Does Commissioned-Based Pay Harm Consumers?

By Kim O’Brien
Commentary

Americans for Annuity Protection is committed to providing an effectively regulated annuity marketplace where consumers can access competitive and comprehensive annuity products of all stripes – fixed, variable, immediate, deferred, guaranteed income and legacy transfer. Our driving principles are: CHOICE and PROTECTION.

The Department of Labor’s Fiduciary Rule’s requirements cast commissioned-based sellers as having an inherent material conflict of interest by being paid a commission. We believe that diverse distribution models offer more choice and no one compensation model - fee-based, commission-based, or asset management-based - is best for all customers.

But, because the Rule takes specific aim at annuities and annuity commissions, let’s examine this issue more closely.

Commissioned sales have been around for a long time and it is the primary method for compensating independent insurance agents. Commissions are used in most industries as the method of compensating the sales team, but some companies use the model for all of its employees.

A company called “Fishbowl” has 100% of its employees on commissions and claims the policy is responsible for “much of its success.” Commissions are also a good way for the manufacturer to place controls and expectations on the sales process and seller without having to create an employer-employee relationship (W-2).

Commissions are typically the only form of income for most sales people and they provide a stable “payroll” for the insurance company, rising and falling with the rise and fall of revenues. Simply put, commissions incentivize people to SELL.

So, can they cause a conflict of interest?   Of course! But we reject the claims that any conflict is unique to commission-based sales. We also reject that the fee-for-service model is conflict free.

Both real and apparent conflicts of interest (or dualities of interest) can occur in almost any situation in life. For our world, conflicts of interests can occur when a recommendation to purchase a financial product, take a specific course of action or NOT purchase or take a specific course of action are made.

Conflicts can also occur when “selling” someone to pay you for advice. From a consumer’s perspective it matters not whether you are recommending an annuity or recommending your advisory services. You are still selling them something.

Conflicts occur because the advisor (both fee and commissioned) should be expected to have, and do in fact generally have, multiple interests, affiliations and various positions of responsibility to their business, their insurance company, their employees, their family and their community. They do not occur simply because a commission is being paid.

The annuity advisor has an obligation to sell the company’s products or risk termination for non-production – another conflict – but also to sell annuities to make a living. Annuity advisors must keep their sales pipeline full to ensure they can stay in business, support their family and pay their employees.

However, what the Rule fails to understand is that the fee-based advisor has inherent conflicts of interest, too. He or she must have a set number of clients or a set number of billable hours to make a living.

Fee-based advisors must keep their sales/client pipeline full or risk being terminated from their firm or not being able to stay in business and support their family. The other conflict that can exist in the fee-based world is profit-sharing plans and other types of performance-based compensation or profit incentives within the firm.

What the Rule also fails to recognize is that in the fee-based world there is nothing in place, statutorily, to mediate a potential conflict because the fiduciary duty is principles-based. Meaning, it is up to each and every individual fee advisor to meet their fiduciary obligations individually with no governing body to oversee them on each recommendation or meeting where advice is being given.

To quote one fee-only advisor in our professional network, “I went to fees because I wanted to be the boss of me and my business practices, not reporting to some insurance company.”

Of course, fee advisors are regulated but not at the individual recommendation level – they don’t have to submit each individual’s financial plan or investment recommendation to a product provider or other higher authority (e.g., their CFP Board). They don’t have to justify each recommendation, at the time they make the recommendation, to anyone other than their client. Fee-based advisors are required – on principle – to follow the fiduciary duty with every customer and every recommendation. That is good. But only occasionally - following a complaint - do they have to justify their actions and business practices beyond that.

Contrarily, annuity advisors, are subject to a statutory adjudication method for conflicts of interests - the rules-based suitability standard. Unbeknownst to most journalists, an agent can’t simply decide to sell an 7% annuity over a 6% annuity. The annuity advisor must justify each and every annuity sale to the insurance company.

They must disclose to the company where the money is coming from, how it will be used, justify why that particular annuity is best for the consumer and document that there are enough liquid funds left to pay for emergencies or unexpected expenses.

Another interesting, apparently little known, requirement for most annuity sales is that annuity advisors are not permitted to place more than a certain percentage of the consumer’s available assets in the annuity (e.g., 60% or 70%). Meaning if the 401(k) is $50,000 only $30,000 or $35,000 can be placed in the annuity.

Whereas, the fee-advisor may recommend, with only themselves as judge, 100% of someone’s assets be placed in a particular investment. Annuity sales are so thoroughly regulated by the insurance company in addition to and in tangent with state insurance oversight. This regulatory system ensures that conflicts that might arise in the sale are eradicated by the insurance company’s review in conjunction with the rule of law that makes them liable for each sale.

Despite this existing system of conflict adjudication in the annuity industry, the Rule places a double burden by imposing on annuity providers an additional requirement of a system of supervision to manage advisor conflicts and warrant the advisor is in compliance with all requirements of the Rule.

It is clear that unless services and recommendations are provided for free with no business expectations or family obligations attached, you can and will have conflicts of interest – regardless of how you are paid.

So perhaps the best way for the DOL to make certain that the advisor is acting in the client’s best interests, is for the Rule to mandate that each and every advisors’ financial recommendation to buy or not buy a particular financial product be subject to a secondary review by the product provider with that provider warranting that the recommendation meets the standards of the Rule and holding the product provider liable for any recommendation that does not.

And, for those recommendations to purchase products that have the requirements of the Rule statutorily in place already – annuities – they will be exempt from the DOL Rule because the consumer is better protected without the confliction of a rules-based law and a principle-based duty.   Just a thought!

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 [email protected].