Key Takeaways
- Two Texas Federal District Courts have “stayed” the effective dates of the DOL’s new fiduciary regulation and related exemptions, meaning that the private sector will not have to comply with those rules until the cases are resolved and if the guidance is vacated, those rules will never be effective.
- As a result, one-time recommendations to plans, participants and IRA owners will not be fiduciary advice for purposes of ERISA and the Internal Revenue Code.
- However, one-time recommendations of securities (and insurance products that are securities) are regulated by the SEC for broker-dealers and investment advisers.
- In addition, one-time recommendations of insurance products are regulated by state insurance departments and almost all of the states have adopted NAIC Model Regulation #275, either verbatim or in large part.
- This post covers NAIC Model Regulation #275’s provisions for recommending exchanges of individual retirement annuities (also referred to as qualified annuities).
The stay of the effective dates of the amended fiduciary regulation and amended exemptions means that the “old” DOL fiduciary regulation (the 5-part test) and the existing exemptions continue in effect indefinitely.
My last post, Fiduciary Rule 48, discussed the DOL’s “old” and continuing definition of fiduciary advice—the 5-part test—and how it might apply to recommendations to transfer IRAs—individual retirement accounts and individual retirement annuities. The post before that, Fiduciary Rule 47, discussed SEC and SEC staff guidance on recommendations to transfer IRAs. This post is about the application of the conduct standards in NAIC Model Regulation #275 to the recommendation of annuities. The Model Regulation has been adopted by substantially all of the states, either verbatim or in large part.
NAIC Model Regulation #275, titled Suitability in Annuity Transactions Model Regulation, imposes several “obligations” on insurance producers who recommend annuities to “consumers.” One of those is a “care obligation.”
The care obligation, which applies to all recommendations, including exchanges of qualified annuities, is:
Care Obligation. The producer, in making a recommendation shall exercise reasonable diligence, care and skill to:
- Know the consumer’s financial situation, insurance needs and financial objectives;
- Understand the available recommendation options after making a reasonable inquiry into options available to the producer;
- Have a reasonable basis to believe the recommended option effectively addresses the consumer’s financial situation, insurance needs and financial objectives over the life of the product, as evaluated in light of the consumer profile information; and
- Communicate the basis or bases of the recommendation.
In its essence, the obligation requires that an insurance producer have a reasonable basis to believe that the recommended annuity addresses the consumer’s needs in light of the consumer’s financial situation and objectives, and the consumer’s insurance needs. On the face of it, there doesn’t appear to be a requirement to assess the consumer’s current financial situation to determine if it is in the best interest of the consumer to stay “as is” (for example, would the consumer’s “best interest” be to continue to hold securities in an existing IRA or would the consumer be better off in an annuity).
However, there are additional considerations for exchanges. For purposes of this article, I am assuming that a recommendation to exchange a qualified annuity (that is, an Individual Retirement Annuity) for another can be viewed as the equivalent of recommending a transfer of an IRA—an Individual Retirement Account.
With regard to recommendations of exchanges of annuities (including qualified annuities), the Model Regulation says:
In the case of an exchange or replacement of an annuity, the producer shall consider the whole transaction, which includes taking into consideration whether:
- The consumer will incur a surrender charge, be subject to the commencement of a new surrender period, lose existing benefits, such as death, living or other contractual benefits, or be subject to increased fees, investment advisory fees or charges for riders and similar product enhancements;
- The replacing product would substantially benefit the consumer in comparison to the replaced product over the life of the product; and
- The consumer has had another annuity exchange or replacement and, in particular, an exchange or replacement within the preceding 60 months.
In the case of exchanges, the producer is required to consider factors about the annuity that will be replaced, for example, whether there will be a surrender charge, a new surrender period, loss of benefits, and increased costs. The producer must also evaluate both the current and the proposed annuity to determine if the replacement annuity would “substantially benefit the consumer.” (As an aside, the recommendation to take money out of a retirement plan, e.g., a 401(k) plan, to purchase an annuity does not require a comparative analysis under the NAIC Model Regulation.)
The Model Regulation goes on to say:
Prior to or at the time of the recommendation or sale of an annuity, the producer shall have a reasonable basis to believe the consumer has been informed of various features of the annuity, such as the potential surrender period and surrender charge, potential tax penalty if the consumer sells, exchanges, surrenders or annuitizes the annuity, mortality and expense fees, investment advisory fees, any annual fees, potential charges for and features of riders or other options of the annuity, limitations on interest returns, potential changes in non-guaranteed elements of the annuity, insurance and investment components and market risk. (Emphasis added by me.)
Under ERISA’s fiduciary standard and the SEC’s best interest standard, the advisor would be required to be consider these factors in developing the recommendation—as opposed to disclosing them to the consumer. To be fair, though, some of these factors would likely be included in the requirements above for consideration for recommendations to exchange annuities.
An interesting aspect of the regulation of annuities is that “insurance only” annuities are regulated by state insurance departments, while “securities annuities” are regulated by state insurance departments and securities regulators (e.g., the SEC, state securities departments and FINRA). The Model Regulation contemplated that and included a carve out for securities advisors subject to regulation by “comparable standards”, which include the SEC’s Regulation Best Interest for broker-dealers and the SEC’s standards for investment advisers under the Investment Advisers Act:
Recommendations and sales of annuities made in compliance with comparable standards shall satisfy the requirements under this regulation. This subsection applies to all recommendations and sales of annuities made by financial professionals in compliance with business rules, controls and procedures that satisfy a comparable standard even if such standard would not otherwise apply to the product or recommendation at issue. However, nothing in this subsection shall limit the insurance commissioner’s ability to investigate and enforce the provisions of this regulation.
That means that, in effect, broker-dealers and investment advisers will be subject to their respective standards, which are fiduciary-like, for the recommendation of “securities annuities”. “Securities annuities” include variable annuities and RILAs, or registered index-linked annuities. On the other hand, insurance-only producers will be subject to the NAIC Model Regulation’s care obligation. Insurance-only annuities would include traditional fixed annuities and fixed indexed annuities.
As a result, there are two separate regulatory regimes for the sales of annuities, with the sale of securities annuities being subject to more demanding standards.
Concluding Thoughts
As I interpret the standards, the DOL’s fiduciary standard of care is the most demanding, as it requires a comparative process and mandates a recommendation that is in the best interest of the retirement investor, even if that is to leave the money in the existing IRA. The SEC standards for broker-dealers and investment advisers is similar, but in my view a bit less demanding than the DOL’s.
The NAIC Model Regulation is more than a suitability rule, but it doesn’t seem to require a comparative analysis of the consumer’s current financial circumstances combined with an obligation to recommend that the consumer not make changes—where that would be appropriate. Nonetheless, with regard to exchanges, the requirement that the replacement annuity “substantially benefit” the consumer provides protections against exchanges that are not in the best interest of the consumer. On the other hand, where the consumer has an IRA—an individual retirement account—that holds securities (e.g., mutual funds or ETFs), there isn’t a requirement to compare the two and make a recommendation that is in the best interest of the consumer. Instead, the requirement is that the producer reasonably determine that “the recommended option effectively addresses the consumer’s” situation, needs and objectives.
