The US Department of Labor has released its package of proposed changes to the regulation defining nondiscretionary fiduciary advice and to the exemptions for conflicts and compensation for investment recommendations to retirement plans, participants (including rollovers), and IRAs.
Key Takeaways
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- Statements from the White House indicate that the DOL and the White House are concerned that fixed indexed annuities may be inappropriately sold to participants and IRA owners (“retirement investors”) in connection with recommendations to roll over benefits from plans and to transfer money from IRAs. Some of the political rhetoric accompanying the release of the proposals was unusually harsh.
- The reaction from the insurance industry and state insurance commissioners has been immediate and strong.
- If the proposals become final as written, the greatest impact of the changes will likely be on insurance agents, particularly independent producers.
- The greatest impact on products will likely be on fixed indexed annuities.
- This and several following articles will cover the impact on independent insurance agents, insurance companies, and annuities.
This article discusses the DOL’s thoughts on prudent processes for evaluating fixed indexed annuities, which dates back to the Obama-era Best Interest Contract Exemption (which was vacated in 2018 by the 5th Circuit of Appeals).
As a starting point, though, I should point out that the threshold issue is whether an insurance agent is a fiduciary when making recommendations of annuities to retirement investors (that is, private sector retirement plans, their participants, or IRA owners).
Under the rules in effect today, a one-time recommendation of a plan-to-IRA rollover is not fiduciary advice—at least where an agent is not already a fiduciary to the plan, participant, or IRA. That is the result of a Florida Federal District Court decision vacating the Trump-era “re-interpretation” of the application of the “regular basis” test for fiduciary advice. It is less clear whether a recommendation to transfer an IRA is fiduciary advice under current rules.
However, the new proposed fiduciary advice regulation defines one-time recommendations, including rollover and IRA transfer recommendations, as fiduciary advice. Since an advisor or agent would make money from the rollover IRA (individual retirement account or annuity) or the transferred annuity, the recommendation is conflicted and, in ERISA and Code parlance, a prohibited transaction. As a result, the protection of a PTE—prohibited transaction exemption—is needed.
Both of the available exemptions under the proposals—PTE 2020-02 and PTE 84-24—require that the fiduciary advisor, e.g., the insurance agent, engage in a best interest process to ensure that the recommendation is in the best interest of the retirement investor. The “best interest” process is a combination of ERISA’s prudent man rule and duty of loyalty.
That process generally requires that a fiduciary advisor determine the factors are material to the decision and therefor that need to be considered. A fiduciary advisor then needs to thoughtfully evaluate the relevant, or material, factors. Obviously, the retirement investor’s profile (that is, the needs and circumstances of the retirement investor) is a material factor. That leaves the question of what else needs to be considered, and specifically what are the material factors for the evaluation of a fixed indexed annuity? The new proposal doesn’t go into detail on that. But if we travel back in time to 2016 and look at the preamble to the Best Interest Contract Exemption, we can get an idea of what the DOL thought, and probably currently thinks, are relevant factors for fixed indexed annuities. To quote:
Assessing the prudence of a particular indexed annuity requires an understanding, inter alia, of surrender terms and charges; interest rate caps; the particular market index or indexes to which the annuity is linked; the scope of any downside risk; associated administrative and other charges; the insurer’s authority to revise terms and charges over the life of the investment; the specific methodology used to compute the index-linked interest rate; and any optional benefits that may be offered, such as living benefits and death benefits. In operation, the index-linked interest rate can be affected by participation rates; spread, margin or asset fees; interest rate caps; the particular method for determining the change in the relevant index over the annuity’s period (annual, high water mark, or point-to-point); and the method for calculating interest earned during the annuity’s term (e.g., simple or compounded interest). Investors can all too easily overestimate the value of these contracts, misunderstand the linkage between the contract value and the index performance, underestimate the costs of the contract, and overestimate the scope of their protection from downside risk (or wrongly believe they have no risk of loss). As a result, Retirement Investors are acutely dependent on sound advice that is untainted by the conflicts of interest posed by Advisers’ incentives to secure the annuity purchase, which can be quite substantial.
This isn’t an exhaustive list of possibly relevant factors. To quote from the definition of best interest in the proposed PTE 84-24, a fiduciary advisor needs to consider the factors that ”a prudent person….familiar with such matters” would consider.
The DOL’s statements in the 2016 BIC exemption are a starting point for understanding what the DOL thinks an independent insurance agent should consider vis-à-vis the needs and circumstances of a retirement investor. In other words, the objective is to recommend what is in the best interest of the retirement investor and, in evaluating fixed indexed annuities, the DOL would expect that an insurance would consider the factors described in the quote from the BIC preamble. Since the burden of engaging in such a best interest process will fall on independent agents, many of whom are small businesses, insurance companies and intermediaries will likely need to provide additional support services for those agents to engage in, and document, a best interest process.
Concluding thoughts
The proposals, if adopted, will require that thought be given to the processes that a fiduciary adviser or agent should use for determining if a fixed indexed annuity is in the best interest of a retirement investor. Insurance companies will probably support insurance agents by providing education, forms and processes, and data to support best interest processes.
While investment advisers and broker-dealers have been subject to DOL and SEC best interest rules for several years, and therefor are familiar with the requirements, this will be a significant change for insurance agents. That is particularly true for independent agents who are, in many cases, are small businesses.
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.
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The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Faegre Drinker.
