Retirement Account Rollovers: PTE 2020-02 vs. PTE 84-24

Recommendations to retirement plan participants to roll their accounts from a plan to an individual retirement account or annuity will often be viewed as fiduciary advice under new Department of Labor (DOL) guidance. That guidance is a new interpretation of the DOL’s 1975 regulation defining fiduciary advice. The new interpretation was disclosed and explained in the preamble to Prohibited Transaction Exemption (PTE) 2020-02, which was issued by the Trump administration and allowed to become effective by the Biden administration.

Insurance companies and their agents that provide “fiduciary” rollover recommendations will need to develop compliant fiduciary processes and will need to consider compliance with the ERISA and Internal Revenue Code prohibited transaction rules. The available exemptions, or exceptions, are PTE 2020-02 and PTE 84-24.

This article discusses both the fiduciary interpretation and those exemptions.

Fiduciary Advice

The DOL uses a five-part test to determine when a recommendation constitutes fiduciary advice. One of the parts of the functional definition is that the advice be given on a “regular basis.” (“Functional” means that fiduciary status is determined by the totality of the facts and circumstances related to the recommendation, including the contemplation of the parties.) In the past, the DOL held that a rollover recommendation generally would not satisfy this part of the text. Guidance that accompanies PTE 2020-02, issued at the end of 2020 (as expanded and clarified in a set of FAQs) says that many rollover recommendations would now satisfy the “regular basis” requirement. However, if the participant and investment professional reasonably understand that the rollover recommendation is not made in anticipation of recurring recommendations related to the IRA, the rollover recommendation would not satisfy the “regular basis” part of the fiduciary test.

For an insurance company and its agents, an example of the latter situation could be a recommendation to roll into a fixed rate annuity. Unless the agent has had an ongoing advisory relationship with the participant regarding retirement assets, the facts and circumstances may be that there is no anticipation for additional advice in the future. Thus, the recommendation would not satisfy the “regular basis” prong, and the rollover recommendation would not be considered fiduciary advice. This is in contrast with the recommendation of a variable annuity, where ongoing advice may be contemplated as part of the service provided to the participant.

Prohibited Transactions

One of the prohibitions under ERISA and the Code is that a fiduciary may not use its authority to cause itself or an affiliate to receive compensation. Since a rollover recommendation that satisfies the regular basis requirement (and will ordinarily be fiduciary advice) will almost always result in increased compensation, an exemption will be needed.

The two exemptions available to an insurance company and its agents are PTEs 2020-02 and 84-24. Both have requirements, or “conditions,” that must be met in order to obtain the relief provided by the exemption.

PTE 2020-02

Under PTE 2020-02, if an “investment professional” (i.e., an insurance agent) gives fiduciary advice to a “retirement investor” (i.e., a plan, participant or IRA holder), the “financial institution” (i.e., an insurance company) is also considered a fiduciary. In order to rely on PTE 2020-02, the insurance company and the agent must:

• Acknowledge their fiduciary status in writing.
• Disclose their services and material conflicts of interest.
• Adhere to “Impartial Conduct Standards,” i.e., that the advice is in the best interest of the participant, the insurance company and the agent receive no more than reasonable compensation, and no materially misleading statements are made.
• The insurance company must adopt policies and procedures designed to ensure compliance with the Impartial Conduct Standards and to mitigate conflicts of interest of the insurance company and the agent that could otherwise cause violations of those standards.
• The insurance company must document and disclose to the retirement investor the specific reasons that a rollover recommendation is in the participant’s best interest.
• The insurance company must conduct an annual retrospective compliance review.

A significant issue under PTE 2020-02 for insurance companies that work with independent agents is how the insurance company can know if the agent is acting as a fiduciary. Under Q18 of the FAQs issued by the DOL, the Department explained that:

While the independent agent may recommend products issued by a variety of insurance companies, PTE 2020-02 does not require insurance companies to exercise supervisory responsibility with respect to the practices of unrelated and unaffiliated insurance companies. When an insurance company is the supervisory financial institution for purposes of the exemption, its obligation is simply to ensure that the insurer, its affiliates, and related parties meet the exemption’s terms with respect to the insurance company’s annuity which is the subject of the transaction.

In other words, an insurance company’s responsibility is to ensure that its products and services satisfy the exemption’s standards, including the best interest standard and that the conflicts of the insurance company and the agent are properly mitigated.

To do so, the insurance company must:

• Adopt and implement prudent supervisory and review mechanisms to safeguard the agent’s compliance with the Impartial Conduct Standards when recommending the insurance company’s products.
• Avoid improper incentives to preferentially recommend the products, riders, and annuity features that are most lucrative for the insurance company at the retirement investor’s expense.
• Ensure that the agent receives no more than reasonable compensation (e.g., by monitoring market prices and benchmarks for the insurance company’s products, services, and agent compensation).
• Adhere to the disclosure and other conditions set forth in the exemption.

The FAQs note that insurance companies could also comply with the exemption by creating oversight and compliance systems through contracts with insurance intermediaries such as independent marketing organizations (IMOs).

However, because of the difficulty in complying with these requirements in supervising independent agents, many insurance companies may not use the 2020-02 exemption and instead opt for an 84-24 approach.

PTE 84-24

An alternative to PTE 2002-02 would be to rely on PTE 84-24. PTE 84-24 requires that:

• The transaction must be effected by the insurance company or agent in the ordinary course of its business.
• The transaction must be on terms at least as favorable to the participant as an arm’s length transaction with an unrelated party would be.
• The combined total of all fees, commissions and other consideration received by the insurance company or agent must be “reasonable.”
• The insurance agent must make certain disclosures to an independent fiduciary of the plan (generally, the plan sponsor or committee), including any affiliation between the agent and the insurance company whose policy is being recommended, the sales commission payable in connection with the recommended transaction and any other costs associated with the purchase, holding, exchange, termination or sale of the recommended contract.
• The independent fiduciary must approve the transaction in writing.

Note that PTE 84-24 only applies to insurance sales (life insurance and variable, fixed indexed and fixed rate annuities) and only applies to the receipt of “commissions” (which is not defined in the exemption). The exemption does not mention other types of financial benefits that might be received by an agent, and the DOL may disagree with an expansive reading of the word “commission.” In the FAQs, the DOL notes that it is reviewing its regulation of fiduciary advice more generally, which may include amending or revoking parts of PTE 84-24 to eliminate variable annuities and fixed indexed annuities from its coverage. It may also define “commission”; if so, it is anticipated that the definition would be narrow. The DOL may also add a best interest standard to the exemption. If the DOL takes these approaches, the effect could be that IMOs and other insurance intermediaries may, as a practical matter, need to apply for individual exemptions as “financial institutions” under PTE 2020-02 to manage compliance with that exemption.

In the context of variable annuity sales, which would be made by agents who are also licensed as broker-dealer representatives, it may be more convenient to rely on PTE 2020-02 since broker-dealers will already be complying with the SEC’s Reg BI and will likely need to utilize PTE 2020-02 for other business activities.

Conclusion

In the short term, PTE 84-24 may be an easier route for insurance companies to avoid the requirements under PTE 2020-02. An insurance company relying on PTE 2020-02 must comply with the Impartial Conduct Standards, adopt policies and supervisory procedures, make additional disclosures to participants and conduct an annual compliance review. However, it is possible — perhaps even likely — that new and more demanding conditions will be added to 84-24. But that is more than a year away, and the current 84-24 may be an effective transition approach.