Fred Reish, a partner at international law firm Drinker Biddle, assesses the impact of the US Department of Labor’s Fiduciary Rule on fixed index sales by independent insurance agents. Reish explains that the implementation of the standards and requirements of the rules will be “tumultuous” and insurance agents will need to overhaul their existing methods of doing business.

In April of this year, the US Department of Labor (DOL) issued a regulation defining fiduciary investment advice for recommendations of investments and insurance products to tax-qualified retirement plans (“plans”) and individual retirement accounts and annuities (“IRAs”).

When the rule is applicable on April 10, 2017, any adviser or agent who recommends an investment or insurance product to a plan or an IRA will become a fiduciary.

As a result, prohibited transaction rules in the Internal Revenue Code (“Code”) and the Employee Retirement Income Security Act (“ERISA”) will prohibit the agent or adviser from receiving any compensation, unless the detailed conditions of exemptions, or exceptions, are satisfied.

The exemption that applies to fixed indexed annuities is the Best Interest Contract Exemption (which is commonly referred to as BICE or BIC).


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While the new rules are requiring many financial service companies to restructure their businesses (for example, broker-dealers), the greatest disruption has occurred in the distribution of fixed indexed annuities.

To understand that statement, some background is necessary. BICE requires that a fiduciary adviser or agent be supervised by a “Financial Institution.”

That exemption identified four types of financial Institutions: broker-dealers; registered investment advisers; bank and trust companies; and insurance companies.

The DOL contemplated that insurance companies would agree to be fiduciaries to oversee the sales practices of, and compliance requirements for, insurance agents.

However, while insurance companies have generally agreed to serve as a fiduciary financial institution for captive or career agents, most felt that the relationships with independent insurance agents were so limited that the insurance companies were unwilling to, in effect, be co-fiduciaries with the independent agents (particularly considering the fiduciary oversight responsibilities and the potential for class action litigation)

It initially appeared that independent insurance agents would not be able to continue to sell fixed indexed annuities.

However, as the insurance industry became familiar with these issues, a number of organizations (for example, independent marketing organizations [IMOs] and field marketing organizations [FMOs]) decided to use a provision in BICE that permitted a fifth category of Financial Institutions.


Qualifying as a financial institution

To qualify as a Financial Institution under that fifth category, organizations must apply to the DOL and establish they are capable of the training and supervision required to comply with the fiduciary standard and the conditions of BICE.

As a result, the DOL is now processing approximately 15 applications for IMOs and FMOs that have applied for Financial Institution status. Once the DOL approves organizations as Financial Institutions, others will utilize Financial Institution status, as well.

However, obtaining that status is just the beginning of the process. These new insurance Financial Institutions will need to develop policies and procedures for the training and supervision of the covered agents; train the agents about the fiduciary approach for recommending fixed indexed annuities (including the fact that, if it is not prudent in a particular case to recommend an annuity, the agents should not make such a recommendation); develop contracts that describe their services, compensation, material conflicts of interest, etc.; and so on.

With regard to the insurance commissions paid to the Financial Institutions and the agents, BICE provides that compensation cannot be more than a reasonable amount for the services provided.

That requires that industry data and benchmarking information be obtained and evaluated and that reasonable compensation programs be developed for payments to the independent agents.

In addition, a Financial Institution can only pay “level compensation” for the products within the particular insurance category. To explain, the Financial Institution will need to establish level (and reasonable) compensation for the agents for their services in the first year (that is, the year of the sale) and for their services in each subsequent year.



Hypothetically, that could mean that a fiduciary agent could earn compensation of 4% of the first year’s deposits and then a trail of 25 basis points a year thereafter.


Since the compensation would be level across all fixed indexed annuities, a fiduciary agent could not be paid more for selling the products of one insurance company than another. The Department of Labor’s thinking is that, if the adviser’s compensation is the same regardless of which insurance company’s annuity is recommended, the fiduciary agent would focus on the needs of the IRA or plan investor.

In addition, the Financial Institution will need to supervise the sales practices of the independent agents to ensure that the recommendations being made are in the best interest of the investor.

This “best interest” standard requires that the independent agent engage in a prudent process for developing the recommendation to the qualified investor, including, for example, an assessment of the financial stability of the insurance company, the terms and conditions of the contract, the guaranteed income needs of the investor, the portion of financial assets to be allocated to the annuity, and so on.

While these changes are highly disruptive, the actions of the intermediary organizations to become Financial Institutions are the beginning of a solution. But, that’s just the first step.

The implementation of the standards and requirements of the rules will be tumultuous, in the sense that those organizations and the insurance agents will need to materially change their existing methods of doing business.