Success was arching upward year to year for Bob Phillips’ firm, but the dotted line for the future of the independent marketing organization is looking less like an arc and more of a question mark.
Because that’s where the line collides with the Department of Labor’s fiduciary rule. Fewer producers are working with the 4-year-old Alternative Brokerage, a trend that’s only deepened with the uncertain future of the rule.
The perfect havoc the rule and the fight over the regulation are wreaking on the industry is encapsulated in this small IMO operating in the heartland, very near the annuity capital of Des Moines.
“There have been so many deadlines, lines in the sand that have come and gone, and lawsuits and appeals,” Phillips said. “There’s been so much going on, most of our agents are just dizzy. Some of them have a deer-in-the-headlights look.
“Some of them are terrified that with April 10 looming, they’re not ready, we’re not ready, nobody’s ready, so…”
Phillips trails off, as if unintentionally summing up where the industry is just weeks and days before the hated fiduciary rule is slated to begin taking effect.
That was before the DOL published the Trump administration’s intention to delay the rule by 60 days. The department will collect public comment during March and the delay is expected to take effect well in advance of April 10.
“Sixty days pushes out all of the problems for a short amount of time,” Phillips said. “We’ve kicked the can down the road, but not long enough to fix anything or get DOL to do what’s in the clients’ best interest.”
The DOL is giving itself time to review the regulation against new standards issued by President Donald Trump. The department is likely to reshape rather than rescind the rule, industry analysts say.
“My suspicion is we’ll see a regulation in place, but perhaps substantially modified, with some additional exceptions and perhaps a cutback on what actually constitutes investment advice,” said Bruce L. Ashton, partner with Drinker Biddle & Reath.
The bottom line is we’re no closer to knowing what the regulation will actually be than we were one year ago, when the DOL published its fiduciary rule. And the relentless ambiguity is taking a toll up and down the industry chain.
This month, we bring you four stories from agents, advisors and IMOs across the business. Each is impacted in a different way and all have nuanced opinions about the fiduciary rule.
But all four are definitely opposed to what they see as overregulation of the industry.
‘Hit with a Shovel’
Flashback to early 2016 — Phillips and his producers were feeling good about the DOL rule. Sure, it was going to mandate more annoying paperwork, raise the liability stakes and even require a written contract to sell variable annuities.
But fixed indexed annuities escaped rigid regulation under the rule, remaining within the 84-24 Prohibited Transaction Exemption. That exemption was tightened to require agents and advisors to abide by an “impartial conduct” standard that puts the client first.
But Phillips and his colleagues could live with that. Keeping FIAs in the 84-24 was significant because those annuities were selling like seat cushions at a rodeo cowboy convention.
In the second quarter of 2016, FIA sales totaled $16.2 billion, 30 percent higher than the prior year and surpassing prior quarterly sales records. Although the stock market performed well over the past six months, the memory of the 2008 crash is fresh on the minds of many investors. As such, safe-money FIAs look to have a bright future for both clients and agents/advisors.
The worry that FIAs would be added to the restrictive and costly Best Interest Contract Exemption seemed to be for naught.
Then the final rule was published on April 6, 2016, and FIAs were listed alongside variable annuities in the BICE. It hit the industry with a jolt.
“It was almost like getting hit with a shovel in the face, like, ‘What happened?’” Phillips recalled. “And since then, it’s been just a battle.”
Alternative Brokerage has about 1,000 producers. The IMO offers back-office and distribution support for sellers of fixed, indexed and alternative products.
The adjustment to a strict regulation that only affects part of the market — retirement funds — and includes fixed annuities proved to be a difficult undertaking for many producers, Phillips said.
The move surprised Phillips, since the Harkin amendment included in the Dodd-Frank legislation established indexed annuities as insurance products.
“It was troubling more than anything, and it caused a lot of panic among the agents who were looking for answers that, frankly, we couldn’t give, nobody could give,” he said.
More Bad News
While the harsh treatment of FIAs sent the industry reeling, Phillips found a silver lining of sorts for IMOs: the DOL considered an exemption allowing IMOs to serve as financial institutions (FIs).
FIs assume the liability for producers who sell annuities. The rule grants FI status to four entities: banks, insurance companies, broker-dealers and registered investment advisors, but not IMOs. And with a blanket exemption, IMOs like Alternative Brokerage would remain in business.
Then the DOL released its criteria for the exemption. In order to qualify, an IMO must have generated an average of $1.5 billion in annual fixed annuity premium over each of the three previous fiscal years. In other words, only the very biggest IMOs will qualify.
“When that came out, I think it was a little shock at what the requirements were, because it was a lot more than some of the smaller broker-dealers out there,” Phillips said.
Now he had to adjust yet again. As of this writing, Alternative Brokerage will join with a larger financial institution if needed to continue selling annuities.
“What happened is these (larger IMOs) invested a lot of money in technology and people and resources, and they were talking to a lot of us smaller groups about coming under an umbrella,” Phillips explained.
If the Clive, Iowa-based business teams up with a larger IMO, it will come with a cost.
“Well, our spreads would decrease, probably depending on who we talked to,” Phillips said. “A few of them weren’t even sure on the pricing. But we’d give up a pretty good portion of our override.”
On the plus side, the larger partner would alleviate the liability risk. And with increased size come greater technology capabilities.
Whether it all translates into a win remains to be seen, Phillips said.
“I’d like to think there’d be a tradeoff, that we could, with new technology and new marketing and not having to assume any liability, that we could grow enough to compensate for the amount of override that we’re losing,” he added.
For now, Phillips is focused on reducing the stress level of his company’s team of producers, for whom uncertainty has given way to fear. Larger IMOs are poaching good producers where they can.
“We’ve lost some of our producers to larger groups,” Phillips said. “There was a bit of a fear factor, especially early on, with things like, ‘If you don’t come to us, we might not have room for you later.’”
The Retiring Kind
Joe Super started out in the insurance business as a regulator for the former National Association of Securities Dealers. A self-regulatory organization of the securities industry, NASD became the Financial Industry Regulatory Authority (FINRA) in 2007.
By that time, Super had long moved to the other side. In 1972, he started selling insurance and investment products and never stopped. Super, 76, is still selling product from his Paoli, Pa., office. And he isn’t bashful about his commitment to a commission-based model.
“I’m a commission person. Pay me for what I do,” Super said. “I don’t have to go out and collect your check for $100,000 and send it to some money managers and forget about it forever and collect 1 percent whether you’re happy or unhappy.
“And if you moved it, well, fine. I got 1 percent for seven or eight years. I never believed in that.”
To call Super old school would be an understatement. He works alone and sells product through Woodbury Financial Services, a broker-dealer. Super recently sold his book of business to Woodbury, but he retains his license and continues to work.
“I’m kind of walking away from it because it’s time,” he said. “But where the industry is going, especially with the new rule … it’s just not worth it.”
Super sells a lot of variable annuities, one of the products in the crosshairs of the DOL rule. He owns two VAs in his personal portfolio, he pointed out. The rest of his business is mutual funds, some insurance and fixed annuities, and a little bit of individual stocks.
While Woodbury would serve as the financial institution and do the heavy lifting if Super continued selling VAs under the new DOL rules, he would still have paperwork headaches.
“I have a lady who runs my computer three days a week and gives me all the information that I need or want — or more,” he said. “But it just means I have to pay her for more hours of work to keep up on the computer. It’s just not worth it.”
Health issues prevented Super from making his regular numbers in 2016, so Woodbury came with an offer to buy his book. Under the deal they made, Super can continue to sell products as long as he doesn’t solicit.
He wants to keep working the business for three more years. Super considered the industry “overregulated” when he left NASD in 1972 and his mind hasn’t changed.
“I’m still doing the kind of business that I always did and so is everybody else,” Super said. “But I’m a believer that if you’re only going to like fee-based business, then a lot of small investors are going to be hurt. You’re not going to go after $40,000 when you can go after $250,000 to send somewhere and get 1 percent forever.”
Randy Kaufmann’s insurance office would fit perfectly along Main Street in Mayberry, N.C., perhaps squeezed in between Floyd’s Barbershop and the Mayberry Security Bank.
For those of a certain age, the fictional Mayberry, setting for “The Andy Griffith Show,” has come to represent small-town life and its associated values.
An independent insurance agent with 40 years of experience in the business, Kaufmann shares those values. And he does it from the small Kaufmann & Associates office in Camp Hill, Pa.
Kaufmann’s office is the first one inside the door. The unassuming workspace is dominated by Kaufmann’s dark brown desk. Two framed pictures of Kaufmann with NASCAR rides hang on the walls. He is a huge racing fan.
Father of five — with 10 grandchildren — Kaufmann and his wife spearhead an annual family vacation getaway to Ocean City.
The clients have become a second family of sorts, he said.
“I think that the number of people that need this help is greater than ever,” he said, alluding to the retirement crisis. “We’re going to do it right.”
Kaufmann works with small business retirement plans. He has between 60 and 70 clients that average about 35 employees. They are the crane operators and landscapers in his community.
When people leave a client company, they often meet with Kaufmann to do a plan rollover. Kaufmann deals in managed money, life insurance and annuities.
Kaufmann has added younger agents in recent years to connect with millennial and GenX clients.
When the proposed DOL fiduciary rule was released in April 2015, Kaufmann took note. He is active in the Pennsylvania chapter of National Association of Insurance and Financial Advisors, and is also a member of the Million Dollar Round Table.
“I looked at it as not concerning, but definitely something that I wanted to monitor as we went forward,” he said. “It was really just a matter of monitoring.”
He sells more variable annuities than fixed indexed, but only when appropriate. Variable and fixed indexed are two products in the crosshairs of the DOL regulators.
“I think we have a fiduciary responsibility to make sure they have that guaranteed income stream,” Kaufmann said, adding of VAs: “It’s not for all assets. It is not a one-bucket-fits-all approach.”
Kaufmann’s broker-dealer took the lead on establishing the network needed to comply with the rule.
“We are already taking our fact-finding approach to another level,” with clients, Kaufmann explained. “It requires us to get a little more detailed.”
“The product itself becomes somewhat incidental to the overall planning process for the client’s wants and needs,” he said. “I have become more intimate with my clients than ever before…”
Kaufmann gets emotional talking about the hundreds of clients who pass through his office, each relying on the advice, information and investment picks that he can provide.
“And I’ve always cared,” he said after a long pause.
The industry is too heavily regulated, Kaufmann said. Having said that, he thinks the fiduciary push would come from someplace else had the DOL not taken the reins.
“It reinforced for me what we’ve always done and if it can take that to another level, then it’s a good thing,” he said. “It’s made me aware of the good things we do with our clients.
“Has it hurt me? I don’t think so. Has it created more expense for me? Perhaps from a time perspective.”
Kaufmann’s broker-dealer is the financial institution and has established the compliance network required by the DOL rule. But compensation has been reduced as a result, so those costs are passed down to some degree.
“We don’t really have much choice on it,” Kaufmann said. “We have to accept where we’re at.”
The rule will eliminate some of the bad actors who give the business a bad name, Kaufmann said.
“It is going to push some of those out of the market,” he said. “Those of us who are left are going to have to adjust and amend accordingly.”
After a pause, he added: “I’m not changing our business model in terms of how we do business.”
A Fee-Based View
Many fee-based firms and trade associations threw their weight behind the DOL rule. Fee-based firms and advisors seek what they call a level playing field in which everyone dealing with retirement investing is compensated the same.
“We have all watched the industry change over the years — moving to fee-based services already with many investment professionals already acting in the best interest of their client,” said Mary Anne Durall, senior vice president of strategy and corporate planning for SE2, a leading third-party administrator for the life insurance and annuity sector.
For many companies who are working to comply with the rule, it isn’t practical to turn back now, she added.
They “have spent the last half of 2016 developing and implementing the rules requirements, making extensive system changes and developing practices and procedures in support,” Durall said. “The additional investment to undo that work seems inconsistent with sound business practices.”
Many are calling the fiduciary rule the biggest change to retirement investing since Congress passed the Employee Retirement Income Security Act of 1974.
The advice world is split into two camps: salespeople (stockbrokers and agents) operating under a suitability standard, and licensed advisors serving as fiduciaries.
Rule supporters, many of whom live in the fiduciary world, say it is long overdue for the industry to operate under one standard. The stakes are large — an estimated $14 trillion is held inside IRAs and 401(k)s.
Registered investment advisors say a uniform fiduciary standard will sharply reduce conflicts of interest and establish greater credibility at a time when millions of baby boomers are entering retirement.
Still, some in the fee-based world say the DOL rule is like using a sledgehammer to crack a nut.
The DOL rule has no impact on Hal Rogers, an advisor and president of Gold Tree Financial in Jacksonville, Fla. A certified financial planner, Rogers is going on 35 years advising clients on retirement strategies via the fiduciary standard.
He doesn’t like the rule for three reasons:
It leaves out non-retirement funds. “We can’t find any reasonable justification for requiring an advisor to function in a client’s best interest on a retirement account, while, by obvious omission, not applying the same standard for all the client’s other accounts with that advisor,” Rogers said.
It offers no mechanism for measuring the “value” advisors bring. Rogers equates the DOL rule to passing a law that requires a hotel owner to “charge the same rate in his five-star property as the ‘No Tell Motel’ at the edge of town, where you can rent rooms by the hour.”
The market is the best way to regulate advisors. Gold Tree has survived and thrived for three decades because it puts clients first, Rogers said. Advisors that don’t will not be in business long, he added.
We take the best care of our clients we know how to take, not because we wear white hats, or because we are social workers, but because it most effectively serves the interests we had when we went into business,” he said.
While it might be a quixotic vision to some, Rogers said regulators and the industry ought to be more focused on the value an advisor brings to a client relationship. When value is the focus, cost is not a consideration, he said.
In a candid admission, Rogers agreed that the fee-based model costs clients more in the long run.
“While it is true that with a fee-based account there is no motivation or even any advantage gained to ‘churn’ an account, the truth is that fee-based accounts are almost always more costly to the client,” he explained.
“In addition, instead of paying once, up front, the client will pay for as long as the account is in place. The advisor will pay, and the client will pay, multiples of what would have occurred with a commission-based account.”
Headed for Fiduciary
Michael Patterson monitors the fiduciary rule for Ernst & Young’s Regulatory Compliance Services team. DOL rule or not, the industry is inching toward a fiduciary way of doing business, he said.
That unrelenting momentum is going to change how products are produced, how they are distributed and how advisors and agents are paid, said Patterson, a principal in E&Y’s Financial Services Advisor practice.
“There are long-term trends here and long-term changes that the rule may just be pushing along,” he said. “Even if it is largely reshaped or repealed, I think a lot of this is going to continue.”
The focus on regulation and rules will change how products look, he explained. Basic supply-and-demand principle will lead to products that are less opaque and do not come with compensation plagued by conflicts of interest.
“The distributors are closer to the customer so they’re going to be more demanding about what product sets are best for their customers in terms of fee structures, and clarity of fees,” Patterson said.
Many firms are creatively energized by the transformation of the industry, he added, and see the impending regulation as a challenge. Those are the firms, and agents/advisors, who are going to thrive in the future.
“I wouldn’t want to hang my hat on a prediction on what the government is going to do because it’s so difficult to say,” Patterson said. “It’s so volatile. But you can see the direction of the industry and there are plenty of opportunities to take advantage of it.”