When it comes to financial planning, how investors receive advice varies depending on what kind of advisor they use and the services they provide.
And the difference between broker-dealers (BDs) and registered reps often comes down to how these various professionals earn their fees. To that end, and in an effort to make understanding the landscape easier and to prevent excess fees, the Securities & Exchange Commission (SEC) unveiled a sweeping new set of rules designed to limit client headaches and force advisors to act in their “best interest.”
Dubbed Reg BI, the rules enacted over the summer cover a wide swath of the planning community. And perhaps no other sector has more coverage than annuities.
Thanks to some bad actors, annuities are often viewed negatively by consumers and some in the financial planning community. Often, savers don’t know exactly what they are buying with the insurance products. However, under the best interest rules, savers will be able to get peace of mind and understand what they are buying into.
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Reg BI in a Nutshell
Regulation Best Interest stems from the idea that not all BDs act in their client’s interest when recommending products. That’s because rather than being paid for their services via a flat hourly rate or percentage of portfolio, they earn commissions on every product bought or sold. What you have is the potential for some brokers to put their clients in higher costing investments or churn portfolios in order to generate commissions. This covers a wide range of investment products from stocks to mutual funds. But annuities have often been the major target for these bad actors.
The reason is annuities often come loaded with various sales fees, redemption fees, hidden charges, and general complexity. How they work can be confusing to most savers and no two annuities, even among the same general type, are similar. Because of this, it makes it easy for BDs to potentially generate higher commissions from unknowing investors.
As a result, the SEC and the National Association of Insurance Commissioners (NAIC) – which is the state regulatory body for insurance companies – have adopted new rules to govern how the planning community treats clients.
Under Reg BI, BDs will be forced to have a general obligation to their customers when making a recommendation of any securities transaction or investment strategy for retail customers. BD’s must “not put [their own] financial interests ahead of the interests of a retail customer when making recommendations.” In a nutshell, they can’t recommend something strictly because of high fees or any benefits to themselves or their firms. Under the rules, BDs must understand all the potential risks, rewards and costs; recognize a customer’s investment profile; and show that buy/sell/transactions are not considered excessive for each client.
Looking at Annuities and Reg BI
Under Reg BI and Model 275, the NAIC has adopted a series of rules designed to keep the BD and insurance sales community honest when it comes to these complex products. Under the new regulation, NAIC will require that agents must not put their financial interests ahead of clients.
The new Suitability in Annuity Transactions Model Regulation requires that brokers must follow the four obligations of Reg BI – care, disclosure, conflict of interest, and documentation – before making a recommendation to a client.
A real-life scenario would be that an insurance salesperson or BD would have to understand a client’s financial situation and goals, alert them to any conflicts, how they are paid and keep a written documentation explaining why they are recommending the annuity and what purpose it is for. A customer would have to sign off on a disclosure document reiterating these points and just how the agent will be paid from the sale.
For BDs and insurance agents, the rules will force them to provide clients with products they actually need. For clients, the rules will make it easier to understand how annuities can fit in their portfolios, generate income and provide safety. Moreover, it’ll make understanding their complex fee structure easier. This means there could be fewer unscrupulous sales and might make it easier for investors to shop around for the best deal. This democratization is exactly what has happened in the exchanged traded fund (ETF) and mutual fund industries.
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Adoption and Sales of Annuity Products
There’s no federal organization that supervises insurance firms. That job is left to the states, with the NAIC being the ranking over-body. Because of this, each state’s own agency must adopt the proposed rules or add their own tweaks.
So far, Arizona and Iowa have already enacted Model 275’s rules. Kentucky, Michigan, Nevada and Ohio are currently debating their adoption or points need to be changed for their states. Both Arkansas and Rhode Island have proposed their own sets of rules that follow a similar framework as Reg BI. The rest of the states hope to get their regulation on the docket in the new year.
Because of the difference in state timelines and rule opinions, analysts are puzzled as to what the sales world will be like for annuities. Currently there are roughly 386 insurance firms in the United States under the NAIC’s umbrella.
However, most early projections predict that sales of annuities will increase due to the rules. While complex products will fall by the wayside as investors understand what they are buying, simple products that provide income for life or guaranteed returns could see their sales increase. Investors may be more inclined to choose an annuity for their portfolios if they know that they are getting a real deal rather than a raw one.
Ultimately, the rules could be a boon for annuity sales and help eliminate some of the stigma associated with the products.
The Bottom Line
With Regulation Best Interest now official for the investment world, the insurance world is ready to receive its own set of guidelines. With BDs and agents now acting in favor of their clients, investors may be more inclined to add the products to their portfolios.
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