DOL 101: The fiduciary rule's impact on annuity carriers

The Department of Labor’s fiduciary rule is the most significant industry game-changing development we have seen since the tax reform to annuities in the early 1980s. As an annuity compliance expert with a leading consulting company, the biggest question I receive these days is: “How do I comply?” Even though I’d like to have a panacea response, my answer is often the same: “It depends.”

Every company, distributor and producer is in a unique position under this rule, and compliance answers will vary based on the licenses a producer carries, the types of annuity products manufactured and the role served by the distribution firm.

This is part 2 of a series of articles taking a deep dive into what the annuity world is likely to look like once the rule takes effect next April. (If you missed part 1 — it addressed the rule’s impact on insurance-only producers). Part 2 takes a look from the perspective of the annuity carrier. Part 3 focuses on the impact on IMOs.

DOL dividing lines

Carriers come in all shapes and sizes, but the DOL rule really only sought to delineate them based on one single criterion: the type of annuity product manufactured and sold. Carriers that only offer so-called fixed-rate annuity contracts, may seek relief under revised Prohibited Transaction Exemption (PTE) 84-24 in order to pay differential compensation to agents, while those manufacturing indexed or variable annuities in the qualified market will have to comply with the new Best Interest Contract Exemption (BICE).

While the DOL clearly intended to draw this line of demarcation, it may not have anticipated a separate, more blurry line created by its rule — that is, those carriers that have distribution partners that are permitted to sign the BICE contract as an eligible financial institution under the rule and those that do not.

For some background, this second, blurry line did not really exist under the DOL’s proposed rule back in April 2015. That’s because the proposed rule differentiated between “variable annuity contracts and other annuity contracts that are securities under federal securities laws” and so-called “non-security annuities” which would include all fixed annuities. However, in the final rule, indexed annuities were transferred from PTE 84-24 to the BICE. As a result, a once clear dividing line separating annuity product types now more closely resembles a gerrymandered map.

Now, the traditional definition of fixed annuity (which, since 2010, has been fairly well-defined in the industry after SEC Rule 151a was vacated by the courts and the Harkin Amendment was adopted) has been bifurcated between the DOL’s newly termed fixed rate annuity contracts and indexed annuities.

The result is a myriad of rule implementation questions — each specific to the type of annuity products the carrier manufactures.

Different products, different implementation standards

Steps for implementation of the DOL rule vary by carrier and products offered. This article identifies three distinct courses — one for the carrier offering fixed rate annuity contracts, one for the carrier manufacturing variable annuities and one for the carrier manufacturing indexed annuities.

First up: Carriers selling fixed rate annuity contracts

Though compliance life for carriers solely offering fixed rate annuity contracts within PTE 84-24’s framework will likely be more palatable than those under the BICE framework, the rule will still require several new implementation steps. PTE 84-24 specifically requires the same impartial conduct standards as BICE, including disclosure of all material conflicts of interest and receipt of only reasonable compensation. Though fixed rate annuity contract manufacturers will not have to worry about BICE’s contractual requirement, they will still likely need to draft new disclosures for compensation and other point-of-sale documents as well as ensure producers are trained on new fiduciary obligations.

Some fixed rate annuity contract carriers may ultimately determine that they don’t have any obligations under the rule because the onus is really on the producer to comply with the new fiduciary standard. While that reading may not technically be inaccurate, it is probably impractical. The reality is that a vast majority of carriers would probably prefer point-of-sale disclosures to be drafted by in-house legal and compliance teams — not individual producers. Most believe carriers will inevitably need to assist distribution with PTE 84-24 requirements.

Second: Carriers selling variable annuities

For carriers that largely operate in the variable annuity space, BICE preparations have been ongoing since last April. Most were resigned to the fact that the BICE would likely be the new normal, and, as a result, they have been working closely with broker-dealer, bank, wirehouse and RIA distribution partners that will be willing to sign as the financial institution on the BICE contract.

Many variable annuity carriers are also actively listening to their distribution’s requests for potential product and compensation changes necessitated by the rule, including levelized commissions, shorter surrender charge schedules, less complex fee structures, and product differentiators and compensation based on neutral factors. In addition, variable annuity product manufacturers are working in concert with their financial institution partners to ensure accurate carrier information is relayed for the drafting of the point-of-sale BICE contract, point-of-sale disclosures and the required “web disclosure,” which must be updated quarterly. 

Third: Carriers selling indexed annuities

While the above two product manufacturers have some unanswered questions under the rule (“Define reasonable compensation?” or “What does a best interest contract really look like?”), the indexed annuity carriers are unquestionably the ones facing the toughest questions at this time. 

It all comes back to the blurry line discussion. The above carriers at least have some guidance for or from their distribution. For many indexed annuity carriers that rely on independent distribution from insurance-only (non-securities licensed) producers for a portion of their business, the rule provides less clarity.

Those indexed carriers that offer products predominately through broker-dealer, bank and RIA channels with little distribution coming from independent marketing organizations (IMOs) or insurance-only producers will likely be following a similar analysis to the variable carriers above. But those indexed carriers that rely heavily on IMO distribution and insurance-only sales are likely asking themselves the following:

If there’s no broker-dealer, RIA or bank in the picture for the insurance-only producer, will the carrier be willing to sign the BICE contract?

Indexed annuity carriers’ big decision

The BICE requires a financial institution to sign an actual, physical contract with the retirement investor at the time of sale. The DOL defines a financial institution as a broker-dealer, a bank, an RIA or an insurance carrier. When no other financial institution is available to sign the contract for an insurance-only agent, the carrier is the only possible option, at least as written today.

The DOL acknowledged as much in the BICE preamble:

“The Department notes that if the product manufacturer is the only entity that satisfies the “Financial Institution” definition with respect to a particular transaction, the product manufacturer must acknowledge fiduciary status and exercise the required supervisory authority with respect to the exemption, including entering into the contract….”

What the DOL may not have intended, though, was the precarious decision an indexed annuity carrier must make with respect to signing such a contract.