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 3 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. (Part 1 addresses the rule’s impact on insurance-only producers, and Part 2 takes a look from the perspective of the annuity carrier). Part 3 analyzes the fiduciary rule’s impact on independent marketing organizations (IMOs).
How did the DOL address IMOs in the rule?
IMOs make up the largest distribution channel for fixed indexed annuities, accounting for around 60 percent of total sales. More than half of those sales are in the qualified market, which the DOL rule seeks to regulate. One would think, then, that such a large distribution market would be discussed at length in the 1,023 pages that make up the fiduciary rule — especially because of the enormous impact the rule has on the distribution of annuity products.
Any guesses how many references the DOL made to the IMO?
In the preamble to Prohibited Transaction Exemption (PTE) 84-24, there is a reference to an IMO in the “Insurance Commission” definition analysis. It reads: “It was not the Department’s intent with respect to the Insurance Commission to disrupt the practice of paying commissions through a third party, such as an independent marketing organization.” That’s it.
(Just for fun, I checked how many times the fiduciary rule made reference to indexed annuities. The Best Interest Contract Exemption (BICE) mentioned them 36 times, and PTE 84-24 referenced them 75 times).
There are a few schools of thought as to why the DOL did not spend much energy discussing the IMO channel. Some believe the DOL did so intentionally because there was not enough evidence to treat them the same as other, more widely regulated distributor “financial institutions,” such as the broker-dealer, RIA, bank or carrier. Others argue that the DOL didn’t completely understand the IMO’s role in the insurance marketplace and decided instead to leave the door open down the line for an individual or class exemption that would classify the IMO as a financial institution if the IMO could prove to the DOL that it could comply as such.
Regardless, the DOL did not provide much of a roadmap for IMOs to comply with the fiduciary rule, leaving many of them with an uncertain future.
IMOs feel the DOL pinch
Because the DOL declined to name the IMO as a “financial institution” under the rule, there are some that question how the IMO as we know it today can survive come April 2017.
There are several reasons for this belief, but most importantly is the pinch the DOL created with the BICE contract requirement, which must accompany the sale of all indexed annuities. Under the BICE, an actual, written contract must be signed by a supervising financial institution and the customer. The contract must warrant compliance and adherence to impartial conduct standards and must disclose any conflicts of interest, among many other requirements.
Because the IMO cannot sign the BICE contract as a financial institution, the IMO must rely on some other entity to sign for indexed annuity sales by the IMO’s agents. There are some carriers that are considering this difficult path, which would certainly help ensure that the IMO has a future role (see Part 2 of this series for more information on that analysis).
But at what cost?
Will the carrier that decides to take on the added liability that accompanies signing the BICE contract also require the IMO to handle supervision on their behalf? Will the carrier reduce compensation to the IMO in return for the extension of an olive branch to help keep them in business? Will the carrier limit the number of IMOs it will work with to only those top few that have the resources to supervise? Does the IMO have another option?
Other potential pathways to compliance
In addition to the above option where carriers take on the BICE liability, there are some additional pathways to compliance being considered by IMOs at this time.
First, the IMO could affiliate with or purchase a broker-dealer or RIA firm. This would eliminate the BICE contract sign-off issue, but only for those indexed annuity sales from registered representatives or investment advisor representatives. Under this new world, it is likely that the current practice of selling insurance products as “outside business activities” would be out the window, with all sales (potentially even nonqualified sales) now running through supervision and oversight from the broker-dealer. This could inevitably result in lower commissions for IMOs as the broker-dealer would condition such supervision on the receipt of additional compensation.
Unfortunately, this option does not fully clear up the BICE contract issue for insurance-only agents, even though some believe an agent could be classified as an “associated person” under FINRA rules and could then be “supervised” by the broker-dealer for indexed annuity sales.
Could this be a potential loophole? Some say yes. Some say no way.
I probably lean toward the latter camp when it comes to the “associated person” angle for several reasons. For one, it might be a stretch to argue that an independent agent meets the spirit of the definition of an associated person under FINRA rules. Perhaps more importantly, it could be a slippery slope to expressly grant securities regulators authority over unregistered insurance-only agents. This could potentially open up Pandora’s Box to full reviews of insurance-only agent business activity (including nonqualified sales if the broker-dealer requires all sales to be run through broker-dealer approval as a condition to be an associated person). Last, the broker-dealer would have to be wholly owned by the IMO because it is extremely unlikely that an affiliated broker-dealer will want to take on liability of insurance-only agents.