Fixed indexed annuities, also referred to as equity indexed annuities, have been a hot button issue for decades now. But FIAs have also been widely misunderstood by investors, advisers and regulators, often being confused with variable annuities.
FIAs can be complex — to a point. They appear to be a security-style investment and an insurance product at the same time. They can also be riddled with confusing internal cost structures, caps on growth and multiple options for riders.
But in general, FIAs protect the principal amount and credit a growth percentage based on an index into the account, with some type of cap on the potential growth. A lot of signs are pointing to an expanding FIA market.
So why are FIAs primed for growth?
Regulatory and market perspective
After years of review, the SEC decided it wanted to treat FIAs as equity-style investments and not an insurance product. As part of the Dodd-Frank Act, the Harkin Amendment essentially sought to keep FIAs as state-regulated insurance products by removing certain annuities from federal securities regulation under the SEC. But the regulation discussion regarding FIAs didn't end there.
Back in 2010, the Department of Labor started a long rule-making process to create an expanded fiduciary rule that would cover certain investment advice within certain types of retirement accounts. Eventually, the DOL fiduciary rule lumped FIAs into a category with variable annuities — a product that clearly falls under the SEC's security regulations.
When the rule passed and initially went into effect in 2017, it appeared that both variable annuities and FIAs took a hit as sales dropped. However, a federal appeals court struck down the DOL rule in 2018 as the Trump administration stalled its defense of the rule.
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Market growth
Perhaps not surprisingly, FIA sales took off shortly after the rule's demise. LIMRA released data showing
FIA sales hit $20 billion in the second quarter — the highest quarterly sales for FIAs ever.
The DOL's regulatory measures slowed down FIA usage, but also helped spur the development of a new type of FIA: a fee-based (not commission-based) product.
In the past, agents sold most, if not all, FIAs and were compensated by a commission. But as the DOL fiduciary rule put pressure on commission-based models, insurance companies started developing new products to comply with a fee-based rule.
The fee-based product world is still extremely small — it comprises less than 1% of the whole FIA market. But the growth is encouraging.
According to the same 2019 data from LIMRA, fee-based FIA sales reached $193 million in the second quarter, up 188% from the prior year. The fee-based products open up the FIA market to fee-only based RIAs who shy away from commission-based annuity sales.
One challenge for financial advisers is validating a best-interest comparison between commission-based FIAs and fee-based FIAs. According to Dave Alison, executive vice president at C2P Enterprises, "the caps can be higher in a fee-based FIA because the insurance company doesn't have to pay the adviser a commission, but if the adviser charges a fee on the annuity account value, it begins to level out
the net-after-fee earnings potential of that product compared to the commissionable option."
Mr. Alison suggests that products with higher caps would probably perform better in a bull market, even after deducting the advisory fee. However, in a sideways or bear market environment, the commissionable product, even with slightly lower caps, may produce better returns because there is no advisory fee drag.
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Upcoming federal laws
FIA sales could also get a boost from the
Secure Act, which passed the House in June and is expected to pass the Senate and be signed into law later this year. One of the many retirement provisions in the Secure Act would make it easier for retirement plans like 401(k)s to add annuities as investment options inside the plan. So while the change might not be immediate, it's expected to increase annuity usage and sales in retirement plans.
FIAs appear to be primed for a long run thanks to regulations settling down, positive federal laws coming down the pipeline and significant growth in the market. Additionally, if we see a continuation of market volatility, low interest rates and increased negative interest rates, investors will begin looking for more secure strategies to place their savings and investments.
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Jamie Hopkins is director of retirement research and vice president of private client services at Carson Group.
