In November 2015, the Obama administration eliminated and phased out Social Security claiming strategies, calling them unintended loopholes. After Mr. Obama fixed Social Security, our savior of social injustice, along with his administration, he decided to fix the financial industry. The result was the Department of Labor conflict-of-interest rule. This rule created its own unintended consequences, which are not only massive but also extremely intriguing.
First, let me say this: I like the idea of all advisors, even bank tellers, being held to a fiduciary standard. But I don't agree with the rule the way it's written. The particulars and the ambiguities of the rule show the DOL's lack of understanding regarding product distribution channels and its inability to use tangible math (such as reasonable compensation — most advisors think every penny they are paid is reasonable).
Here's a quick recap of the rule. Since the 1970s, we've had what's called Prohibited Transaction Exemption (PTE) 84-24. This exemption allows fiduciaries to sell commissionable products, such as annuities and mutual funds. The new rule drags fixed index annuities (FIAs) out from under the warm PTE 84-24 umbrella and shoves them into the cold confines of the Best Interest Contract Exemption (BICE) juvenile detention center with variable annuities (VAs) and mutual funds. Proposed rules in 2010 and 2015 showed no indication that this was to come.
The new rule, among other things, limits compensation to what's reasonable, seeks to eliminate conflicts of interest including trips and rewards, and requires a financial institution to sign as a fiduciary. This is fine and dandy in the VA world, because VAs are primarily sold through broker-dealers who already act as the financial institution between the producer and the insurer. But in the FIA world, often there is no financial institution intermediary. So either insurers, who have tens of thousands of 1099 contract employees must decide to take on the liability of producers they've barely trained and often have never met, or the distribution of FIAs must change.
Here's an easy fix: Require all insurance producers to create a limited liability company and have that LLC apply for an insurance agency license through the state. Then ask the DOL to give insurance agencies an exemption so they can be listed as a financial institution. Voila! There's now a financial institution between the producer and the insurer. That might work, but there's a much better way. (We'll come back to this, I promise.)
The DOL rule will be the death of:
- Variable annuities with an income rider
- Bank CDs with maturities greater than 3 years
- Index annuities provided at point of sale (pay particular attention to this)
The death of CDs
First we'll do number two. Crap, that's not what I meant. (Tell me puns aren't funny!)
If you read through the rule or the many abstracts found online, buried within is the fiduciary regulation of qualified CDs. The banks asked for an exemption and the DOL bluntly said no. Good for you sirs and madams of the DOL.
Imagine the world of CDs going forward — a minimum wage (not to be confused with the Bernie Sandersites' "working wage") bank teller will now be held as a fiduciary. Right now this financially illiterate pest spews out bad math faster than Dave Ramsey to convince bank customers to leave their money at the bank in a CD rather than in the financial products you've suggested. This will happen no longer my friends. No longer. Now, they'll be regulated as a fiduciary, and as such, corporate will tell them to no longer give advice. Kudos since they weren't qualified to give advice anyway.
It doesn't end there though.
How will a bank justify the lower returns and lower liquidity of a bank CD in comparison to a multi-year guaranteed annuity (MYGA)? Given the relatively few MYGAs with surrender periods less than 3 years, CDs with shorter maturities should survive, but those with a maturity greater than, say, 36 months will become extinct. Only the qualified ones you say. Wrong. Come on. It's only a matter of time until these rules pervade into the nonqualified investment arena.
The death of FIA distribution
Now onto the death of the current distribution of FIAs. I know, I know. What a travesty for our industry. Or is it? Remember this article is about unintended consequences. The unintended consequence to the FIA market will simplify and purify the product back to how it was initially designed. I'm telling you right now, this is super exciting. If only I could type as fast as I can talk!
When in doubt do what the government does. Just break it up.
First, imagine the mortgage world simplified. (Yes this is about annuities, but stay with me.) Can you imagine if the mortgage world only allowed the sale of 30-year fixed-rate mortgages? Everyone from age 18 to 94 understands a 30-year fixed-rate mortgage. After the loan is placed, the buyer has a mandatory blackout period of 6 months to a year. At this point, the buyer can exchange a 30-year fixed-rate mortgage for any mortgage offered by the lender at the current market rates. No more new underwriting, appraisal or closing costs are required when staying with the same lender.
You may choose to change the mortgage for any number of reasons, but they will be reasons you came up with — reasons you understand. Not reasons only a broker, or better yet a math whiz, can explain. Can you imagine the money the average homeowner would save by eliminating these charges that are only justified by a small interest rate decrease with a breakeven point past the average mortgage holding period? Just as importantly, can you imagine the amount of cost savings the mortgage companies would realize? Right now it's the same mortgage being sold, re-sold and repackaged. Does this sound like annuities at all?
Moving qualified indexed annuities out from under the protection of PTE 84-24 doesn't lead to their extinction like some carriers seem to think. In fact, it's the opposite. With change comes innovation. The answer is in front of us. We can simplify and strengthen. We can increase market share and profitability per dollar deposited.
Indexed annuities generally have both indexing options and a fixed interest rate option. These should be priced without bias, meaning the carrier does not make a larger or smaller spread regardless of the allocation between the different options. Therefore, break the annuity up and it will be regulated as it always has under PTE 84-24.
