Some firms opting to sell fixed annuities under best-interest contract exemption to keep trips, bonuses intact

Some financial institutions are opting to sell certain types of fixed annuities under a stricter compliance regime of the Labor Department’s fiduciary rule than is necessary, in order to continue to offer incentives such as bonuses and trips.

The Department of Labor rule, which raises investment advice standards for retirement accounts, allows for forms of variable compensation such as commissions and bonuses it believes could lead to conflicted investment advice.
However, brokers and insurance agents must adhere to the strict compliance guidelines set forth in a “prohibited transaction exemption” to earn this type of compensation.
One such exemption, the best-interest contract exemption, is viewed as particularly onerous by the financial services industry due to the exposure it gives to potential class-action lawsuits from investors. It is a broad, flexible exemption covering several products such as variable and fixed indexed annuities.
Another, known as Prohibited Transaction Exemption (PTE) 84-24, is a narrower exemption covering sales of “fixed-rate annuity contracts,” such as immediate annuities and deferred income annuities. It’s generally seen as less threatening and burdensome, especially due to insulation from class-action exposure.
However, Fred Reish, a partner Drinker Biddle & Reath, said some of his clients want to sell fixed-rate annuities under BICE rather than PTE 84-24 to keep some entrenched compensation practices intact.
“84-24 says the adviser or agent can only receive a commission, period. No trips, awards, bonuses, no nothing. Only a commission,” Mr. Reish said. “BICE, if properly managed, allows additional compensation.”
Financial institutions are determining if trips and bonuses are important enough to forego the “relative ease” of complying with PTE 84-24, and take on the difficulty and risk of complying with BICE, Mr. Reish said.
As an example of BICE’s potency, Merrill Lynch, which houses 14,000 advisers, is nixing commissions in new IRAs as of April 2017, when the DOL rule comes into effect, in order to avoid having to use that exemption.
Also speaking to the potency of BICE in relation to PTE 84-24 is the insurance industry’s uproar over fixed indexed annuities being removed from 84-24 and placed within BICE in the final rule.
The fact that some large brokerages are trying to get out from under BICE’s thumb makes it all the more remarkable that some would actively seek to use it, and speaks to the importance of incentive compensation among some brokerages, registered representatives and insurance agents.
“That’s a fairly standard thing, bonus trips tied to production,” according to Jamie Hopkins, a professor in the retirement income program at The American College of Financial Services. “It encourages people to go out, sell, work with clients and get product out there, so that behavior was encouraged.”
Even though BICE may technically allow for non-cash compensation such as bonus trips, financial institutions would still have to ensure aggregate fees, including those tied to non-cash compensation, are reasonable, Mr. Hopkins said.
Further, because the DOL amended language of PTE 84-24, which existed prior to the fiduciary rule, to remove the possibility of bonus trips under that exemption, it’s a signal regulators are looking to tamp down on this compensation arrangement.
“While technically [BICE] will allow for it, it seems it’s not favored under the DOL rules,” according to Mr. Hopkins. “I think it’s still doable. You just have to look at it and say, ‘What’s the cost of this and the other fees to the client?’ If it’s reasonable, it’ll be OK.”
Some firms have discussed keeping incentives such as trips intact, but developing another measure than sales to earn them, such as customer satisfaction ratings, Mr. Hopkins said. However, it’s still a little risky to do this, said Mr. Hopkins, who gave a hypothetical scenario where annuity sales leaders still somehow end up earning the trips but under different metrics.
“Just because you call it something else doesn’t necessarily mean it’s different,” he said.
Of course, sellers of fixed-rate annuities may be looking to use BICE for other reasons, and being able to use some non-cash compensation is a fortunate secondary outcome for them.
For example, because a recommendation to roll over money from a 401(k) to IRA would more than likely require use of BICE, using that same exemption to cover the recommendation to buy a fixed-rate annuity may not be much of a stretch, Mr. Hopkins said.