," says Kehrer, who notes that in one recent conference call with bank broker/dealers on this issue, 112 people called in to be briefed on regulatory and compliance matters.

Are banks becoming gun-shy then, given the problems of AmSouth and some others? "I’m not sure they’re gun-shy, but they’re evaluating their compliance processes," particularly in regard to suitability, notes Phoenix’s Tully. Has it put a damper on bank VA sales? "It probably has a bit, but the [volatile] market has had more of an impact."

Are indications that some banks may be pulling out of the VA market? "There’s no indication of that whatsoever," says Tully. Rather, they’re continuing to evaluate and improve their compliance processes. "And that’s a good thing."

Kehrer was asked if he’s seen banks shutting down VA sales altogether. "I don’t think that would happen," but he could foresee a tightening up on disclosure, an out-lawing or restriction on 1035 exchanges, perhaps, and a prohibition on the placement of VAs within qualified plans. One might see, too, a reduction of commission credits to financial advisors. This would go to the heart of regulators’ complaints—that is, the high VA commissions would encourage financial advisors to sell the product to people who should not be buying VAs. If banks added the same percentage to a broker’s compensation grid for a VA sale as for a mutual fund sale, there would be no incentive to favor one over the other.

Variable annuities have declined in line with total investment revenues, including those from fixed annuities. 'Sales are just down in all broker/dealers.'

—Lynn Abbott, American Express

Some distributors might even go to A-share VAs, suggests Kehrer. (Historically, VAs have been B shares.) These would have break points like mutual funds, with reduced commission rates for higher-ticket sales. Again, this would presumably address many of regulators’ complaints with regard to compensation.

One interesting development vis-à-vis variable annuities is the recent uptick in the sales of equity-indexed annuities. This comes after a long dormant period. Technically these are fixed-annuity products, but they may be replacing VAs among customers who don’t want to miss out on a market rally—but still fear market turmoil.

Are banks becoming gun-shy, given the regulatory issues? "i'm not sure they're gun-shy, but they're evaluating their compliance processes.'

—Mark Tully, Phoenix Companies

First-quarter sales of equity-index annuities were five times what they were a year earlier, notes Kehrer, although they still comprise less than two percent of all fixed-annuity sales. "But it shows they may [be] an alternative to variable annuities."

Jefferson-Pilot Life Insurance Company (Greenville, NC), one of the largest suppliers of the product, sold $160 million in its equity-indexed annuity through banks in 2003. This year they’re on track to sell $400 million, says Bob Wick, vice president for financial institution marketing. "Sales are robust." The company does not sell variable annuities through banks.

Wick says he’s hearing two things that explain the upturn. One is that industry sales of variable annuities are off—for whatever reason. Second, Baby Boomers have suffered market-wise in their 401(k) plans and are unsure what to do next. CD rates are low and unattractive, and they are reluctant to put their assets in the stock market.

So Jefferson-Pilot offers three alternatives (or buckets), each about equally popular. One offers customers a fixed rate for six or eight years; they paid out 3.4 percent and 3.65 percent, respectively, in early October. For customers who think the stock market will go up some or remain flat, there is a bucket indexed to the S&P that currently pays 5.9 percent. (The client receives nothing if the market goes down.) For those who think that the stock market will climb, there is another S&P-indexed bucket that is capped at 16 percent.

In the past, equity-indexed annuities were too complicated, particularly for bank sale, says Wick. "There were too many parts." The carrier sought to simplify the product.

Accumulation versus retirement

Despite the recent downturn, "We’re still bullish on variable annuities," says Amex’s Abbott. "What Baby Boomers really need are true retirement solutions." VAs can fit the bill. In three of five appointments with consumers, brokers are hearing that clients want their principal, and they want enough to live on when they retire, she reports.

Today, there’s more focus on "money you can’t outlive," continues Abbott, which means that clients need to be in the stock market. There is an inflation risk with fixed annuities, after all. A variable annuity can play the same role as a pension. It can guarantee a dollar amount for the rest of a client’s life. "The products are out there now," she says. A client who puts up $100,000 and invests it according to his or her risk tolerance, moderate to aggressive, can reap 7-12 percent, at least according to historic measures, "and that $100,000 is protected."

"Everyone’s done accumulation. We’re going to have to go to retirement," says Abbott. Brokers are already doing this. They have great tools for asset allocation and wealth management.

David Giertz heads Nationwide’s Financial Institution Distributors unit, and he agrees that firms will have to be more innovative to develop products that will provide an income stream for retirement. People need more than their Social Security payments and pensions, he points out. People are living longer, and they’ll require a longer income stream. He foresees the development of more products that will give clients the option of taking an income stream.

More emphasis on retirement versus accumulation? "It’s starting to happen, but it will be a slow evolution," says Tully. "It’s a process of education [for] the advisor as well as the client."

That said, the fact remains that at present "no one’s annuitizing," says Kehrer. He does see a focus on continuing to market to people once they’ve retired.

Otherwise, principal protection remains a popular feature of variable annuities, adds Giertz. It’s found now on the majority of Nationwide’s variable-annuity contributions. About 50 percent of the VAs sold today have principal protection, adds Abbott; her company is in line with the industry.

More platform sales?

Recently, there has been more talk about selling VAs through bank platforms—as is done increasingly with fixed annuities. Amex sells VAs in two of the largest bank platforms in the country, according to Abbott (she declined to name them), and they’ve been successful at this—although less than 20 percent of VA revenues are from the platform.

Typically, platform reps target younger clients with fewer investable assets. "Is it a high volume? No," says Abbott. "Is it meaningful? Yes." As for clients with higher investable assets, the bankers usually refer them upward to dedicated investment reps.

The Amex product is simple enough for the platform reps to sell, Abbott insists. The bankers conduct a simple survey, developed by Morningstar, to determine the client’s risk tolerance; and then they have five portfolios from which to choose: conservative, moderately conservative, moderate, moderately aggressive, and aggressive. There is good acceptance of the survey tool.

More VA sales through bank platforms? 'There's no question; banks want to do more of it.

—David Giertz, Nationwide

What is the platform’s share of overall VA production in banks? It fluctuates between 10 and 20 percent, says Abbott, depending on whether platform reps are focused on bank products or fee income in any given season or year.

The bulk of Nationwide’s bank distribution is still through dedicated brokers, but more banks are now asking for training for their platform personnel, notes Giertz. Is he seeing more VA sales through the platform, then? "There’s no question; banks want to do more of it."

"We are also seeing the opening up of variable annuities to bank platforms," says Tully, although this may be a "slow evolution." Banks may put a cap on the investment amounts that might be sold by platform bankers. "We’re seeing more discussion" about it. It may be more talk than action at this point, however, he acknowledges.

Kehrer, for one, is not seeing more platform sales. "No. Only 25 percent of banks with platform reps ask their reps to sell variable annuities. And among those, only one-quarter of the reps in those banks are asked to sell."

Why is that? Typically, banks select their best platform sellers of fixed annuities to sell mutual funds, says Kehrer. Later, they take the best of these and ask them to sell variable annuities. The variable annuity is a more-complex product, and platform reps probably won’t sell more "until the product is drastically simplified," he suggests. VAs offer customers many options. This makes them tricky for full-time financial advisors—let alone platform reps.

Variable annuities versus fixed annuities

Bank-sold annuities swing toward the fixed side and then back toward the variable side with the regularity of a pendulum. Or so it seems. Nationwide’s product mix is now 60/40 in terms of variable and fixed annuities. Variable annuities are down compared with the preceding year, but not significantly, says Giertz. With the economy, "Clients are looking for safer alleys to park dollars."

The most significant factor affecting the mix in recent years has been the "high increase in platform reps," the large majority of who are selling fixed annuities, says Kehrer. There are now twice as many platform reps as full-time advisors, he adds. In the early to mid-1990s, bank fixed-annuity sales were essentially flat because all the banks that could sell were selling already. In recent years, though, "in part driven by the additional salespeople," fixed annuities have surged. Still, those platform reps may one day become better mutual-fund salespeople, and in time, variable-annuity salespeople. That could change the balance. "But it’s clearly not happening now."

NASD has warned investors to be especially careful during market downturns because exchanges may be 'the only way a salesperson can generate additional business'.

There’s no denying that at present "the overall trend is back to fixed annuities" in banks, observes Tully. Phoenix eliminated fixed annuities from its lineup at the end of the third quarter of 2003, given the problems with three-percent minimums and tightening profit markets. Does he regret that decision now? "We have no regrets. The spreads were so minimal—it was difficult to make money. It didn’t make sense." Still, the fixed-income bucket within their VA has been the most popular one in recent months. Regarding VAs, people ought to be more comfortable after November, Tully speculates, and be ready to jump back into the market.

Asked to project Amex’s VA bank sales over the next year, Abbott answers, "Similar to last year’s or up a little bit. We’re ranked fifth. We’ll stay in the top five."

Yes, after the elections and a period of uncertainty, Tully sees a good year ahead. "I guess I’m an optimist."