Is anyone getting tired of reading story after story about the DOL Rule with the obligatory and oft-repeated phrase that fiduciary is the “higher” standard? Those of you who must navigate the various carrier rules, limits and stringent liquidity requirements to meet the standard of suitability are all nodding your proverbial heads with us!
Some historians trace the roots of fiduciary principles back to the Code of Hammurabi (ca. 1790 BC) in Babylon. According to our research, Hammurabi established one of the first written codes of law and set forth the rules governing the behavior of agents entrusted with property, demonstrating fiduciary considerations at the very beginning of recorded legal history.
For the United States, the fiduciary standard – putting your client’s interest ahead of your own - is known as a prudent person standard of care, a standard that originally stems from an 1830 court ruling. This formulation of the prudent-person rule required that a person acting as fiduciary was required to act first and foremost with the needs of beneficiaries in mind and that they must work to preserve the estate or corpus of a trust, as well as the amount and regularity of income.
There have been many reports that predict we will hear from the Department with its final Rule as early as next week. Others are saying that may be pushed back by one or two more weeks. Regardless, we can agree a final Rule is imminent. So what is this “rule” or, asked a different way, what is the set of explicit regulations or principles governing conduct?
That’s where it gets tricky. The difficulty lies in the fact that a fiduciary standard is a “principles-based” standard. There are no explicit regulations or requirements governing the conduct. Best interest is in the eye of the beholder.
The Department’s Rule has determined that commission-based earnings are an inherent conflict of interest. However, the Rule allows commissions if they are “reasonable.” What is reasonable you ask? We don’t know; the Rule doesn’t offer any measurement criteria. Is 6% more reasonable than 7%? Perhaps, but what if the 7% product is with an A-rated carrier and the 6% is with one holding a B rating? Which is more reasonable? Is 1% a year, every year reasonable if the IRA is held for 15 years?
Other forms of compensation are prohibited; but shouldn’t deferred compensation arrangements encouraging persistency and in turn offering consumers better pricing be considered “more reasonable” than single-pay up front commissions? A lower up front commission with a profit-sharing or deferred compensation arrangement may be less expensive for the carrier and therefore, better for the consumer. Unfortunately, these arrangements are prohibited in the proposed Rule.
Education, one of the most ambiguous parts of the Rule, is okay but to educate the consumer about the various choices among products and navigate them to a choice that is in their best interest, imposes the onerous and impossibly vague “fiduciary standard of care.”
By comparison, the Suitability law has a very specific set of standards and explicit expectations outlined in the 2010 NAIC Suitability Model Regulation. Taking it even further, insurance companies have quantified most aspects of the Law’s requirements and made them applicable nationwide. The detailed specifications make their ultimate review and final determination of the sale measurable and actionable. We suspect that these additional limitations were established to meet the Law’s system of supervision requirement and to limit potential liability.
We reviewed a dozen different carriers’ suitability rules. Here’s a collection of the quantifiable and measurable requirements that surround a “merely” suitable recommendation.
The funds being used to purchase the annuity may not represent more than a specified percentage of a person’s net worth (often 50%).
The consumer has a minimum of dollars in cash savings after the annuity purchase. Higher thresholds are placed on applicants approaching retirement.
Monthly Household Income and Expenses
Certain carriers require that a minimum of 6 months to a year of liquid assets be available for monthly expenses. This requirement is in addition to the net worth requirement.
Some carriers prohibit any replacement if the annuity being replaced is still in its surrender period. Others have a year limit which is typically 3-5 years. Still Others limit replacements with surrender charges higher than 5 – 7% in the replaced annuity. Some require a combination of the above.
Source of funds
Reverse mortgages are not allowed to fund the annuity – these were explicitly prohibited in California’s adoption of Suitability and most carriers have enforced that limitation in all states. Recently, a major annuity carrier added the following disclosure to “Source of Funds” section of their suitability questionnaire:
A registered representative who is currently licensed with a broker dealer may be required to assist you with the liquidation of your portfolio to fund the purchase of the fixed annuity. If the producer who recommended the purchase of the fixed annuity compared your existing portfolio to the fixed annuity, they must be licensed with a broker dealer or acting in a fiduciary capacity to you, pursuant to a written agreement, and be a Registered Investment Advisor, an Investment Advisor Representative or an associated person of a Registered Investment Advisor.
While, the comparison of a specific, existing security or security portfolio owned by the annuity purchaser has long been considered investment advice, it is the first time we have seen this disclosed to the customer and stating unambiguously the licenses their annuity professional should hold.
Rules without enforcement capabilities are, of course, meaningless. That is why all the carriers we reviewed have 7-10 pages of questions and data collection that the agent and consumer must complete before they can submit the application to the carrier. The data gathered portrays their entire financial picture, their financial holdings, goals and objectives. This data is then scrubbed, reviewed and analyzed by the carrier, leaving them with the ultimate determination, and liability.
Americans for Annuity Protection, considers the suitability rules and carrier requirements to be good for annuity consumers. While, we’d prefer that the rules had more uniformity, there is little doubt that the existing secondary system of supervision and warranty of information serves consumers best. This service is borne out by the minuscule number of complaints handled each year by department of insurances across the country.
Adding dozens of pages of new disclosures and fiduciary questions that the DOL Rule will require will create annuity applications that are over 30 pages long and will do little more than add confusion to consumers simply seeking safety and income certainty. Even the Department’s own impact analysis recognized that lengthy forms and disclosures were not helpful..
Is it any wonder that Ken Fisher hates annuities? Today he is bound by principle and there are no rules that prohibit him from putting 100% of assets in risk-based investments, using reverse mortgages, or demanding that he demonstrate enough cash liquidity remaining to fund household expenses. Most harmfully, he can take any annuity with any amount of surrender charge and replace it without having to worry about following those pesky suitability rules. “Merely” suitable, indeed!
Kim O’Brien is the vice chairman and CEO of Americans for Annuity Protection. She has 35 years of experience in the insurance industry. O’Brien served The National Association for Fixed Annuities (NAFA) for almost 12 years and led the organization to defeat the SEC’s Rule 151A. Contact Kim at firstname.lastname@example.org.
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