Final fiduciary rule: the benefits and burdens for indexed annuities

The final version of the recently released Department of Labor (DOL) fiduciary rules contained some changes to the rules governing fixed annuity products that may have surprised some advisors who deal in these products. Certain types of fixed annuities will now be subject to the heightened — and potentially costly — fiduciary standards that many expected to impact only variable annuity products — meaning that advisors who sell these products will now be subject to the heightened “best interests” standard, rather than the traditionally applicable suitability standard. Fortunately, because the DOL appears to have recognized the potential difficulties that advisors may encounter in implementing the new requirements, the final version of the rules contains several provisions that could potentially ease the compliance burdens that these changes may generate.

Fixed indexed annuities: the new standard

The final version of the DOL fiduciary rules contains an important change from the version that was originally proposed — under the final rule, fixed indexed annuity products will be subject to the best interest contract exemption along with variable annuity products. Many in the industry had expected that fixed indexed annuities would continue to be covered by prohibited transaction exemption (PTE) 84.24, which is as exemption that protects compliant advisors from IRS penalties that may apply if the advisor enters a prohibited transaction (simpler products, such as immediate annuities, will continue to be covered by PTE 84-24).

Generally, it is expected that the cost of compliance — and the risk of penalty for noncompliance — will be much steeper for advisors who must comply with the best interest contract exemption requirements.

The best interest contract exemption allows financial advisory firms to continue to set their own compensation practices as long as certain requirements are met. Specifically, the exemption requires that the advisor enter into a formal contract with the client that commits the advisor to act in the best interest of the client.  The advisor must avoid any misleading statements about fees, commissions and conflicts of interest generally.

Further, the advisor must warrant that the firm has adopted policies and procedures designed to mitigate any conflicts of interest (meaning that the firm has identified conflicts and compensation structures that could cause the advisor to fail the bests interests standard, and has adopted procedures to mitigate their impact). Any conflicts, including hidden fees, must be clearly disclosed to the client. The exemption also specifically requires that compensation charged by advisors be “reasonable.”

DOL Eases the Compliance Burden

Recognizing the potential compliance burdens that the new standard may generate, the final DOL rule provides for a delay in the time period when the contract required by the best interest contract exemption must be signed. The contract may be signed as a part of the transaction execution documents, rather than before the advice related to the product is provided — basically, this means that the contract can be executed at the same time the client completes the rest of the paperwork necessary to complete the transaction. The fiduciary standard, however, will apply to all discussions, even those that occur before the contract is executed.

The final rule also contains a grandfathering provision, which allows existing transactions to continue on their current commission basis. The DOL has provided a one-year implementation period, so that advisors who will now be subject to the new rules have until one year after publication of the final rule to comply, rather than the 8-month period that was widely expected. Implementation of the rule will take place in phases — full compliance with the requirements pertaining to the disclosures, development of policies and procedures and contract execution components of the best interest contract exemption will not be required until Jan. 1, 2018.