Indexed annuities exception would ease DOL fiduciary burdenArticle added by William H. Byrnes, Esq. on February 10, 2017
William Byrnes

William H. Byrnes, Esq.

Joined: January 16, 2014

Co-written by Robert Bloink

The Department of Labor (DOL) fiduciary rule, as it currently stands, would sweep sellers of increasingly popular fixed indexed annuities under the definition of fiduciaries—requiring these sellers to take steps toward compliance in just a few short months (by April 10).

Related: Annuity Sales to Plunge Under DOL Fiduciary Rule: Cerulli

This would create a daunting complication for some independent distributors of these products because under the currently drafted rule, they would potentially be ineligible to take advantage of the valuable best interest contract exemption (BIC, or BICE). Fortunately, the DOL has proposed a class exemption that would, in certain circumstances, allow these independent insurance intermediaries to sell fixed indexed annuity products and continue to receive the associated compensation without creating prohibited transactions that would violate the fiduciary rule—if a specific set of criteria is satisfied.

The DOL Proposed Exemption

As discussed in more detail below, the best interest contract exemption allows financial institutions that enter into formal written contracts with clients to continue to work with advisors who will sell fixed indexed annuity products to clients (and receive the associated compensation). However, the current draft of the exemption limits the definition of “financial institution” so that it excludes certain insurance intermediaries and independent marketing organizations (IMOs) that support independent producers in their sale of financial products—the route by which most fixed indexed annuity products are sold.

These IMOs would therefore be ineligible to take advantage of the best interest contract exemption to continue selling fixed indexed annuity products for a commission. Under the proposed class exemption for IMOs, however, these sales would be permitted for sales involving fixed annuities that satisfy certain state forfeiture laws at the time of issuance and for which benefits do not vary based on the investment experience of a separate account maintained by the insurer.

The proposal would also expand the definition of financial institution to include intermediaries that have a written contract governing the distribution of the annuity products with the insurance company and the advisor (multiple tiers of intermediaries may also be permitted).

Additional requirements regarding capitalization levels, proper state licensing and submission to audits also may apply. This class exemption would grant IMOs financial institution status similar to that of broker-dealers, insurance companies and banks.

Compliance With the Best Interest Contract Exemption

Under the DOL fiduciary rule, when a fiduciary receives compensation in connection with selling an indexed annuity, a prohibited transaction would occur because of the potential conflict of interest that this compensation creates—unless an exemption applies. As a result, in order to continue selling fixed indexed annuity products, the advisor must generally comply with the best interest contract exemption.

The terms of this exemption require the applicable financial institution to enter into a contract with the client acknowledging that it and the advisor are acting in a fiduciary capacity (i.e., will act in the client's best interests and avoid any conflicts of interest, especially regarding compensation arrangements). Note that the firm itself is party to the contract, and that it assumes liability for the recommendations of advisors.

The exemption also requires that the advisor avoid misleading statements and receive no more than reasonable compensation, which must be disclosed. The advisor is not specifically required to monitor investment performance, but must disclose whether or not investment performance will be monitored and, if it is, how frequently and the reasons why a client will be alerted to any changes in performance.

The firm must warrant that it has adopted policies and procedures designed to mitigate conflicts, and promise to comply with those polices and procedures.

Conclusion

While the proposed exemption remains to be finalized (comments are due February 18), and many have criticized the rule for falling short of the relief that is actually needed, if adopted it could provide a valuable route to allow some independent producers to continue selling fixed indexed annuity products under the currently existing structure.

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See these addtional blog posts by Professors Bloink and Byrnes:

Fixed Indexed Annuities to Dominate 2017 Annuity Marketplace

How to Minimize Pricey Medicare Surcharges

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Originally published on Tax Facts Online, the premier resource providing practical, actionable and affordable coverage of the taxation of insurance, employee benefits, small business and individuals.

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