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June 10, 2016 at 04:49 AM
In my last post, (Don’t Let BICE Hubbub Drown Out Burden of DOL Best Interest Standard), I noted that advisors are underestimating the significance of the best interest standard of care in the Department of Labor’s fiduciary rule. While I believe that focused 401(k) advisors understand ERISA’s prudent man rule and duty of loyalty, I’m concerned that many advisors don’t understand how the best interest standard of care will impact their advice to IRAs (once the new DOL rules apply on April 10, 2017).
In my opinion, the change is much greater than people think.
To explain the impact, I divide the best interest standard of care duties into two categories: macro and micro.
The macro requirement is that the investment products be generally prudent for retirement investors. The micro requirement is that the recommended combination of investment products and services be prudent for the particular retirement investor. Let’s look at each of those.
Macro Prudence
For insurance products—including traditional fixed annuities, variable annuities and fixed indexed annuities, one macro issue is whether the insurance company is financially stable—that is, based on current circumstances, will it be able to make annuity payments 30, 40 or more years from now?
That requires a financial analysis of the insurance company, including consideration of its general account investment practices. It also requires an evaluation of the terms and conditions in the annuity contract. For example, when discussing fixed indexed annuities, the DOL said:
“Assessing the prudence of a particular indexed annuity requires an understanding of surrender terms and charges; interest rate caps; the particular marked 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; and the specific methodology used to compute the index-lined interest rate and any optional benefits that may be offered, such as living benefits and death benefits. In operation, the index-lined 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 of compounded interest).”
That raises the question of whether an individual advisor has the knowledge and experience to perform the analysis in a prudent manner. If not, then the advisor will need help from his supervisory entity (for example, a broker-dealer) or from reputable outside sources.
