In Practice March 31, 2007

Annuities Need to Be Part of Holistic Retirement Income Plan

Although qualified annuity sales are increasing, most of them are coming from IRAs, not 401(k) distributions.
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According to a recent report from Cerulli Associates, more than half of annuity assets (55%) and annuity sales (55%) were attributable to qualified arrangements as of second quarter 2006, the highest level in more than 10 years. However, approximately two-thirds (67%) of total assets among those qualified arrangements were from individual retirement accounts (IRAs), and another quarter are from 403(b) plans. Cerulli’s data show that only small amounts are coming from 401(k), Keogh, and deferred compensation plans.

There has been some development of annuity options as an investment choice within 401(k) plans and it will continue, Cerulli noted. Forty percent of firms in 2006 told Cerulli there is a high likelihood they will consider this strategy in the future. Challenges to this strategy are the persistent view of 401(k) plans as solely accumulation vehicles and the reality that purchasing annuity units for future income is not intuitive to most workers, the report says.

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Driven by demographic trends and the development of products that address guaranteed income and principal protection, annuity assets are expected to swell 39% to $2.6 trillion by 2011, according to predictions by Cerulli Associates. The research by Cerulli found that deferred variable annuities represent the largest portion of annuity sales, accounting for 68% of industry sales as of second quarter 2006, according to a press release. While variable annuities have shown rapid growth, fixed income annuity sales showed relatively little change, from 4% in 2001 to 11% during that period.

 

New Money?

 

Despite anticipated growth, Cerulli points out that a particular challenge to the growth of annuity sales is that less than one-quarter of both fixed and variable annuity sales come from money that is new to the industry. Much (about 75%) of the distribution of annuity sales is derived from third-party distribution, which requires a greater understanding of the mindset of advisers and wholesalers by the insurance companies. Successful distribution will require some work on the parts of insurers, Cerulli says; most notably, annuities need to be included “as part of a larger, advice-driven, income plan.’

Advisers have an opportunity to increase sales of annuities, Cerulli suggested, in recommending their usage as part of a retirement income strategy. Currently, 82% of advisers say they frequently or occasionally recommend systematic withdrawals as a retirement income strategy. “This is not surprising given their high comfort level with systematic withdrawals, as well as the insurance industry’s long time positioning of deferred annuities as tax-deferred accounts,’ Cerulli said. However, “variable annuities feature many characteristics that help make them a fairly smooth transition for retirees who are rolling over a portion of funds from a 401(k) plan–such as a variety of fund choices, flexibility in selecting and transferring between fund choices, and benefits that protect principal, income, or both.’

Advisers who do select annuities for clients tend to place greater importance on principal protection than retirement income, as 79% and 70% selected these factors, respectively, in 2006. Principal protection and retirement income were closer among fee-based advisers, at 70% and 66%, respectively, while commission-based advisers prefer systematic withdrawals to guaranteed withdrawals when recommending a decumulation option from a variable annuity.

In the selection of annuities, commission-based advisers were more likely (26%) to recommend variable annuities than fee-based advisers (9%). Further, nearly half (48%) of fee-based advisers will not consider annuities for qualified rollovers versus 19% of commission-based advisers.

Compliance March 31, 2007

SEC “Merrill Lynch Rule″ Governing Advice Struck Down

The Securities and Exchange Commission’s (SEC) rule exempting certain broker-dealers who offer investment planning advice from strict disclosure requirements was overturned Friday.
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In its 2-1 ruling, in the case Financial Planning Association (FPA) vs. the Securities and Exchange Commission (SEC), the U.S. Court of Appeals for the District of Columbia Circuit said the SEC had overstepped its authority in issuing the 2005 rule.

The rule, referred to as “the Merrill Lynch rule,’ exempts broker-dealer firms that provide investment advice if the advice is “solely incidental to brokerage services provided on a customer’s account” and if specific disclosure is made to the customer, from regulation under the Investment Advisers Act of 1940. The exemption was issued to clear up regulatory confusion so that brokers could offer fee-based accounts without having to register as financial advisers, according to the Securities Industry and Financial Markets Association (SIFMA).

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The Financial Planning Association (FPA), which represents accountants, bankers, attorneys, insurance agents and others who offer financial planning services, brought the suit arguing the SEC should not have adopted regulations which exempted certain broker-dealers from registering as advisers and allowed stock brokers to give advice to clients without having to disclose conflicts of interest, according to Reuters.

The court ruled that the SEC’s rule is inconsistent with the Act because, among the six exemptions from the definition of “investment adviser” provided for by the Act, is one that exempts any broker or dealer “whose performance of such services is solely incidental to the conduct of his business as a broker or dealer” and “who receives no special compensation therefor.” The Act also gave the SEC the power to exempt other persons not within the intent of the law’s other exemptions. Therefore, the court said that charging asset-based fees means they must register as advisers.

“Now that the SEC rules have been overturned, some regulatory uncertainty will exist until new rules are promulgated,’ SIFMA predicted, in a statement released Friday afternoon.

“In the wake of this decision, our highest priority must be to our investors – ensuring there is no disruption to our customers while we wait for the SEC to provide interim guidance which conforms to the court’s ruling,’ said Ira Hammerman, general counsel at SIFMA, in the statement; “In the meantime, we encourage firms affected by today’s verdict to comply with the decision while simultaneously working to provide customers as much disclosure as is reasonable, given the ruling.’

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