The New Fiduciary Rule (17): Permissible Compensation under PTE 84-24

The U.S. Department of Labor has released its package of proposed changes to the regulation defining fiduciary advice and to the exemptions for conflicts and compensation for investment recommendations to retirement plans, participants (including rollovers), and IRAs.

Key Takeaways

  • ERISA’s fiduciary and prohibited transaction rules require consideration of costs and compensation when fiduciary recommendations are made to “retirement investors,” that is, to private sector retirement plans, participants in those plans, and IRA owners.
  • Where the Internal Revenue Code’s prohibited transaction rules would be violated, the protection of an exemption is needed. In that case, the protections of PTEs 84-24 and 2020-02 will require that costs and compensation be considered.
  • This article focuses on limitations on compensation under PTE 84-24.
  • While the general rule in ERISA and the Code is that compensation cannot be more than a reasonable amount, the PTE has additional limitations.

ERISA’s fiduciary responsibility rules require that costs, for investments, insurance products and services, be no more than a reasonable amount. In other words, a prudent process will consider the costs of products and services relative to their value to the retirement investor and relative to reasonably available alternatives. ERISA’s prohibited transaction rules, and the exemptions to the prohibitions, impose a similar limit on compensation when a fiduciary recommendation is conflicted, that is, the compensation cannot be more than a reasonable amount when compared to the value of services being offered. These rules apply to all ERISA-governed retirement plans and participant accounts in those plans (including rollover recommendations).

The Code has prohibited transaction provisions with similar limitations on compensation, that is, compensation cannot exceed a reasonable amount relative to the services provided. The Code limits apply to both tax-qualified retirement plans and IRAs (including individual retirement annuities). However, the Code does not have a standard of care for recommendations to IRA owners. Instead, the applicable standard of care is imposed by other laws and regulations (for example, the best interest standard for insurance agents in NAIC model rule 275).

An earlier post, The New Fiduciary Rule (15), discussed the meaning of “reasonable” for compensation and costs. My post before this one, The New Fiduciary Rule (16), discussed the compensation limitations in PTE 2020-02.

This article focuses on limitations on compensation in the DOL’s proposed PTE (Prohibited Transaction Exemption) 84-24, which applies to conflicted recommendations by “Independent Producers”. Note that, while insurance companies working with independent insurance agents can use PTE 2020-02, but the companies would need to act as co-fiduciaries with the independent agents, most will likely elect to use PTE 84-24 where they will not be required to act as co-fiduciaries.

The DOL’s proposed amended PTE 84-24 has a number of compensation related requirements.

  • Under the Impartial Conduct Standards, the independent agent cannot receive more than reasonable compensation for the services rendered. This is a common limitation in prohibited transaction exemptions, including PTE 2020-02.

    The Independent Producer receives no compensation in connection with the transaction other than the Insurance Sales Commission, and the Insurance Sales Commission does not exceed reasonable compensation within the meaning of ERISA section 408(b)(2) and Code section 4975(d)(2)….
  • As stated in that quote from PTE 84-24, the agent cannot receive any compensation “other than the Insurance Sales Commission.” The PTE defines Insurance Sales Commission as:

    …a sales commission paid by the Insurance Company or an Affiliate to the Independent Producer for the service of recommending and/or effecting the purchase or sale of an insurance or annuity contract, including renewal fees and trailing fees, but excluding revenue sharing payments, administrative fees or marketing payments, payments from parties other than the Insurance Company or its Affiliates, or any other similar fees.

    This would appear to prohibit any cash or non-cash compensation for independent insurance agents based on production. For example, the preamble to PTE 84-24 explains the DOL’s thinking:

    Under proposed Section VII(c)(2), an Insurer could not offer incentive vacations, trips, or even educational conferences, if qualification for the vacation, trip or conference is based on sales volume or satisfaction of sales quotas.

  • The independent agent must disclose his or her commission as a dollar amount and as a percent of the premium.

    A written statement of the amount of the Insurance Commission that will be paid to the Independent Producer in connection with the purchase by a Retirement Investor of the recommended annuity. The statement must disclose the amount of expected Insurance Sales Commission, expressed both in dollars and as a percentage of gross annual premium payments, if applicable, for the first year and for each of the succeeding years. [Emphasis added by me.]

  • The independent agent must give the retirement investor a disclosure document about the right to obtain additional information about costs, fees, and compensation.

    A written statement that the Retirement Investor has the right to obtain specific information regarding costs, fees, and compensation, described in dollar amounts, percentages, formulas, or other means reasonably designed to present full and fair disclosure that is materially accurate in scope, magnitude, and nature, with sufficient detail to permit the Retirement Investor to make an informed judgment about the costs of the transaction and about the significance and severity of the Conflicts of Interest, and that describes how the Retirement Investor can get the information, free of charge….
    [Emphasis added by me.]

    Comment: The preamble to the PTE provides model language for this disclosure. However, independent agents will need to develop their written responses if a retirement investor asks for the information. Insurance companies may need to support agents in their ability to respond to any requests for this information. Note that the DOL says that this information can be on a website for retirement investors.

  • The insurance company must have and enforce policies and procedures that mitigate compensation-related conflicts of interest of the independent agent.

    The Insurer’s policies and procedures mitigate Conflicts of Interest to the extent that a reasonable person reviewing the policies and procedures and incentive practices as a whole would conclude that they do not create an incentive for the Independent Producer to place its interests, or those of the Insurer, or any Affiliate or Related Entity, ahead of the interests of the Retirement Investor. The Insurer’s procedures identify and eliminate quotas, appraisals, performance or personnel actions, bonuses, contests, special awards, differential compensation, or other similar actions or incentives that are intended, or that a reasonable person would conclude are likely, to result in recommendations that are not in the Retirement Investor’s Best Interest, or that subordinate the interests of the Retirement Investor to the Independent Producer’s own interests, or those of the Insurer, or to make recommendations based on the Independent Producer’s considerations of factors or interests other than the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor. [Emphasis added by me.]

    Comment: It is difficult to reconcile this provision with the prohibition of cash and noncash compensation beyond the Insurance Sales Commission. One plausible interpretation is that other incentive programs that are not based on production must also be mitigated. Hopefully the DOL will provide additional guidance on this.

Concluding Thoughts

These requirements may be effective as early as this summer. While we don’t know if they will be immediately applicable at that time, it is possible that the applicability date could also be this summer or a few months thereafter. Insurance companies that sell through independent producers should be considering how these compensation limitations will affect their practices. If there is only a limited time for these policies to be implemented, insurers would be well advised to consider the impact of the changes even before we see the final rules.

The material contained in this communication is informational, general in nature and does not constitute legal advice. The material contained in this communication should not be relied upon or used without consulting a lawyer to consider your specific circumstances. This communication was published on the date specified and may not include any changes in the topics, laws, rules or regulations covered. Receipt of this communication does not establish an attorney-client relationship. In some jurisdictions, this communication may be considered attorney advertising.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Faegre Drinker.