IMOs to DOL: Fiduciary rule class exemption sets too high a bar

Critics are voicing alarm over a Department of Labor proposal permitting independent marketing organizations to act as financial institutions under the DOL's best interest conflict rule. Chief among their concerns: that the proposal establishes too high a sales threshold for most IMOs, one that could force widespread consolidation of a distribution channel already facing an uncertain future under the rule.

That's the assessment of industry stakeholders contacted by LifeHealthPro following the department's January 19 release of its "Proposed Best Interest Contract Exemption for Insurance Intermediaries." Published in the Federal Register, the 220-page proposal (29 CFR 2550) would extend to qualifying IMOs a class exemption under the fiduciary rule from certain prohibited transactions of the Employee Retirement Security Act of 1974.

The proposal would allow IMOs, as well as insurance agents and life insurers they contract with, to receive compensation from sales of fixed indexed annuities. Absent the class exemption, sales commissions on FIAs would violate DOL provisions prohibiting fiduciaries from "engaging in self-dealing" and "receiving compensation from third parties" in respect to employee benefit plans and individual retirement transactions (notably plan rollovers) governed by ERISA.

"The proposal represents one step ahead, but two steps back," says Michael Kalen, CEO of Futurity First Insurance Group, a Middletown, Conn.-based IMO. "That the DOL took the time to understand what we do and grant us a class exemption, albeit an imperfect one, is a validation of the work we do. But we believe the additional requirements are onerous and not necessary to operate as a financial institution."

The sentiment is echoed by other market-watchers, who applaud the DOL's efforts to streamline the process for IMOs seeking to qualify as a financial institution under the rule's best interest contract (BIC) exemption, but object to the proposal's conditions. A key one is a provision stipulating that an IMO generate an average of $1.5 billion in fixed indexed annuity contract premiums for each of the three last fiscal years.

That eye-popping sum exceeds what most independent marketing organizations derive in FIA sales annually. Indeed, of the estimated 350 independent and field marketing organizations nationwide, observers say, fewer than a dozen meet the DOL's threshold. For those that don't (or can't), there are a handful of options:

- - exit the FIA business, selling only products, such as traditional fixed annuities, that fall outside the DOL's purview;
  - become a broker-dealer or registered advisory (RIA) firm subject to SEC and FINRA regulations governing the sale of securities products;
  - secure a non-class exemption, an avenue that some 20 IMOs had been pursuing until the DOL unveiled its proposal, but which may now be much more difficult to procure given the DOL's sales threshold; or
  - merge or partner with a larger IMOs that does qualify for the class exemption.

Clarity 2 Prosperity CEO Jason Smith says the DOL's class exemption for IMOs, if not revised, could prompt "massive industry consolidation" among the insurance intermediaries. (Photo: Thinkstock)

The last is considered highly likely — and on a huge scale — if the DOL doesn't significantly reduce the $1.5 billion requirement.

"There will massive industry consolidation," predicts Jason Smith, CEO of Clarity 2 Prosperity, an Ohio-based distributor. "Everyone in the IMO world will be looking to either buy or sell."

Even for those IMOs that do meet the $1.5 billion bar, the outlook may not be sustainable. Forcing insurers and producers to consolidate sales around a smattering of distributors could prove enormously disruptive, if not altogether damaging to the FIA market, the proposal's critics say.

Also a worrisome prospect: a big push by IMOs to meet the DOL's premium quota. That could create conflicts of interest — the very thing the department sought to address in establishing the fiduciary rule — as IMOs sell FIAs at the expense of other financial products that might be better suited to clients.

"The DOL has proposed a very rigid [floor] for qualifying as a financial institution," says Futurity First's Kalen. "This runs afoul of the spirit of the fiduciary rule, which ought to focus on principles-based concepts.

"With the $1.5 billion bar, you're incentivizing IMOs to sell more commission-based fixed indexed annuities to meet the threshold, as opposed to encouraging them to act as fiduciaries by incorporating level-fee investment products into training of insurance-only agents," adds Clarity 2's Smith. "Such a conflict of interest would be an unintended consequence of the proposal."

And one that would upend Clarity 2's efforts to date to secure FI status under the fiduciary rule. The company trains affiliated advisors on a holistic, fiduciary-compliant financial planning model offering both protection and investment products to clients.

Smith says the company had expected to broaden the training to insurance-only agents. But if the $1.5 billion bar isn't much reduced, the company will stick with its core field force: producers licensed to sell investment products.

The FIA sales minimum is not the only hurdle confronting IMOs seeking to qualify as financial institutions. Also to be satisfied are other provisions the proposed class exemption. Among them:

- - Submitting to an annual audit of financial statements by a certified public accountant;
  - Delegating an individual to review pending indexed annuity sales before sending FIA applications to insurers;
  - Giving agents annual class exemption compliance training; and
  - Maintaining fiduciary liability insurance (and/or unencumbered cash, bonds, bank CDs or other assets), equal to 1 percent-plus of the average annual amount of FIA contract sales.

IMOs have 30 days to comment on the proposal — and to try to persuade the DOL to make changes in line with what critics say the industry can support. (Photo: Thinkstock)

In respect to the last, the DOL proposal estimates that an IMO with average sales of $2 billion could satisfy this liability requirement by setting aside $20 million. If valued at 7 percent (3 percent net), the IMO's "attendant opportunity cost" would total $1.4 million ($600,000 net) in the first year.

"This is a very costly proposal, which we're not sure adds value to the end-consumer," says Futurity First's Kalen. "It will significantly raise costs, diminish advice and place undue administrative burdens on IMOs and advisors."

Smith says he can meet the additional requirements, but thinks the audit's focus is out of sync with the fiduciary's rule aim: getting agents and advisors to act in their client's best interest.

"I was surprised the DOL didn't place more emphasis on vetting of IMOs' best interest process," says Smith. "That's the most important thing: training their reps on what to say and do to ensure they're acting as true fiduciaries."

IMOs and other industry players have 30 days to comment on the proposal — and to try to persuade the DOL to make changes in line with what critics say the industry can support. But the finalizing of verbiage for the class exemption could be short-circuited by the fiduciary rule's opponents.

They encompass complainants in four court cases challenging the rule, including a 9-party lawsuit in Texas; congressional lawmakers who have introduced legislation to delay the fiduciary rule's implementation; and anti-regulatory Trump administration officials who may gut the rule entirely.

"There's a lot of uncertainty about the fate of the fiduciary rule, particularly in light of the change in administrations," says Bradford Campbell, an attorney at Drinker Biddle, which is representing several IMOs before the DOL. "With President Trump taking office, the rule could be repealed, which would make the IMO class exemption a moot issue."

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