I put the finishing touches on this article just hours after the Department of Labor (DOL) proposed an 18-month delay to the fiduciary rule. Now we will have to wait and see how the rule might be changed during this delay.
Regardless of the final version of the DOL rule, there is little doubt that the entire financial services industry is moving toward a best-interest standard. While DOL may have provided the initial push toward a common fiduciary standard, the following three events are increasing the momentum.
The Certified Financial Planner Board of Standards is currently taking comments on a recently proposed update to the Standards of Professional Conduct governing all 77,000 CFP professionals. This proposed update would require CFP professionals to act as fiduciaries on all financial advice.
In June, the state of Nevada surprised the industry when it revised an existing law to include brokers and investment advisors under its fiduciary standard. Effective July 1, 2017, financial advisors must disclose any “profit or commission” they receive based on their guidance to Nevada clients and must make a “diligent inquiry” about a client’s financial condition and goals. Other states are considering similar requirements.
Jay Clayton, the new chairman of the Securities and Exchange Commission, has indicated that at long last the SEC is getting serious about creating a fiduciary standard for all types of investment accounts.
A fiduciary has both a duty of loyalty and a duty of care. In plain English, the duty of loyalty requires an advisor to put the interests of the client above his or her own. Any conflicts of interest must be eliminated. To the extent the conflicts cannot be eliminated, they must be minimized and fully disclosed. The duty of care requires the advisor to give advice only if he or she is qualified to do so.
What would a duty of loyalty and care mean to the annuity industry?
Most advisors would most certainly say that they already put their clients’ best interests first; therefore, they already meet the duties of loyalty and care. However, one cannot meet a fiduciary standard through intent alone. Working within a fiduciary framework with the least amount of liability also means the creation of a process, the documentation of that process and the reduction of potential conflicts of interest. It is these aspects that are driving changes throughout the entire industry. Within the annuity industry specifically, we can expect to see the following changes occur.
1. Commissions will be more “level,” if they continue to exist at all. Despite the obvious conflicts created by any product paying a commission, no current proposal or law prohibits them. While the CFP Board’s proposal makes it clear that commission-free advice is preferred, it would allow its members to receive commissions as long as they are clearly disclosed in plain English. The current DOL rule created an exemption permitting the continued recommendation of commissionable products. Although commissions are still allowed, the inherent conflict they create does in turn create additional legal exposure for firms and individuals in this new fiduciary world.
In an attempt to reduce the potential legal exposure inherent with the conflict, distributors are building supervisory frameworks that will make every recommendation of a commissionable annuity look a lot like the supervisory process that today is reserved for 1035 annuity exchanges.
This enhanced supervision will provide a tremendous incentive for advisors to simplify their lives by recommending a fee-based annuity instead of a commission-based annuity. If enough advisors choose the fee-based route, then the annuity distributors are likely to eventually reach the conclusion that the additional supervisory costs and infrastructure required to support commissionable annuities are simply not worth it.
In the interim, we will see commissions leveled by product type in order to eliminate any possibility of an advisor being accused of recommending one annuity over another because of compensation. For example, every variable annuity offered on a firm’s platform will likely pay the same commission.
In short, the days of insurance companies offering multiple flavors of products — especially in the fixed and indexed annuity space — in order to justify products at different commission points is about to come to an end. Eventually, the annuity companies will get out of the commission business completely. They will likely offer only a non-commission product that an advisor can either place in a fee-based account or have his or her back office tack on a “reasonable commission.”
2. The industry will have to work with regulators to rethink the current annuity suitability requirements. At most distributors, annuities are the most highly supervised product on the platform. Not only do advisors face the supervisory requirements related to the Financial Industry Regulatory Authority’s annual list of complex products, but they have all of the state insurance suitability requirements as well. And if an advisor proposes the replacement of one annuity for another, he faces supervision on steroids. These requirements are based mostly on regulators’ concerns that advisors make annuity recommendations that are unduly impacted by the commissions they receive.