Insurers: Retirement Plans Look Less Golden

Dan Ryan is Leader of the Financial Services Advisory Practice at PricewaterhouseCoopers LLP. This post is based on a PwC publication by Mr. Ryan, Mike Alix, Adam Gilbert, Armen Meyer, and Chris Joline.

Earlier this year, the Department of Labor (“DOL”) released a proposed regulatory package impacting the way investment advisors and brokers are compensated. [1] Under the proposal, recommendations to an employee retirement benefit plan or an individual retirement account (“IRA”) investor will be considered “fiduciary” investment advice, thus requiring the advice to be in the “best interest” of the client rather than being merely “suitable.” As a result, insurance brokers and agents who provide investment advice will face limits on receiving commission-based (as opposed to flat fee) compensation. [2]

The proposal’s compensation limitation does not apply to general investment education. Furthermore, the proposal’s amended “prohibited transaction exemption 84-24” (“PTE 84-24”) allows for commission-based compensation when selling certain insurance products. However, in order to continue receiving commissions for variable annuity (“VA”) sales to IRAs, insurers would need to utilize the separate Best Interest Contract exemption (“BIC”).

Beyond compensation, the operational impact of the proposal is especially significant in the areas of technology and product development. The business model will also be challenged, due to reduced revenues and fewer clients for whom it will be economically feasible to service.

Although some insurers are already taking action and anticipating the effect of expected changes, many do not fully appreciate the far reaching operational impact of the proposal and have not developed a plan to meet its challenging compliance and disclosure requirements. While the DOL has indicated that a number of changes will be made to better enable industry compliance, the core framework is unlikely to change. We expect the rule to be finalized in the first half of next year.

This post provides (a) the options that insurers have to comply with the DOL’s proposed rule, and (b) our analysis of key considerations for the industry.

Rule compliance

Insurers are considering the following options to comply with the rule: (1) utilize the amended PTE 84-24 to continue to sell certain insurance products to plans and IRAs, (2) comply with the BIC requirements for VA sales to IRAs, (3) move to an advisory model which uses a flat fee for compensation, or (4) move to a self-directed model where the current commission-based fee structure is maintained.

Amended PTE 84-24 requirements

The proposal’s amendments to PTE 84-24 prohibit commission-based compensation for sales of VA contracts to IRAs. It also prohibits the payment of certain types of fees to insurance advisors, such as revenue sharing payments, administrative fees, and marketing payments. Insurers who take advantage of PTE 84-24 would have to disclose conflicts of interest and act in the “best interest” of the plan, plan participant, or IRA.

BIC requirements

The BIC is a key exemption for insurers to consider in determining how to best comply with the rule. It allows certain forms of commission-based compensation structures to remain in place if the insurer complies with the DOL’s enhanced disclosure and contract requirements.

Complying with the BIC requires financial institutions to disclose to retirement investors the total projected cost of each new investment over holding periods of one, five, and ten years, prior to the execution of the transaction. Additionally, the BIC requires that prior to providing investment recommendations, the financial advisor, financial institution, and investor enter into a written contract that acknowledges fiduciary status, commits the advisor to follow impartial conduct standards, and includes warranties to which the financial advisor and institution must adhere.

While the BIC enables current certain commission-based compensation structures to remain in place, complying with the BIC poses challenges for insurers that will likely increase monitoring costs, require technology improvements, increase training needs, and call for increased supervision.

Specifically, the proposal suggests that insurers will need to delay transactions until the customer acknowledges projected costs provided as part of the disclosure requirements. Insurers may be able to expedite the process through electronic client notification methods, although some customers may find this transition difficult. Additionally, obtaining all of the cost information in a central location to expedite these disclosures will be challenging for insurers without significant technology upgrades. Finally, insurers will need to rewrite or amend existing customer contracts, and such contract modifications would likely require state insurance board approval.

Advisory model

Moving to an advisory model will require additional licensing and training for insurance registered representatives who are not currently licensed as advisors. Additionally, sales incentives would need to be adjusted to address the move from commission-based to flat fee compensation.

Self-directed model

The self-directed model, which relies on directed orders from consumers, is suitable for some brokers and investment advisors but is far less appropriate for the insurance industry’s complex tailored products. Since these insurance products require the advice and guidance of an agent in selecting products for their portfolio, using a self-directed model in the insurance industry is challenging.

Considerations for the industry

We expect that the proposal will significantly impact the insurance industry by requiring training and technology enhancements. Especially if companies choose to leverage the BIC exemption, systems will need to be enhanced to detect and block certain products that are not allowed under the BIC. Additionally, new user interface tools may be required to produce timely pre- and post-sale customer disclosures, as insurers often do not have a central repository of relevant fee and cost data. Insurers should begin to identify gaps in data collection and establish sources to collect fee information including contracts, amendments, and prospectuses.

Insurers should also understand and assess new costs associated with maintaining small accounts to determine whether retaining them can continue to be justified under current business models. Insurers may find that new entrants, such as low cost (often automated) fee-based service providers, will disrupt their businesses.

Below we describe the particular impact of the proposal on a variety of stakeholders in the insurance industry, including insurance companies, affiliated broker-dealers (“BDs”) and their insurance agents, non-affiliated BDs and retail financial advisors, and wholesalers.

Insurance companies

Insurance companies will need to adhere to the proposal’s general investment education carve-out that defines the boundary between education and sales.
Front line operational resources (e.g., call center representatives) that provide customer service to potential customers may be considered fiduciaries, and thus be unable to receive a commission, if the customer service is linked to a sale. However, call center representatives may, for example, provide educational information about a VA or fixed annuity product to a potential customer for funds in an IRA rolled over from a 401(k) plan.

Additionally, in order for the insurance company to remain competitive, a new class of products may need to be developed. Product manufacturers will need to find a balance between creating plain vanilla and complex products. Complex products (e.g., VAs) are more costly to offer and maintain, so the proposal’s downward pressure on compensation (by restricting commissions) will force insurers to reconsider offering such products. Furthermore, consumers will be asking more questions as a result of sale disclosure requirements, so market forces will also constrain compensation.

Insurance companies should consider the following in preparing for the final rule:

  • Training and education should be enhanced to detail specific product nuances that help enable advisors to determine which products are in the best interest of the client.
  • Policies and procedures should be created or updated to clearly differentiate between providing general education versus investment advice. This includes call center scripting and training to ensure that advice is not provided to prospective customers by call center representatives.
  • Pricing models may need to change as a result of revenue losses caused by changes toward lower cost product offerings.
  • Compensation will need to be adjusted to align with the new product offerings.

Affiliated BDs and insurance agents

Transitioning from the suitability standard to the “best interest” standard will be significant for affiliated BDs and their agents due to more restrictions on providing investment advice to prospective clients.

When assessing the rule’s impact on these entities, there are two typical scenarios, each with differing implications. In the first scenario, the agent may suggest a VA or fixed annuity or a variable universal life policy for a non-retirement account, and the agent will remain regulated as is and only needs to satisfy existing suitability requirements. In the second scenario, however, the agent may suggest a VA or a variable universal life policy for a prospective customer’s IRA, and the agent may be treated as a fiduciary under the rule absent a carve-out or exemption.

Affiliated BDs and their agents should consider the following in preparing for the final rule:

  • Training for agents taking the BIC exemption should be enhanced regarding disclosures
    and updated policies, so they may continue to receive commissions.
  • Agents that must begin acting as fiduciaries will need to be trained in product details to be able to demonstrate that one product is in the best interest of their client over another product.
  • Agents will need to enhance their client profiling to refresh and verify the client’s objectives on an ongoing basis in order to determine what is in the client’s best interest.
  • Agents will need to provide clear guidance on permissible products and services to customers, and optimize methods to convey such information to customers. This may be challenging and could potentially cause confusion, particularly if a retirement investor owns multiple accounts where different rules apply.

Retail financial advisors and non-affiliated BDs

Retail financial advisors and BDs independent of the insurance company will also be impacted under the proposal. For example, if a registered representative at an independent BD suggests transferring an existing VA in a customer’s IRA to a new VA at a different insurer, the regcomp3nistered representative will be subject to the fiduciary standard. Additionally, if the registered representative suggests rolling funds from a client’s 401(k) to an IRA, or the registered representative suggests that the client begin taking distributions from his IRA in order to contribute them to a VA, the registered representative may be classified as a fiduciary under the rule as this constitutes retirement plan advice. Each of these scenarios is very common in the industry, and loss of rollover commissions will impact the bottom line.

As a result, registered representatives may be reluctant to make recommendations to transfer policies, which will likely affect the transaction volume of new annuity purchases. Additionally, because the fiduciary standard’s explicit intent is to eliminate sales incentives to move retirement investments from one product to another irrespective of the client’s best interest, there may be fewer funds available to buy VA products as liquidating IRAs may not be in the best interest of the client.

Retail advisors and non-affiliated BDs should consider the following in preparing for the final rule:

  • Compensation structures will need to be adjusted as certain commission structures will be banned by the proposal.
  • Registered representatives will need to refresh client profiles in order to align product advice with what is in the client’s best interest.
  • Training for registered representatives should be enhanced to include which product recommendations will subject them to the new fiduciary standard.

Wholesalers

Wholesalers will also be impacted. In a scenario where a wholesaler attends a meeting with an insurance agent or advisor for a group of retirement plan participants and provides “educational information” on specific investments in their 401k or other retirement plans, information provided by the wholesaler may be classified as fiduciary investment advice unless the information conforms to the education carve-out. Since wholesalers may be constrained in terms of their sales activities, the final rule could potentially have a negative impact on insurer product sales.

At a minimum, wholesaler training will need to be enhanced to ensure educational information is separate and distinct from investment advice.

Endnotes:

[1] For an overview of the proposal, see PwC’s DOL proposes to redefine fiduciary investment advice, update class exemptions (April 2015).
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[2] For an analysis of the proposal’s impact on asset managers, see PwC’s Regulatory brief, Fiduciary duty proposal: Disruptors at the gate (August 2015).
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