Extracted from Law360.com
The U.S. Department of Labor's latest attempt to expand the Employee Retirement Income Security Act's definition of "fiduciary" remains on ice after two Texas federal district courts stayed its effective date in July.
If implemented, however, the new fiduciary rule would have a chilling effect on the sales of annuities, impacting both the agents, brokers and insurers who sell them, and the middle-class Americans who depend on them for their retirement.
2024 Fiduciary Rule
On April 25, the DOL promulgated its 2024 fiduciary rule, which defines an "investment advice fiduciary" as any professional who recommends a product — such as an annuity — to an investor when rolling over assets from an employer-based plan to an individual retirement account. The new rule would also require insurance agents deemed fiduciaries to meet additional conditions to receive commission compensation.[1]
Texas District Courts Stay the Rule's Implementation
On May 2, a group of insurance industry plaintiffs filed a complaint against the 2024 fiduciary rule in the U.S. District Court for the Eastern District of Texas.[2] The plaintiffs in Federation of Americans for Consumer Choice Inc. v. DOL alleged the rule would "fundamentally reshape" 50 years of settled practices in the insurance industry.[3]
On July 25, the court put the rule on hold, concluding that it conflicted with ERISA because there would no longer be any requirement that the agent or broker give advice to the insured on a "regular basis" or that the advice formed the "primary basis" for the purchase.[4]
The court also found that the 2024 rule conflicted with the ERISA requirement that advice be rendered for a fee or other compensation. Under the rule, it's enough that there's a fee associated with the sale; there needn't be a fee associated with the advice.[5]
The court found that the plaintiffs are likely to succeed on the merits of their claim and stayed the rule's effective date until further order from the court.
Just a few days after the Eastern District of Texas court's order, a judge for the U.S. District Court for the Northern District of Texas stayed the rule's remaining regulations in American Council of Life Insurers v. DOL.[6]
The DOL filed a notice of appeal for both cases to the U.S. Court of Appeals for the Fifth Circuit on Sept. 20. A Fifth Circuit reversal of the Texas district court rulings could have deleterious effects on the insurance industry, creating additional hurdles for insurance agents to operate their businesses.
Expansion of Who Is Deemed a Fiduciary
Under the 2024 fiduciary rule, the meaning of "fiduciary" would be expanded to include one-time transactions such as IRA rollovers, and there needn't be any relationship of trust or confidence between the agent and the client.[7] The agent need only make professional investment recommendations to investors regularly as part of the agent's business, not regularly to any particular client.[8]
This change means that every investment recommendation made by a stockbroker or insurance agent accepted by a retirement investor could be considered a fiduciary transaction.
Increased Compliance Standards for Insurance Agents Deemed Fiduciaries
Agents deemed fiduciaries under the 2024 rule would be required to comply with strict standards, such as the requirement to submit additional disclosures and documentation for all tax-qualified annuity sales, and would face potential liability under ERISA as well as the risk of enforcement actions by the DOL.
Reducing the Sales of Annuities, Potential Consumer Harm
Stricter, onerous requirements and heightened liability risk could lead to agents deciding to forgo making recommendations — or doing so less often. Notably, this could decrease the sales of annuities, which can provide reliable income through a person's retirement years.
As a result, the new rule could end up harming those middle-class retirees who had counted on the financial stability and security that annuities can offer. These consumers might choose to purchase products that don't fit their exact financial needs, leaving them in less-than-ideal positions as they head into retirement.
Decreased Sales of Annuities Could Have a Long-Term Effect on the Insurance Industry
By adversely affecting the sales of annuities, the 2024 fiduciary rule could reduce insurers' profitability and result in a shift in focus to other products. In addition to agents being less likely to sell annuity products, there might be fewer annuity products available on the market. Less consumer choice would negatively affect consumers.
A Proliferation of Litigation
If the barrier to being deemed a fiduciary is lowered, we can expect to see an increase in breach of fiduciary duty claims filed by the plaintiffs bar. Agents who merely accept an annuity application from a prospective insured may be liable if the plaintiffs no longer have the burden to demonstrate a relationship of trust or confidence.
It's black-letter law that an insurer doesn't owe a fiduciary relationship to its insured, but the new rule's erosion of the trust or confidence requirement to establish a fiduciary relationship between an agent or broker and an insured may mean that courts are willing to lower the pleading hurdle for insureds as well, resulting in a flood of litigation. This in turn could lead to higher costs for insurers and more expensive products on the market.
If there's a decline in sales of annuity products or a reduction in annuity products available on the market, we can expect the plaintiffs bar to allege that life insurance agents and insurers failed to offer life insurance products that were the most suitable for insureds. This could result in a catch-22 where the industry reduces sales of annuity products to avoid liability, while plaintiffs allege they should have been sold an annuity product because it would have been the best product on the market for them.
While the district court opinions out of Texas may signal that the 2024 fiduciary rule won't ever take effect, members of the insurance industry should be aware of the rule's potential ripple effects on the industry should it be implemented.
The entire industry and the plaintiffs bar will be keeping a close eye on the appeal.