Not ready to become a DOL-compliant FI? Go partner with one

By Warren S. Hersch

September 16, 2016 at 03:30 AM

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The handful of independent marketing organizations that, since July, have applied to become a financial institution under the Department of Labor's fiduciary rule has a lot of market-watchers wondering how other IMOs on the sidelines intend to do business once the rule is phased in next year. Indeed, there are more than 350 of these insurance distribution intermediaries — many of them big sellers of fixed indexed annuities — that stand to lose a ton of business in the retirement space if they fail to take action.

For those not prepared to become an FI — and make the substantial investment in DOL-compliant business processes, technology and people — there's one potentially attractive alternative: partner with an IMO that is a financial institution. One organization that's availing IMOs of this option is Legacy Marketing Group, a Petaluma, California-based firm that, now its 23^rd year, has relationships with more than 200 IMOs and 27,000 producers nationwide.

To learn more about the company's go-to-market strategy under the rule, LifeHealthPro interviewed three Legacy executives: President Preston Pitts; Chief Marketing Officer Niju Vaswani; and Vice President of Compliance Chris Eaken. The following are excerpts from this 4^th installment in a series of Q&As with IMO executives and stakeholders on the DOL application process.

LHP: What did your FI application with the DOL entail? What remains to be done?

Eaken: We worked with outside counsel — the law firm Drinker & Biddle — in developing the application to comply with the DOL requirements. We're now awaiting feedback on business processes and procedures we've outlined for complying with fiduciary rule requirements: how we intend to levelize sales commissions for like products; mitigate potential conflicts of interest; and ensure that advisor-recommended products are appropriate for the client.

LHP: How would you describe the financial process at Legacy Marketing Group? Do you subscribe to, say, a holistic financial planning model that some IMOs believe most closely aligns with the new fiduciary rule?

Vaswani: We're different in that we work with many IMOs to help their advisors become successful selling insurance and financial services. We'll continue to occupy this niche under the fiduciary regime: As a financial institution, we'll avail their agents and advisors of training, education and guidance needed to be compliant with the DOL rule.

Pitts: We're now affiliated with about 200 independent marketing organizations, of which about 50 to 60 actively do business with us. We'll sign off on BIC [best interest contract] agreements for these IMOs and supervise their advisors throughout the sales process.

Compliance aside, these IMOs will remain actively involved in other aspects of their business: recruiting producers; providing sales training; assisting with product recommendations and, at a certain level, ensuring regulatory compliance.

LHP: Might the fact that Legacy-affiliated IMOs are operating under separate business models — some subscribing to holistic planning, others not — present a challenge for your organization in complying with the DOL rule?

Vaswani: There are indeed differences among marketing organizations. And, as you point out, some might have a more holistic approach than others.

What we plan to do is to share with our IMO partners the holistic method, including accompany training and education, which Legacy Marketing is developing to operate under a fiduciary regime. The goal is to have every IMO follow this DOL-compliant process.

LHP: How does the current process at your organization vary from what you'll be implementing to comply with the DOL rule?

Pitts: In today's world, producers do a fact-finding and needs analysis to ascertain the client's goals and objectives and then formulate a product recommendation that's suitable. In the new fiduciary world, the producer will have to ensure the recommendation is in the client's best interest — a higher standard of care than product suitability. There will also have to be more disclosures — including compensation to be paid to the producer — to mitigate potential conflicts of interest.

Eaken: Under the DOL rule, agents and advisors will have to compare clients' existing products with proposed products. Producers will also have to document their recommendations, explaining why a solution is in the client's best interest.

LHP: Do you envision that the transition from the old model to the new will be more or less seamless? Or do you expect there will be challenges along the way? Will your firm, partnering IMOs or their advisors have to revamp their businesses to such an extent that operating under the rule may prove problematic?

Pitts: There will be a transition period where the client conversations, disclosures of compensation and more general disclosures will be different. That may entail pain in the short-term for some; long-term, our DOL-compliant processes and disclosure will simply become a normal part of doing business.

LHP: How involved will the training be? And how will it be facilitated?

Eaken: LIMRA is now developing in-depth training for complying with the rule's BIC exemption requirements. Our goal will be to expand on their training by incorporating our sales process and technologies.

The education — covering documentation of the sales process, gathering info through fact-finders and a needs analysis, gauging the client's risk tolerance, then comparing and recommending products — could be delivered through a series of webinars and in-classroom instruction. We also have regional sales VPs who train across the country.

LHP: How many advisors are now affiliated with your partner IMOs? What's the extent of their current training and expertise?

Vaswani: About 27,000 producers are affiliated with us through the various IMOs. Between 25 to 30 percent, or about 5,000, actively do business with us. Based on our research, roughly 50 percent of the advisors have a Series 65 license and/or registration with a broker-dealer, allowing them to sell securities and/or provide other investment advice. The other half are insurance-only producers.

LHP: How else might these producers have to adapt their practices going forward? Should they expect a reduction and/or compression of sales commissions?

Pitts: Our expectation is that there will be some compression. But I don't think we're talking about a huge reduction: perhaps a 1 percent drop.

As to a levelizing of commissions, we will set up-front commission for products that are similar. To that end, we'll be conducting research to ensure we're offering compensation commensurate with what is generally acceptable (or) reasonable in relation to the products we sell and that present no conflict of interest.

LHP: Among the issues to be litigated in several lawsuits underway against the DOL are: (1) what constitutes reasonable compensation under the fiduciary rule; and (2) whether financial institutions and advisors should face legal exposure — the risk of lawsuits by the class action bar — for non-compliance with the rule. Do you see these as potentially significant issues to surmount?

Pitts: As to advisors, if they follow the guidelines of the financial institution, I would say they'll be reasonably protected relative to these issues. However, if they choose to recommend product the FI is not aware of and are creating their own conflicts, then they'll face litigation risk independent of any liability or exposure incurred by the financial institution.

Vaswani: The expectation is that the financial institution will help the advisor be insulated from legal exposure. By creating an integrated sales and compliance process, of which levelized commissions for similar products will be a part, Legacy Marketing will help to reduce and eliminate potential conflicts of interests tied to product recommendations.

Pitts: Respecting our own legal exposure, we wouldn't be applying to become a financial institution if we didn't believe we could appropriately balance sales and compliance in accordance with the DOL regulations. Yes, the industry will be more prone to lawsuits under the rule, but we're confident we'll be able to defend ourselves and create an environment to help insulate our advisors against such litigation.

LHP: As a result of this more litigious environment, would you expect many producers to leave the retirement space, an exodus not unlike what the U.K. experienced in 2013, when Britain's Financial Conduct Authority banned commissions?

Pitts: Some producers do have significant concerns about the fiduciary rule. They may opt to shift their business from qualified- to non-qualified plans, or to other revenue sources in the life insurance and financial services arena.

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But producers who take steps to understand the DOL's requirements, associate with a sound and reputable financial institution and follow that institution's prescribed process can be reasonably assured they won't face undue legal risk. I expect the vast majority of producers will find doing business under the rule acceptable in the long-run.

LHP: What about advisors who may wish to shift to a fee-only model to avoid the BIC exemption requirements respecting disclosures and such? Do you see this happening on a large scale? And is it a model you can work with at your own organization?

Pitts: To your last question, we have a registered investment advisory firm and we encourage insurance professionals to get Series 65-licensed. As part of the transition, they may sell insurance products while also deriving fees for managing assets as part of their planning process.

But it's a huge challenge to stop all income from commissions today and shift immediately to fees. A more reasonable approach is to evolve the method of compensation by gradually replacing commissions with fee income. Whether it's 100 percent or some lesser number, I would expect some proportion of producers to make this transition under the DOL rule.

LHP: As this transition happens, would you also expect more product manufacturers to institute fee-based or fee-like compensation for the products, as for example, Jefferson National has done with its Monument Advisor variable annuity platform?

Eaken: We have heard that a number of product providers are looking to develop and distribute fee-based fixed indexed annuities in tandem with an evolution of the marketplace under the DOL rule. We do believe more of these products will become available over time. As that happens, more Series 65-licensed advisors will look to incorporate these solutions into their product portfolios.

LHP: What lessons, tips or best practices can you share with other independent marketing organizations that are looking to qualify as a financial institution under the DOL rule or, alternatively, affiliate with an IMO like yours that's due to become an FI?

Pitts: A couple of things come to mind. One is don't be too casual about it. You need to do a good job of assessing the potential liability and costs you'll be taking on as a financial institution.

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Second, IMOs must be willing and able to make the financial investments — in technology, people and businesses processes — needed to create an integrated sales and compliance platform. Or, in the event of a lawsuit, they then have the documentation needed to mount a vigorous defense. They'll also need to review their E&O [errors and omissions] insurance to be sure they're properly covered against potential damages awarded a suit.

LHP: Given the required investments, would you expect more IMOs to subscribe to the model you're offering: not to become a financial institution themselves, but to partner with an IMO that is one?

Pitts: Yes, for those IMOs that are not prepared to make significant investments, we're offering a viable alternative. They can still provide support and services to their producers, while not taking on all of the other infrastructure needed as a financial institution. They'll be able to leverage what we or, should they choose a different partner, other DOL-approved IMOs have put together.