The Department of Labor’s Fiduciary Proposals

At a Glance

• The proposed regulation’s new definition will likely cause almost all advisors and agents to be considered fiduciaries under ERISA and the Internal Revenue Code when making securities or insurance recommendations involving plans, participants or IRAs.
• Under proposed amendments to Prohibited Transaction Exemption (PTE) 2020-02, insurance companies are required to be co-fiduciaries for the recommendations of fixed and fixed index annuities sold by their employees and statutory employees. This change will result in significant new compliance obligations for insurance companies and producers.
• Under the proposed amendments to PTE 84-24, only the producer will be a fiduciary for the annuity recommendations. However, while the insurance companies will not be co-fiduciaries with the agents, they will have demanding supervisory and compliance oversight obligations.

On November 3, 2023 the Department of Labor (DOL) published its new proposed regulatory package redefining fiduciary investment advice and materially amending prohibited transaction exemptions for compensation resulting from investment and insurance recommendations to “retirement investors” — that is, to private sector retirement plans, participants in those plans and IRA owners. The proposed guidance has since been finalized and sent to the Office of Management and Budget (OMB) in the White House. The final rules have been approved by the OMB and may be publicly available as early as May 1.

These proposals will significantly impact recommendations of annuities, securities and other investments by insurance producers and securities professionals to retirement investors. The changes significantly impact both financial professionals and the financial institutions they represent.

However, the impact will be greatest on the distribution of annuities, and regulatory attention is particularly focused on fixed indexed annuities (FIAs).

The Proposals

For purposes of the impact on annuities to retirement investors (including FIAs), the package can be divided into three pieces:

1. The proposed fiduciary regulation, expanding the definition of fiduciary status in a manner that will cause almost all advisors and agents to be fiduciaries when they recommend annuities to “retirement investors,” that is, to private sector retirement plans, their participants (including rollover recommendations) or IRAs (including exchange recommendations)
2. Proposed amendments to PTE 2020-02, which is available for all annuity recommendations and the compensation of insurance producers, but which is the required PTE for producers (i) who are employees or statutory employees of insurance companies and (ii) when the annuities are securities (e.g., variable annuities)
3. Proposed amendments fundamentally revising PTE 84-24, permitting — with extensive new conditions — limited commissions for non-securities annuity products recommended by independent insurance producers

The Fiduciary Definition

The regulation’s new definition will likely cause almost all advisors and agents to be considered fiduciaries under ERISA and the Internal Revenue Code when making securities or insurance recommendations involving plans, participants or IRAs. Under the current rules, one-time recommendations — such as recommending that a participant roll over a 401(k) plan account into an annuity — generally are not fiduciary advice. Under the DOL’s new approach, however, if the producer regularly makes recommendations in the course of the producer’s business, receives compensation, and is making a recommendation individualized to the “retirement investor” that could reasonably be viewed by the investor as being made in his or her best interest, the advisor or agent will be a fiduciary.

That would apply, for example, to a recommendation to take a distribution from a retirement plan and roll it over into an annuity. It would also apply to a recommendation to transfer an annuity or IRA to a new annuity. And it could apply to a recommendation to take a withdrawal from an IRA to purchase an insurance product.

The effect of being a fiduciary is that normal compensation, such as a commission, is a prohibited transaction, and may only be received by satisfying the conditions of an applicable prohibited transaction exemption (PTE).

PTE 2020-02

Many broker-dealers and investment advisory firms are already complying with the current version of this exemption if they are making fiduciary recommendations. However, the amendments to the PTE create new conditions and limitations, and the expanded definition of fiduciary advice will force more producers and advisors to use the exemption.

The proposal would require these fiduciary producers and their supervisory entities (e.g., the insurance company or its broker-dealer) to satisfy the conditions of PTE 2020-02:

1. If the producers are employees or statutory employees of insurance companies, to use PTE 2020-02
   
2. If the annuities can only be sold with a securities registration (e.g., a variable annuity)

Under PTE 2020-02, insurance companies are required to be co-fiduciaries for the recommendations of fixed and fixed index annuities sold by their employees and statutory employees. As a result, insurance companies will need to comply with the PTE’s extensive requirements. This change will result in significant new compliance obligations for those companies and producers.

In addition, for annuities that are treated as securities, the broker-dealer or registered investment advisor (RIA) will need to be a co-fiduciary for the annuities recommended to retirement investors by their representatives (who are also acting as fiduciaries) and the conditions of PTE 2020-02 will need to be satisfied.

The conditions in PTE 2020-02 can be briefly summarized as:

1. The Impartial Conduct Standards, including a best interest standard of care and a limitation on compensation to reasonable amounts
2. Written disclosures, including, but not limited to, services, conflicts of interest and documentation of why a rollover recommendation is in the best interest of a retirement investor
3. Policies and procedures of the entity — e.g., the insurance company — to ensure compliance with the Impartial Conduct Standards and the disclosure requirements
4. Annual retrospective reviews of compliance in the prior year, which must be reduced to a written report signed by a senior executive officer for the entity
5. Correction of any identified compliance failures

PTE 84-24

The current version of this PTE is straightforward and is frequently used by insurance companies and their agents. However, the proposal will fundamentally revise the exemption, affecting both independent producers and the insurance companies issuing the annuities they recommend. Under the proposed amendments to PTE 84-24, only the producer will be a fiduciary for the annuity recommendations. However, while the insurance companies will not be co-fiduciaries with the agents, they will have demanding supervisory and compliance oversight obligations.

The independent producers will be fiduciaries with new and unfamiliar compliance requirements, as well as new documentation and process requirements. Significantly, their compensation will be limited to commissions, trials and renewal commissions. Other production-based cash and noncash compensation, including trips and allowances, will not be permitted. The producer’s compensation must be disclosed in writing as a dollar amount.

The conditions in the PTE are similar, but not identical, to 2020-02; perhaps the most significant is that the insurance company is not a fiduciary. To summarize those conditions:

1. The producer, as a fiduciary, must comply with the Impartial Conduct Standards.
2. The producer, as a fiduciary, must provide disclosures similar to those in PTE 2020-02, but with more demanding compensation disclosures.
3. The insurance company does not act as a fiduciary, but must have policies and procedures for oversight of the producer’s compliance. A critical policy and procedure requirement is that the insurance company review every application for an annuity funded by qualified money (e.g., a rollover or an exchange) for compliance by the producer with the Impartial Conduct Standards and the disclosure requirements.
4. The insurance company must conduct an annual retrospective review of its oversight and policies and procedures in the preceding year, which must be reduced to a written report and signed by a senior executive officer.
5. Any identified compliance failures must be corrected.

Another significant addition to proposed PTE 84-24 — which is not in PTE 2020-02 — is that insurance companies must annually review the producers that they authorize to sell their products and determine whether to continue to authorize the producer to sell their annuity contracts to retirement investors. The proposed PTE describes the objectives and process in some detail.

A controversial provision in the proposed PTE 84-24, as well as PTE 2020-02, is that an insurance company can lose its eligibility to use the exemptions for certain behaviors — e.g., a pattern of noncompliance or specified felony convictions of the insurer or any affiliate (domestic or foreign).

Next Steps

Insurance companies need to fully understand these proposals and their likely impacts as soon as possible. The authors have produced a series of short “vodcasts” discussing these issues available for viewing here.

While the fiduciary requirements under 84-24 are imposed on the producers, they effectively become the burden of the insurers because each application for annuities funded by qualified money must be reviewed for compliance. An annuity cannot be issued where the producer failed to comply with the PTE requirements. As a result, insurers will need to help producers comply with the PTE requirements in order to avoid the need to reject applications that are noncompliant.

The comment period on the proposals ended on January 2, 2024. The regulation is moving quickly and will likely be approved and published in the Federal Register by early May of 2024. Once published, the rules will be final 60 days later. However, there will likely be a deferred “applicability” date, which is the day that insurance companies and producers must be in compliance with the terms of the new rules. While the DOL has given little indication of the applicability date, there is some thinking that it could be as early as January 1, 2025. That would mean that insurers would only have a little over six months to be in compliance with the new process, disclosure, policies and procedures, and correction requirements.

Attorneys in Faegre Drinker’s Financial Services ERISA team — Fred Reish and Brad Campbell — regularly share their takes on the new fiduciary proposal and other ERISA-related developments via ERISA Moments, a series of quick-hit video updates, and on FredReish.com. To receive these updates in real time, please subscribe to the Spotlight on Benefits blog and to FredReish.com.