As of June 9, all sales involving qualified funds must follow the Impartial Conduct Standards.
One of the standards is that advisors who make a recommendation to purchase an annuity must receive no more than reasonable compensation. Naturally, advisors call us all the time asking what is a reasonable and what is an unreasonable commission?
Because reasonable compensation is a vague and undefined standard, this question cannot be answered with absolute certainty and assurance. However, the DOL has held ERISA plan fiduciaries to this standard for many years, which gives much history to guide us and how fixed annuity commission structure may help to apply best compensation practices in an annuity practice.
The AssessBEST Team has spent hundreds of hours reading ERISA, the Fiduciary Rule and all relevant White Papers. We are working with many legal experts from the industry, as well as our own legal counsel, to understand the Rule’s compliance requirements. We have also had multiple meetings with the DOL to discuss this requirement. However, it is important to make a special note that this column’s purpose is to guide advisors to understanding reasonable compensation issues. This is not legal advice. Readers should always consult their own legal experts who are familiar with your business practice and policies.
What is Reasonable Compensation?
The DOL Rule states that reasonable compensation has traditionally been interpreted and applied against market-based benchmarks which typically means what is “usual and customary” in the marketplace.
Compliance with this standard will be determined based on whether an advisor’s compensation is generally in line with amounts being received by others in the market making recommendations of similar products, as well as the services, rights, and benefits the advisor and firm provide to your clients.
Advisors should ask themselves a simple question: “Is this recommendation paying about the average of what is paid for similar product types and product classes”? If the answer is “yes,” then it will likely be considered reasonable.
Examples of product types are fixed annuities versus variable; fixed indexed versus fixed rate, mutual funds versus annuities. Examples of product classes are MYGAs versus Book Value; 10-year surrender versus 7-year surrender, deferred versus immediate.
However, the compensation paid for Company A’s 7-year FIA versus Company B’s is not the only measurement. Our conversations with the Department made some things clear. If a product type (for example, an FIA) was recommended when a different type (a MYGA) may appear to better meet the client’s goals, needs, risk tolerance and time horizon, then the FIA recommendation may look like unreasonable compensation.
In this example the MYGA paid 2 or 3 percent less commission and was “better” for the client. The advisor must make the case through thorough analysis AND with documentation why an FIA recommendation was a better fit for the client.
The standard applies to a specific recommendation. A claim of unreasonable compensation can be made on an individual sale. The reasonable compensation requirement can also be applied to an advisor’s patterns and practices of recommendations. For example, if every recommendation for every client is Company A’s Product XYZ, that pattern and practice could be a red flag for lawyers trolling for lawsuits.
Advisors should review the compensation they are paid on the products they have are authorized to sell and identify products whose compensation is outside the average for the market of similar product types and classes.
Recommendations of the higher compensation products will be subject to higher scrutiny and, again, require detailed documentation of their analysis and rationale why the recommended product best met the client’s goals. Recommendations outside the average or higher than street (what others receive) will require neutral factors to justify the compensation differential and the recommendation.
What is Differential Compensation?
Reasonability of compensation is not the only compensation consideration of Impartial Conduct Standards. If compensation differs among products of the same type and class that you determine to be in the client’s best interest, and you make a recommendation with a higher compensation, that differential must be justified by “neutral factors.”
Or, if you are receiving compensation higher than others who sell that product, the “above street” differential must be justified by “neutral factors.”
Neutral factors may include:
1. Additional services provided
2. Experience, skills and knowledge
3. Additional time to thoroughly assess the client’s needs and goals
4. Additional time to analyze product options and features, company strength and ratings etc.
Providing more than one product for consideration and documenting how you and your client arrived at the final product(s) selection will be critical to defending a best-interest recommendation and justifying differential compensation. We read recently that it is better to not make a single-product recommendation but to offer more than one solution and the advisor and client arrive at the final product together.
What About Bonuses and Do They Need to be Disclosed?
The Transitional 84-24 Prohibited Transaction requires the advisor to disclose, in dollar or percentage terms, the amount of commission that will be paid for the recommendation/sale. Any other “material conflict of interest” must also be disclosed.
The AssessBEST 84-24 disclosure addresses it this way:
“The Insurance Company may also pay commission to other agents and third-parties who assist in supporting and managing the relationship between the Advisor and the Insurance Company. These third-parties may pay the Advisor a part of their payment. An Insurance Company or third-party may offer additional incentives (in addition to commissions) to the Advisor that is not based on the sale of an individual Annuity or Life Insurance Contract, but rather based on overall sales with the Insurance Company or third-party.”
The general rule of thumb should be what will your paycheck for that specific recommendation/sale be? That is the compensation to disclose “in dollar or percentage terms” DURING this TRANSITIONAL RULE period.
The reasonable compensation standard does not dictate or prescribe any specific amount of compensation advisors and firms can receive. This vagueness may very well be the biggest liability and exposure under the Rule. You can bet lawyers will be targeting this requirement and seeking the most significant outliers.
Advisors should prepare their businesses with practices and procedures for carrier and product selection, assessing customers financial goals, product analysis and factors used in determining the recommendation, and, last but not least, record documentation and retention.
Kim O’Brien is a 35-year veteran of the insurance industry specializing in guaranteed annuities and life insurance. She is the current CEO of Americans for Annuity Protection and Founder of AssessBEST, Inc., a sales and compliance software system. Visit www.AAPnow.com or www.AssessBEST.com for more information.
This article is provided for educational and informative purposes only and not for the purpose of providing legal advice. Readers should consult with their own legal and compliance counsels to obtain guidance and direction with respect to any issue or question. Contact Kim at email@example.com.
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