When fiduciary duty is at odds with what's right for clients

In the world of fiduciary financial planning, there's always going to be a new knot to untie, but some challenges just seem complex for no good reason.

Exhibit A is the example of a fee-only advisor trying to help a client secure a term life insurance policy.

As an insurance product, the term life policy will trigger a commission that the client will have to pay in addition to her advisory fee.

Being a fee-only planner, the advisor can’t accept the commission but understands how directing the client to the insurance increases her cost for financial planning.

One solution, pointed out by Chuck Failla, founder of Sovereign Financial Group, is to let the advisory firm collect the commission and then rebate back the value of the commission to the client so her total cost of financial planning doesn't change.

The problem with that strategy, Failla explained, is that the practice of offsetting fees and commissions is against the rules, which puts advisors in the position of perhaps not doing what's best for their clients in order to operate as a fiduciary.

So the only solution, which is really no solution at all, is to just let the client absorb the commission or bypass the fiduciary duty to provide the client with a comprehensive plan that would include buying a term life policy.

Failla said such scenarios aren't uncommon, particularly when working with so-called HENRY clients, an acronym for high-net-worth not rich yet.

“They usually don’t have a lot of money to manage, but they have a great need for financial planning work, and one of the things they really need is insurance,” he said.

In essence, Failla believes an advisor should be able to provide comprehensive financial planning without inflating the client’s fees and without running afoul of fiduciary guidelines.

“You set fees to justify the time you would need to work with a client,” he said. “But the client also needs a term policy, disability or long-term care insurance that will generate a commission for someone. That will happen. Period. Full stop.”

Even though Failla acknowledges the rules against rebating insurance commissions, he believes such rules put advisors in a position of not doing the right thing in order to adhere to certain fiduciary guidelines.

“As it stands right now, rebating insurance commissions would be deemed against the regulations,” he said. “But I think it’s hugely ethical to do that.”

Enter Knut Rostad, president of the Institute for the Fiduciary Standard.

“I have two problems with that idea,” Rostad said. “One relates to the level and full extent of the transparency in terms of what the sale means to the agent and the insurance company. The other problem is a principled problem in terms of a fiduciary changing roles to be both a product provider and protector of the client.”

Read more: The role of a fiduciary financial planner

It’s that second point that underscores the kinds of challenges fiduciaries can face.

Without putting words in Rostad’s mouth, strict adherence to fiduciary standards would subject a client to higher fees to stay clear of any connection to a product sale.

“I hear what you’re saying, but for fiduciary advisors, one of their main jobs is to protect clients from everything else out there,” Rostad said. “I get the idea but I’m still not comfortable because [the sale of a product] dilutes the role and job of a fiduciary.”

To be clear, Failla isn't advocating for insurance products or commissions. And Rostad shouldn’t be painted as the singular roadblock to flexibility on fees and commission offsets.

Unfortunately, it’s too easy to find examples of how following certain fiduciary guidelines can introduce situations that just seem counter to doing the right thing for clients.

Kate McBride, an analyst at the Center for Fiduciary Excellence and founder of the consulting firm Fiduciary Path, describes the insurance space as the last piece of turf to be tilled by fiduciary and fee-based influences.

“I think it’s noble that someone would want to avoid a conflict of interest that could arise,” McBride said. But she wonders whether it’s better to direct a client to an online discount insurance brokerage “where the client might end up with the wrong insurance.

“The most thoughtful advisors I’ve been working with are all familiar with this conundrum, and I don’t know of anyone who has solved it,” she said.