Selling annuities under the DOL fiduciary rule is a whole new ballgame

Selection process will be like a suitability standard on steroids, requiring an analysis like those done by a financial planner

Sep 21, 2016 @ 1:20 pm

By Greg Iacurci

The Department of Labor's fiduciary rule will fundamentally change the way brokers can select annuities for clients.

Brokers are currently able to sell annuities under a suitability standard, but fiduciary experts describe new DOL requirements as a suitability standard on steroids that will require a comprehensive client analysis similar to one performed by a traditional financial planner.

“The focus of the fiduciary rule is to compensate people for planning, not for product sales,” Jamie Hopkins, a professor in the retirement income program at The American College of Financial Services, said. “So that's the big change.”

The DOL rule, which goes into effect in April 2017, makes a fiduciary of any adviser receiving compensation for an investment recommendation in retirement accounts.

As such, advisers will need to determine if a specific annuity recommendation is in a customer's best interest, a standard that involves giving “prudent” advice (as defined by the Employee Retirement Income Security Act of 1974) and maintaining a duty of loyalty to the client.

(More: State Farm, citing DOL fiduciary rule, cuts agents from mutual fund and variable annuity sales)

Those requirements are “over and above what is normally thought to be a suitability analysis, at least in the broker-dealer sense,” said Bruce Ashton, a partner in the employee benefits and executive compensation practice group at Drinker Biddle & Reath. “Is this a prudent choice for the client as opposed to an acceptable choice?”

Suitability requirements exist at the federal level, but state suitability law dictating annuity sales can vary. The National Association of Insurance Commissioners established a model regulation years ago, which several states have adopted or modified, that lays out client information a broker needs to make a suitable recommendation.

Those data points include age, income, financial experience and objectives, time horizon for holding the annuity, existing assets, tax status and risk tolerance. A broker would likely still require this information under the DOL rule, but will have to scrutinize additional data points and analyze the impact on the client's total financial situation, as opposed to doing an analysis solely at the transaction level, Mr. Hopkins said.

Kevin Loffredi, senior product manager of annuity solutions Morningstar Inc., said an annuity analysis should combine both qualitative and quantitative factors.

It starts with one question: Does it make sense to have guaranteed income? This analysis determines if an adviser should even consider an annuity for a particular client.

That can be broken down into four considerations: a client's desire for income; likelihood of staying in the product for life; longevity (the longer someone is expected to live, the more annuitization makes sense); and presence of a retirement income gap (after Social Security and other income streams, will there be a gap in covering fixed expenses?).

Then, determining when a client needs the annuity income (now or later) whittles the choice down to an immediate versus deferred income annuity, Mr. Loffredi said.

If a variable or indexed annuity, two types of deferred annuity, make sense, advisers have to delve into the specifics of any living-benefit rider attached, Mr. Loffredi added. For example, what is its baseline guaranteed income, what investment restrictions exist, does the insurer have the right to increase fees on the benefit and how high can they go, and what are the income step-ups to reward positive market performance?

“It really comes down to knowing the client, which is part of suitability, but it's taking that and going to the next step, which is working out what's the best option for that particular client,” Mr. Loffredi said.

Further, advisers would need to look at an insurer's credit to determine its ability to make annuity payments in the future, according to Mr. Ashton.

The DOL rule gives guidelines for assessing the prudence of a particular indexed annuity, saying advisers should have an understanding of: surrender terms and charges; interest rate caps; the particular market index to which an annuity is linked; the scope of any downside risk; associated administrative and other charges; the insurer's ability to revise terms and charges over the life of the investment; methodology used to compute the index-linked interest rate; and any optional benefits, such as living and death benefits.

Advisers can “somewhat extrapolate” from this list what the DOL may require for other types of annuities as well, Mr. Ashton said. However, there will be differences in scrutiny based on the type of annuity.

(More: Government Accountability Office pushes DOL to update 401(k) annuity rules)

For example, in a variable annuity, advisers should look at the quality of the underlying investments as well as the quality of the annuity product, which ends up being a similar analysis to that of a suite of mutual funds, Mr. Ashton said.

And even though variable and indexed annuities fall under the enhanced compliance regime of the best-interest contract exemption when compared with fixed rate annuities such as immediate annuities, the fiduciary standard of care remains the same, no matter the product, Mr. Hopkins said.

Companies such as Morningstar and CapitalRock have programs in place to help walk brokers through the annuity-selection process and document why a particular decision was in a client's best interest.

Raymond James Financial Services Inc. was a development partner on CapitalRock's product, called Annuity Wizard, and uses it with its registered reps. Morningstar's tool is called the Best Interest Proposal System.

There's a caveat to all this: If a broker-dealer doesn't offer any annuities on its platform that represent a prudent investment for a client, the broker may not be able to use one at all.

“There's no blanket protection for products you have access to,” Mr. Hopkins said. “There are situations where you'll just have to say, 'We don't have something that fits your needs.'”

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