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AALU: Life industry facing a 'bloody battle' over DOL's fiduciary rule

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Washington — At the AALU’s closing general session on Tuesday, members of AALU’s advocacy teams warned of coming fights in Washington, including expected legislation on income tax reform, repeal of the estate tax and, most immediately, the Department of Labor’s proposed fiduciary rule governing IRA and 401(k) plan providers. The session’s panel included Kenneth Kies, managing director of the Federal Policy Group and an outside counsel to the AALU; Chris Morton, the AALU’s vice president of legislative affairs; moderator Marc Cadin, AALU’s senior vice president of government affairs; and Jeff Ricchetti, also an outside counsel to the AALU. The following are excerpts.


Cadin (photo, right): According to our onsite poll of AALU members [attending the annual meeting], most believe that tax reform will happen in 2017. Ken, how would you assess the tax reform bill, H.R. 1, in terms of its potential impact on the industry?

Kies: On a scale of 1 to 10, it rates about a 12. When we first saw the bill, our immediate reaction to the Republican House Ways and Means Committee staff was, “This is terrible.” Their reaction was, “You really need to take into account the whole bill because tax rates are being reduced to 25 percent from 35 percent.”

But to get to that reduced rate, the legislation hits life insurance companies and products with $60.5 billion in new taxes. And whereas businesses generally would be subject to a 1 percent tax increase under the bill, the tax liability of life insurers is 26 percent. As a policy matter, we think there’s a very strong argument to make that the bill reflects poor decisions.

Cadin: Chris, why in your view, did our industry fair worse than others under the tax bill?

Morton: There was a concurrent trade-off: The committee said, “We protected inside build-up — what the AALU wanted — but then other tax increases affecting the industry came into play. Frankly, we didn’t argue our case as vociferously as we could have. There’s also the perception that we received a preferential deal. That’s why we need to we need to be talking more about why our industry and products are now taxed appropriately.

Ricchetti: The Camp draft only got the top marginal tax rate down rate to 35 percent, but it still resulted in a $60.5 billion tax hit to the industry. [New House Ways and Means Committee Chairman] Congressman Paul Ryan wants to reduce it to 25 percent, which would require another two to three trillion dollars in taxes. Dramatic income tax reduction is really the enemy here. So I expect that 2017 will be a difficult year for the industry.

Cadin: The Camp discussion draft provides for taxes on DRD [dividends received deduction], capital reserves, COLI [corporate owned life insurance], non-qualified deferred compensation, among other items. Why should agents and advisors on the distribution side care about these tax threats to the carriers?

Kies: The carrier threats materially impact the ability of insurers to take on risk. The actuarial firm Milliman predicts the $60.5 billion of industry tax increases will result in $25 billion less of capital over the next 10 years. As we all know, life insurers need capital to take on long-term risks and commitments.

Milliman estimates that $1 dollar of capital is required to support $170 of face amount in life insurance coverage. So $25 billion less of capital, multiplied by $170, would yield $4.2 trillion less of face amount coverage over the next 10 years. Milliman also forecasts that, absent changes to current tax law, that life insurance companies would sell $8.4 trillion of face amount coverage. So the various tax increases would cut in half coverage face amounts.

I’m  big believer in having a one-floor elevator pitch ride to deliver to members of Congress as to why the proposed tax increases are bad. On such a ride, you can’t talk about DRD or reserves, but what you can say is, “Congressman, can you imagine that during the next 10 years, we’ll have $4.2 trillion less of face amount coverage under this tax bill?”

Cadin: Observers have said that we at AALU have to diversify our message. As you think about the Camp Discussion Draft [the working document for tax reform in the last Congressional session] do the various taxes just impact life insurance?

Morton: The numbers Ken talks about also pertains to annuities. The ratio there is 1 to 200. Applying $25 billion less in capital to the annuity space results in $5 trillion less in lifetime income guarantees annuity coverage over the 10-year period, a significant reduction.

Cadin: Before we switch from [House Ways and Means Committee Chairman David Camp] to today, why do we still care about Camp? He will be retiring and the Ways and Committee will have a new chairman, Representative Paul Ryan.

Ricchetti: Ideas, once they get out, develop a life of their own. Camp put out a treatise of ideas about ways to raise revenue, $60.5 billion of which adversely affect our industry. And his ideas survive.

The Camp Draft was also guided by the thinking of the committee’s tax staff. The tax code is a long and complicated thing: Most of the members of Congress are not [experts] on tax policy. They defer in large measure to their staffs.

Kies: When you all go to Capitol Hill today, I guarantee that more than once you’ll hear staff members say, “Don’t worry about the Camp Draft. We’re starting with a blank slate. The translation of that is: We’re starting with the Camp Draft. Truth is, the document is still sitting there.

Cadin: What is actually happening up on Capitol Hill now tax-wise?

Kies: There is a lot of activity. Paul Ryan, who is dealing with a lot of other things in his committee — a highway bill, the Export-Import Bank, the debt ceiling, tax extenders — is working very diligently on framing tax reform legislation.

He wants to be in a position to move a tax reform bill through the committee during the first 8 months of 2017. In the Senate, various working groups are discussing tax reform and probably also working on a 2017 timeline to advance legislation.

Cadin: What will we be doing over the same timeline?


Morton (photo, right): Education is key. We’ve met with a number of members on both the Ways and Means Committee and the Senate Finance Committee to express our concerns about taxes on COLI, deferred comp and other taxes. We’re also meeting with members of Congress in their districts. More importantly, we’re engaging people in distribution to build a grassroots effort that will be critical when Congress finally tables a bill.

Cadin: According to the second of our onsite polls, about 83 percent of our audience members spend some or a lot of time on COLI, BOLI and non-qualified deferred compensation plans. What are we doing about the Camp Draft’s targeting of these items?

Kies: We’ve put together a history of how COLI has been regulated since1984. It’s a very impressive story. No other financial product is looked at more carefully and legislated on more frequently to the point where we feel very confident in saying we think Congress has got its right. There’s no need to change a period in the way in which COLI is treated.

In respect to non-qualified deferred comp, we’ve been engaged in a very substantial educational effort to overcome [Congressional] staff bias against these plans. There are 4 million non-qualified deferred comp plans in the U.S., established for people who are taking personal responsibility for their own retirement. That’s a powerful statistic.

Morton: We’ve surveyed the membership and gotten real world examples of how these products are used to help people and businesses save jobs, create jobs and protect people. This is all outlined in a letter we sent to one Congressional working group.

Cadin: What’s our plan for going on offense on the Hill?

Morton: Let’s consider the retirement side first. We’re supporting policies and legislation to do things like auto-enrollment and auto escalation of plans; simplifying start-up rules for small businesses; and providing workers with disclosure about lifetime income — all low-hanging fruit.

As we gather momentum, we’ll leverage these discussions to promote our positions on group term life insurance and creating a permanent life exclusion — ideas that will give employees basic financial protection and the opportunity to save for retirement through their employers. So there are a lot of things on the table and we’re in a good spot.

Cadin: What impact will presidential politics have on what Congress actually does in 2017?

Kies: By September, presidential politics will likely pull everyone back from doing anything serious legislatively, as Congress will want to see first where the candidates stand on tax positions. These will probably be framed in the most general terms until one of them takes office.

Whoever wins the White House will have a major role in shaping tax reform. And tax reform is more likely if we have a Republican as president and Republicans controlling both houses of Congress.

Ricchetti: No question: If there is a Republican-controlled Congress and White House, we’re likely to see tax and entitlement reform during the president’s first year in office. Bill Clinton did it in 1993. George W. Bush did it 2001. And Obama advanced the Affordable Care Act in 2009.

Cadin: Turning to the estate tax: On April 16, the House passed a bill to repeal the estate tax by a vote of 240 to 179. The legislation is different than previous bills repealing the estate tax. Jeff, give us an update.

Ricchetti: What you can’t make up is the absurdity of certain tax policies introduced and passed by the Congress. The current legislation, sponsored by Congressman Kevin Brady (R-Tex.) repeals the estate tax, but also provides a step-up in basis.

So, for example, of $80 billion in assets owned by the Gates family and Koch brothers, virtually all of which represents appreciation in Microsoft or Koch industry stock…that appreciation would not be taxed at death. People inheriting their assets would get a step up in basis and could liquidate all of their $80 billion estates without every paying a nickel of tax.

The proposal would create a set of people — those who inherit these absurd amounts of wealth — who will never again pay federal tax. It’s the craziest tax policy, one that all but three Republicans voted for in the House. That said, I don’t think the bill will pass in the Senate.

Morton: The proposal allows for planning to take place over multiple decades. And the cost of repeal puts significant pressure on tax reform and on the federal budget.

Cadin: Our next onsite polls that shows most of you in this room — again 83 percent — are in the estate planning market. So the estate tax bill is a big deal. Jeff, what are we doing about it?


Ricchetti (photo, right): We’re educating members about the implications of the Brady bill. And we’re trying to ensure that Democrats in the Senate oppose its consideration. I believe Senate Majority Leader Mitch McConnell will bring the bill up in the Senate — if for no other reason than to force a vote among the Democrats.

But the bill will not likely become law. If it gets past the House and Senate, it will be vetoed by the president. But again, the legislation will help set the legislative agenda for 2017.


Cadin: Last month, the Department of Labor introduced a proposed fiduciary rule to extend the definition of what constitutes a fiduciary under ERISA [Employment Retirement Income Security Act of 1974]. Chris, what does the rule stipulate?

Morton: In broad strokes, the DOL proposal will likely increase the cost of savings vehicles while reducing consumer choice; and it reduces access to professional planning in the retirement space. It may be well intentioned, but it’s probably unworkable as currently constructed.

The details are this: For advisors who are serving investors, including those with individual retirement accounts and small qualified plans, you would be generally prohibited from receiving conflicted payments, such as commissions or revenue-sharing. You could receive an exemption from the general prohibition under what’s being called the “best interest contract exemption,” which would require an advisor to enter into a pre-advice, pre point-of-sale contract with a potential investor.

The requirements are that you:

  • act in the client’s best interest; receive reasonable compensation

  • avoid misleading statements;

  • identify and disclose potential conflicts of interest; and

  • warrant that you have policies and procedures to mitigate and disclose conflicts if you offer proprietary products or a limited set of products.

[In respect to the last], the DOL would determine if you’re acting in the client’s best interest. So there are a lot of details in the proposal. There is also the presumption that what you do is somehow inherently conflicted; and that commissions are somehow bad. I think [the DOL] would like to abandon commissions. They just found a way to do it differently.

Our position is that the DOL has not proven the need for rule. The proposal will only hurt middle market consumers for whom the DOL claims to be expanding advice and services. So the proposal really doesn’t make much sense to our members.

Cadin: I have a copy of the DOL proposal, which includes background material that purportedly proves the need for the rule. One of the pieces therein is a letter from the U.K.’s Financial Conduct Authority. The FCA claims that…replacing commissions [under the U.K.'s Retail Distribution Review (RDR) requirements] with “advisor charges” or fees, where intermediaries charge the consumers directly for the advice they provide, helps consumers understand that advice comes at a charge and what that charge is. There seems to be no question that the DOL is targeting commissions when they include letters like this as a rationale for proposing their rule.

Ricchetti: Agreed. There is very little evidence of [commission-based insurance] products being oversold when people are egregiously underinsured. Most have face amounts of life coverage totaling two times their income when they should be closer to 10 times income. Again, there is no meaningful or credible evidence of people upshifting individuals to products that carry a higher commission.

We need to educate [the DOL] and the Democrats, who ought to be concerned about the adverse effects of the proposal on lower and middle consumers. Many people don’t want 1 percent of their assets eroded every year by fees. They only want to pay a charge when they get something at the point-of-sale. That’s what the commission structure provides. So we need to explain why and how commission-based products work.

Cadin: Ken, what are the chances that we’ll be able to beat back the DOL proposal? Is the rule, in your judgment, a fait accompli?

Kies: This proposal, coming out of the Elizabeth Warren or progressive wing of the Democratic Party, poses a serious risk to the industry. The President put a lot of pressure on the DOL to put out this proposal.

Since its release, they’ve received thousands of comments. My guess is they’ll read a few of them, but then put the proposal on a fast track. We may have to try to get Congress to stop it or get the next administration to reverse it. That’s the reality.

Ricchetti: The good news is that a broad coalition is opposed to the proposal — and not just the industry. The coalition is bringing a lot of resources to bear. We’re raising red flags with Democrats, 6 of whom met with [Department of Labor Secretary] Perez last week and had a vociferous dialogue about the challenges presented by the proposal.

And we’re going to engage all of you in the audience in terms of commenting and visiting with your congressional representatives and senators to deliver this message once we have more specifics on the proposal. Ken is right: We’re facing a big battle on the DOL rule — and it will be a bloody battle.

Check out more of our AALU coverage here:

Romney to AALU: Instability is the enemy of planning

Here are the 12 things to keep tabs on at the AALU meeting in DC

See also:

These are the regulatory trends to watch for in 2015

NAFA responds to Sen. Warren, says annuities offer consumer protections

Will a revised fiduciary rule change advisor behavior?


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