This paper explains the basis for our conclusions about the impact of the Department of Labor (DOL) proposal to amend the fiduciary investment advice regulation and the prohibited transaction (PT) exemptions for sales of insurance products to plans, participants and IRAs.
These changes affect insurance agents, brokers, and consultants (who we collectively refer to as “Insurance Advisors”), as well as their affiliates (which could include insurance companies and broker-dealers). We use the term “sales” to refer to fiduciary recommendations, since the expanded definition of fiduciary investment advice is so broad as to encompass most sales practices.
Conclusion No. 1: PT relief for the receipt of sales commissions has been available under Prohibited Transaction Exemption (PTE) 84-24 for sales by “fiduciary” Insurance Advisors of fixed and variable insurance products to plans and IRAs, and this will continue (but with some changes). Under the proposal, the PTE will continue to be available for sales of fixed and variable products to plans and participants, and for sales of fixed annuity products to IRAs. (By “fixed,” we mean insurance products that are not treated as securities.) However, for IRAs 84-24 relief will not be available for insurance products that are treated as securities under federal securities laws “annuity securities”). To satisfy the conditions of the exemption, the Insurance Advisor and the insurance company would need, among other things, to comply with “Impartial Conduct Standards.” That is, they would need to act in the best interest of the plan, participant or IRA in making recommendations. Also, Insurance Advisors and their affiliates would not be able to receive revenue sharing, administrative and marketing fees.
Under the current 84-24 exemption, Insurance Advisors who make fiduciary recommendations can receive commissions for selling insurance products to plans, participants and IRAs without committing a PT, so long as specified conditions are met. In its current form, this PTE applies to the fiduciary sale of insurance and annuity contracts, regardless of whether such products are treated as securities under federal securities law.
The proposed amendments to 84-24 would make three significant changes.
- For sales to IRAs, the availability of PTE 84-24 would be limited to sales of insurance products that are not securities under federal securities laws, such as fixed annuity contracts. This means that Insurance Advisors who sell variable annuity contracts (or “annuity securities”) - which are securities under federal securities law – to IRAs would not be able to use PTE 84-24 to avoid a PT for those sales. (But, see Conclusion No. 3 below, which explains that the Best Interest Contract Exemption (BICE) is available for these sales.) However, for sales to plans and participants, 84-24 would be available for all insurance and annuity products, regardless of whether they are annuity securities.
- The proposal defines “commission” to mean a sales commission paid by the insurance company or its affiliate to the Insurance Advisor for effecting the sale, and includes renewal fees and trailers. The proposed exemption excludes the following “compensation” from PT relief: (1) revenue sharing payments, (2) administrative fees, (3) marketing payments, or (4) payments from parties other than the insurance company or its affiliates. Thus, Insurance Advisors and their affiliates would not be able to receive those types of payments for sales to plans, participants or IRAs, if 84-24 is amended as proposed.
- The proposal would require the fiduciary Insurance Advisor to adhere to “Impartial Conduct Standards.” These standards would require that the Insurance Advisor act in the “Best Interest” of the plan, participant or IRA and disclose “Material Conflicts of Interest.” The definition of “Best Interest” is almost identical to the ERISA prudent man and duty of loyalty rules -- except that it also requires that the recommendation be without regard to the financial or other interests of the Insurance Advisor, insurance company, related entity or other party. Even though the “Best Interest” standard is included in 84-24, the contract requirement of BICE is not.
Impact: Because of the expansion of the definition of fiduciary advice and the new Best Interest standard, these proposed amendments could materially impact Insurance Advisors. That is particularly true for sales of variable annuities to IRAs. In order to avoid a PT for those sales, they would need to comply with the requirements of BICE, discussed below.
Also, revenue sharing, administrative or marketing payments are not covered by PTE 84-24. In other words, those payments would be PTs even if 84-24 was otherwise satisfied.
Conclusion No. 2: Under the expanded re-definition of fiduciary, recommending a distribution or rollover or making recommendations about the investment of property to be distributed or rolled over also constitutes fiduciary investment advice. As a result, Insurance Advisors making these recommendations would be considered fiduciaries, would be subject to the ERISA PT rules, and would need exemptive relief to avoid the adverse consequences of a PT.
The fiduciary advice proposal covers recommendations to plans and/or participants that they invest in insurance or annuity products. That would include, for example, the “sale” of insurance products to a participant’s account. Similarly, it could cover the sales of group annuity contracts to plans.
The proposal also expands the definition of fiduciary investment advice to include a recommendation to take a distribution or rollover and recommendations as to the investment of the property to be distributed or rolled over from the plan or IRA. As a result, Insurance Advisors who recommend distributions and rollovers from plans and/or who recommend investing distributable plan or IRA assets in insurance or annuity products would be fiduciaries and would be subject to the ERISA and Code self-dealing PT rules..
Under the PT rules, a fiduciary cannot cause itself or an affiliate to receive additional compensation or to receive compensation from a third party in connection with transactions involving plan assets. This means that an Insurance Advisor who is a fiduciary cannot cause himself to receive additional compensation (for example, a commission) or to receive a payment from a third party (e.g., an insurance company) for the sale of an insurance product recommended to the plan, participant or IRA. To avoid committing a PT, an Insurance Advisor needs exemptive relief. For fixed annuities, that relief would be found in PTE 84-24. For variable annuities (or “annuity securities”), it would be in BICE.
Conclusion No. 3: The exemption for sales of insurance products that are securities under federal securities laws, such as variable annuities, was transferred to the proposed “Best Interest Contract Exemption” or “BICE,” which has a number of new and difficult conditions.
For sales of annuity securities to IRAs, the proposal transfers the exemptive relief to a new exemption called the Best Interest Contract Exemption (or BICE). That exemption would allow Insurance Advisors who sell annuity securities to IRAs to receive commissions without violating the PT rules, so long as the detailed and difficult conditions of BICE are satisfied.
Under BICE, the Insurance Advisor and insurance company would need to enter into a contract with the IRA owner before making an investment recommendation. The contract would need to contain a number of provisions including: (i) an acknowledgement of fiduciary status; (ii) various warranties; (iii) provisions under which the Insurance Advisor and insurance company would agree to adhere to the best interest standard, receive no more than reasonable compensation and not make misleading disclosures; and (iv) financial disclosures.
The financial disclosures – a transactional disclosure and an annual disclosure – must be made in dollar amounts. The transactional disclosure would be made prior to investing in the variable annuity contract and disclose the total cost of investing in it. The annual disclosure would be made each year and would report the total dollar costs of the contract (and investments) in the preceding year and the total dollar amount of the compensation paid to the Insurance Advisor and the Financial Institution (e.g., the insurance company or broker-dealer) in the preceding year. Also, the insurance company (or broker-dealer) would be required to maintain a website with detailed financial information and file a notice of intent to use the exemption with the DOL.
A more detailed discussion about BICE is beyond the scope of this Analysis, but we believe that compliance with the requirements will be challenging and will require operational and systems changes. However, it will be discussed in a future Alert and Analysis.
The proposal will have a significant impact on Insurance Advisors. Under the proposed fiduciary definition, most Insurance Advisors would be considered fiduciaries, subject to the Best Interest standard and PT rules. In order to avoid a PT on the sale of insurance products to plans and participants, an Insurance Advisor would need to satisfy the requirements of PTE 84-24. In order to avoid a PT on the sale of insurance products to an IRA, the Insurance Advisor would need to comply with PTE 84-24 for sales of fixed annuity contracts and BICE for sales of variable annuity contracts (i.e., annuity securities).
 Definition of the Term “Fiduciary”: Conflict of Interest Rule — Retirement Investment Advice, 80 Fed. Reg. 21928; Proposed Best Interest Contract Exemption, 80 Fed. Reg. 21960; Proposed Class Exemption for Principal Transactions in Certain Debt Securities etc., 80 Fed. Reg. 21989; Proposed Amendment to Prohibited Transaction Exemption (PTE) 75-1, Part V, etc., 80 Fed. Reg. 22004; Proposed Amendment to and Proposed Partial Revocation of Prohibited Transaction Exemption (PTE) 84-24 etc., 80 Fed. Reg. 22010; Proposed Amendment and Proposed Partial Revocation of Prohibited Transaction Exemption (PTE) 86-128 etc., 80 Fed Reg. 22012; and Proposed Amendments to Class Exemptions 75-1, 77-4, 80-83 and 83-1, 80 Fed Reg. 22035 (all April 30, 2015).