DOL May Grant All IMOs Financial Institution Status In Fiduciary Rule

By Cyril Tuohy

The Department of Labor is likely to develop a new financial institution category allowing independent marketing organizations (IMOs) to sell fixed indexed annuities with retirement funds, but the reserving requirements might be a high hurdle for those marketing companies.

Reserving requirements have emerged as a major issue for regulators because the financial institution carries the professional liability on behalf of agents who could later be sued for recommending an annuity that in hindsight was not in the best interest of a retirement investor.

A class exemption would raise the profile of qualifying IMOs to one of a “financial institution” on a par with four other financial product distributors -- banks, broker-dealers, registered investment advisors and insurers -- for the purposes of the sale of financial products and advice into and for retirement accounts.

“I’m told that they are leaning toward a fifth category rather than an individual exemption granted to IMOs that apply,” said David Rauch, general counsel and chief operating officer of Annexus, an annuity product development company in Scottsdale, Ariz.

“In the end, the idea is to have an IMO or FMO that does the same thing as the companies — banks, broker-dealers, registered investment advisors and insurers — in the other four classes,” Rauch said.

Annexus and 19 other marketing organizations have individual financial institution applications pending before the DOL.

As a fifth category, IMOS would just need to give notice that they intend to reply on the Best Interest Contract Exemption, and then move ahead. It would be up to the DOL to come in and audit the IMO if regulators want to confirm standards that may be necessary to qualify under the terms of the fifth category, Rauch said.

Whether to grant financial institution status individually to IMOs or as an entire class had been on the regulators’ radar for months after the DOL in April announced that fixed indexed annuities, on which agents collect a commission, would have to be sold under the fiduciary rule’s Best Interest Contract Exemption.

The bulk of fixed indexed annuities are sold through independent agents and IMOs. When IMOs weren’t included as financial institutions, some wondered aloud whether selling fixed indexed annuities under the DOL’s new fiduciary rule was still viable.

IMOs recruit independent insurance agents to sell fixed indexed annuities, a $53 billion segment of the fixed annuity market. In exchange for recruiting agents, IMOs provide sales, marketing and compliance help to agents.

Reserving Requirements

Investors look to FIAs to guarantee their investment principal while generating higher returns than they would receive in other products during an era when interest rates and the income generated by those savings remains at record lows.

As a result, FIAs represent one of the best-selling annuity products in the market. But before setting the parameters for IMOs as an entire class, regulators are grappling with how IMOs meet capitalization and reserving requirements, Rauch said.

Setting the proper levels of capitalization requirements is considered a vital point for regulators who need to allow IMOs and the thousands of agents to continue to operate profitably in the market, yet ensure that safeguards remain.

Capitalization and reserving set too high could hamper an IMO's ability to conduct business, but if the capitalization levels are set too low, IMOs representing agents may not have enough to pay a legal judgment levied against them, said the chief executive of a marketing organization that applied for financial institution status.

“If a financial institution is going to stand behind the recommendation of their advisors, they need to be capitalized well enough to withstand changing market conditions and be able to ensure longevity and stability for the customers they serve,” said Mike Kalen, CEO of Futurity First Financial in an interview with InsuranceNewsNet in October.

Kalen said he was generally in favor of setting capital and financial strength requirements for IMOs, so long as the requirements are not too onerous. Futurity First Financial owns three IMOs.

Federally regulated banks and state-regulated Insurance companies are routinely audited to make sure claims reserves are set at appropriate amounts, but IMOs, which aren’t similarly regulated, haven’t had to face the same capital requirements.

So who is responsible for making sure IMOs are adequately capitalized? For the moment, that’s not quite clear.

“I don’t see how the DOL could transfer this to state regulators — whether an IMO is qualified to, and acting as a financial institution, seems to be a DOL-only issue, to be overseen and regulated by DOL,” Rauch said.

Many IMOs have listed per-occurrence errors and omissions, or E&O, limits of $5 million and aggregate E&O limits of $10 million, IMO application materials indicate, but this isn’t nearly the same as setting capitalization requirements which affects the balance sheet of a company.

Regulators are expected to release the capitalization and reserving framework shortly and are said to have all the information they need to develop a short list of bullet points – not pages and pages of fine print – around requirements necessary for the fifth and final class of “financial institution.”

DOL has told IMOs that it doesn’t want any more applications.

The 20 IMOs with applications before the DOL are: Advisors Excel, Topeka, Kansas; Alpine Brokerage Services, Marleton, New Jersey; AmeriLife Group, Clearwater, Florida; Annexus, Scottsdale, Arizona; Brokers International, Panora, Iowa; Clarity 2 Prosperity, Westlake, Ohio; ECA Marketing Inc., Eden Prairie, Minnesota; Futurity First Financial Corp., Hartford, Connecticut; Financial Independence Group, Cornelius, North Carolina; Gradient Insurance Brokerage, Topeka, Kansas; Ideal Producers Group, Overland Park, Kansas; InForce Solutions, Woodstock, Georgia; Insurance Advocates; Kapolei, Hawaii; InsurMark, Houston, Texas; Legacy Marketing Group, Petaluma, California; M&O Financial, Southfield, Michigan; Saybrus Partners, Hartford, Connecticut; and The Annuity Source, Bellevue, Washington; Kestler Financial Group, Leesburg, Virginia; First Income Advisors, Eden Prairie, Minnesota.

InsuranceNewsNet Senior Writer Cyril Tuohy has covered the financial services industry for more than 15 years. Cyril may be reached at [email protected].

Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. He can be reached at [email protected].