DOL May Classify Indexed Annuities Same As Variable in New Rule

By Linda Koco

The Department of Labor (DOL) staff appears to be thinking that fixed index annuities should be treated more like variable annuities than fixed annuities under its new "conflict of interest" fiduciary rule, according to an insurance executive who met with top-level staffers.

John E. Dunn of Northwestern Mutual told a packed breakout session at LIMRA's annual meeting this week that DOL officials who were at a September face-to-face had indicated they had changed their views on fixed index annuity treatment.

A DOL spokesman on Friday declined comment on any possible changes.

‘Made a mistake’

“Basically, they said that, four days after they released their proposal in April, they realized they had made a mistake, and that indexed annuities shouldn’t have been treated like fixed annuities in their rule proposal,” said Dunn, who is vice president and investment products and services counsel at Northwestern Mutual. The meeting had been set up to discuss the proposed fiduciary rule..

During the meeting, the DOL officials asked the executives some “pointed questions” about fixed index annuities (which the DOL calls equity index annuities), Dunn recalled. His company does not sell those products, he pointed out. But he said he expected that indexed annuities might be “moving more toward variable annuity treatment as opposed to fixed annuity treatment” in the prohibited transaction exemptions under the proposal.

Dunn’s comments were not lost upon fixed annuity executives who attended the LIMRA breakout session. Hallway buzz about this continued for the rest of that day and on to the next. The speculation was about how deep this “made a mistake” thinking is running at DOL, and how it might affect the indexed annuity business.

The DOL is drafting a final version of its "conflict of interest" rule, which would require agents and advisors to act as fiduciaries when providing advice that affects retirement funds. The rule is expected in the spring.

As the first version of the rule stands, some provisions in the proposal would treat fixed annuities sold through IRAs differently from variable annuities sold through IRAs, noted James F. Jorden, a Washington attorney and shareholder of Carlton Fields Jorden Burt.

Specifically, these provisions would allow fixed annuities in IRAs to retain their current exemption under Prohibited Transaction Exemption 84-24 (PTE 84-24), he said.

In the proposed rule, fixed annuities, including indexed annuities, will remain covered by 84-24. However, the exemption is beefed up to include an “impartial conduct standard.” While a contract would not be required, financial professionals still need to provide several disclosures covering the product and any compensation received.

This is where Dunn said the DOL might peel away fixed index annuities, which are considered insurance, and classify them with variable annuities, which are considered securities. Variable annuities and mutual funds, which are currently also included in PTE 84-24, would lose this exemption if the proposed rules are adopted.

Instead, these product sales could be eligible for the rule’s Best Interest Contract (BIC) exemption. In order to sell VAs with commissions, financial professionals need to adhere to the BIC, which includes a signed contract with the client, as well as disclosures on the product and any compensation received.

Dunn said all of the annuities -- fixed and variable -- should be put back into PTE 84-24. “Those two products should be treated the same under 84-24, the simpler method of distributing those products.”

Regarding PTE 84-24, Jorden stressed that it does not provide an exemption from lawsuits brought by customers. It is a federal exemption from Internal Revenue Code 4975 penalties. Section 4975 imposes a penalty on advisors who enter a prohibited transaction and don’t have an exemption, Jorden said. “It doesn’t have anything to do with your relationship with your customer.”

The BIC exemption would enable advisors to sell variable annuities (and potentially fixed index annuities) in the IRA marketplace . However, he said, the transactions must be performed “with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent person would exercise based upon investment objectives, risk tolerance, financial circumstances and needs,” according to the proposed rule.

Dunn said he doesn’t think that DOL will move variable annuities back into 84-24. He based that on comments made during the September face-to-face meeting.

He said that one of the officials at the meeting explained that variable annuities are too complex a product and need treatment as mutual funds — i.e. both could use the BIC exemption but not the 84-24 exemption.

Possible litigation

Dunn and Jorden both noted that the industry is already laying the groundwork for possible litigation around the proposed rule, citing a variety of issues (not just annuity concerns).

He predicted that DOL will fix the earlier version “at the edges” before issuing a final version, but also said that “there’s no doubt, we’re going to have a rule.”

Jorden concurred: “When was the last time, if ever, that you heard of a President showing up for the announcement of a proposed rule by a federal agency?” he asked. “It’s clear that the Administration is behind it. It’s a big deal. There’s going to be a rule.”

The industry’s task now is to develop a plan of action for dealing with the rule, even if there is litigation, Jorden said.

InsuranceNewsNet Editor-at-Large Linda Koco, MBA, specializes in life insurance, annuities and income planning. Linda can be reached at [email protected].

Linda Koco, MBA, is a contributing editor to InsuranceNewsNet, specializing in life insurance, annuities and income planning. Linda can be reached at [email protected].