Sales of fee-based annuities have soared in recent years.
However, the financial planners and investment advisers that use
them with clients may be unknowingly exposing themselves to future
enforcement action from state insurance regulators. As is often the
case with hybrid products, the devil is in the details. First,
however, a little background information is needed.

Background

“Fee-based” or “fee-only” annuities are
insurance products designed for distribution through the registered
investment adviser (“RIA”) channel rather than the
traditional broker-dealer or insurance agency channel. Instead of
receiving a sales commission, financial planners who recommend
fee-based annuities are paid a flat, ongoing annual advisory fee,
typically calculated as a percentage of the underlying value of the
annuity contract. In other words, feebased annuities pay no sales
load to compensate the financial planner. Thus, what makes an
annuity “fee-based” is its compensation structure. There
are both fee-based fixed indexed annuities (“FIAs”), most
of which are not securities,1 and fee-based variable
annuities (“VAs”), which are always
securities.2

According to the LIMRA Secure Retirement Institute, fee-based
FIA sales jumped 55% in the fourth quarter of 2021 to $74.5
million. More significantly, fee-based VA sales rose to $1.24
billion in the fourth quarter of 2021, an increase of 24% from
2020, marking the fifth consecutive quarter of fee-based VA product
sales over $1 billion. In 2021, fee-based VA sales topped out at
$4.9 billion, a 49% increase from 2020.3 This rise in
popularity is not surprising and has been driven by three main
factors.

First, the financial planning industry has seen an ongoing shift
to fee-only practices due to the financial stability and benefits
of recurring advisory revenue.4 This trend was
accelerated beginning in 2016 with the Department of Labor’s
(“DOL”) open disdain for broker-dealer commissions
derived from sales involving individual retirement accounts
(“IRAs”).5

Second, in 2019, the Internal Revenue Service began issuing
private letter rulings (“PLRs”) to insurance companies
which allow an advisory fee to be withdrawn directly from a
fee-based annuity sold at net asset value (i.e., without a sales
commission) as compensation to an investment adviser that provides
ongoing investment advice to the owner of the annuity contract.
Prior to the issuance of such PLRs, withdrawing advisory fees from
the annuity would have triggered taxes and penalties for the
annuity owner as an early distribution. Under the terms of the
PLRs, investment advisers can now charge (and annuity owners will
pay) an advisory fee not to exceed 1.5% as
“consideration” for investment advice provided by the
investment adviser in relation to the annuity contract.6
The PLRs also indicate that the contract owner will receive ongoing
investment advice from the investment adviser concerning the
annuity contract, which includes helping the owner select options
related to the contract, and the fees will only be used to pay for
investment advisory services related to the
contract.7

Third, many financial planners prefer (or are invited) to
discard their Financial Industry Regulatory Authority
(“FINRA”) licenses for the comparative ease of working
within the RIA model. The number of FINRA-registered
representatives has been slowly declining for years,8
while the number of state-registered investment advisers has
continued to climb9 , given the ease of registration and
the perceived freedom from more onerous FINRA oversight. As one
large annuity manufacturer has advertised, “Our fully licensed
concierge team makes it possible for independent, non-licensed
wealth managers to access annuity products without the need to hold
state insurance licenses or FINRA
registrations.”10

A Trap for the Unwary

The belief that selling fee-based annuities does not require a
separate insurance license is quite common; however, it is also
quite mistaken in some jurisdictions. Given the expanding
popularity of fee-based annuities, the failure of many financial
planners to obtain additional insurance licensing could very well
constitute a lurking but growing enforcement risk, especially as
insurance regulators’ awareness of these popular annuity
products increases.

The reason for the misunderstanding is not surprising. When
selling a VA that pays a sales commission, financial planners are
fully aware that they must hold both a FINRA securities license
(Series 6 or Series 7) and an insurance producer license due to the
hybrid nature of the VA product. Because a VA straddles the
securities and insurance regulatory regimes, financial planners
need two licenses to satisfy both securities and insurance
regulations.

So what happens when the VA no longer pays a sales commission
and instead pays an ongoing advisory fee? Financial planners are
correct that FINRA broker registration is no longer required.
Instead, they must operate as an investment adviser representative
(“IAR”) of an RIA, either by obtaining a Series 65 (or
Series 66) license or holding one of several professional
designations.11 The conclusion about IAR status is
certainly correct for fee-based VAs, since a financial planner will
receive an ongoing advisory fee as payment for advice about a
security. In the case of fee-based FIAs, IAR status would be
largely inapplicable because FIAs are rarely securities.

However, unbeknownst to many financial planners, there is an
insurance analogue in the case of annuity advisory services in
roughly half of all U.S. jurisdictions. In other words, many
financial planners fail to realize that the insurance producer
license is not the only game in town; other insurance licensing
requirements could potentially be triggered when a fee is received
instead of a sales commission in connection with providing advice
relative to annuities. Many financial planners (and perhaps even
some insurance companies) presume the situation is as follows:

In fact, in many jurisdictions, there is once again a
dual-licensing requirement for fee-based VAs and a state insurance
licensing requirement for fee-based FIAs:

1283250b.jpg

As the National Association of Insurance Commissioners
(“NAIC”) explains in chapter 22 of its State Licensing
Handbook:

An insurance consultant is a person who charges a fee for giving
advice about insurance products. Not all states require a separate
consultant license. . . In states that do require a special
license, the applicant is usually required to pass an examination .
. . In all cases where an individual is acting as an insurance
consultant, a written contract should be used to clearly explain
the terms of the consultant arrangement. In states that have a
separate insurance consultant license, it is a common practice to
have a continuing education (CE) requirement that mirrors the CE
requirement for insurance producers.12

Depending on the jurisdiction, an insurance consultant may also
be known as an “insurance counselor,” an “insurance
adviser,” or an “insurance analyst,” but the concept
is the same.

Avoiding the Trap

At present, 27 jurisdictions have some form of statute or
regulation—separate or distinct from that of insurance
producers—for those who act as insurance
consultants.13 However, available exemptions and other
requirements14 differ across jurisdictions, so working
with a knowledgeable insurance attorney is strongly recommended to
ensure compliance with the insurance laws and regulations of the
relevant jurisdiction.

Ultimately, those who wish to sell fee-based annuities have
several options depending on their appetite for risk:

  • Low: Limit the sale of fee-based annuities to only
    those jurisdictions that lack any form of insurance consultant
    regulation.

  • Medium: Obtain the necessary insurance licensing so
    that fee-based annuities can be offered in any jurisdiction.
    However, in some jurisdictions, it may be necessary for both the
    IAR and the RIA to be licensed, which presents certain
    risks. For example, licensing an RIA as an insurance consultant
    will require updates to the RIA’s Form ADV filings. In
    addition, even a small insurance fine exceeding $2,500 would
    trigger special notice (i.e., an “interim amendment”) to
    all advisory clients,15 a process that can be expensive
    and may result in reputational harm.

  • Unknown: Offer fee-based annuities and take a
    wait-and-see approach. At present, the risk of enforcement appears
    low, as state insurance regulators are not actively enforcing
    insurance consultant licensing requirements despite the growing
    popularity of fee-based annuities. However, this enforcement
    posture could easily change in the future and without warning,
    making this approach aggressive with an unknown degree of
    risk.

If none of these options are satisfying, the industry is
developing other novel solutions. These include working through a
general agency, partnering with an insurance company that will
shoulder the regulatory load,16 or partnering with a
third party.17 To the extent these other arrangements
might involve acting as a promoter18 for an investment
adviser, financial planners should keep in mind the requirements of
Advisers Act Rule 206(4)-1 and registration requirements for
solicitors under state securities laws.19

No matter what, innovation is sure to continue in this growing
segment of the financial services industry. Whether insurance
regulators will take notice and keep up, or turn to their
enforcement toolbox, remains to be seen.

Footnotes

1. Subject to certain conditions, Section 989J of the
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
(P.L. 111-203) instructs the SEC to treat such annuities as exempt
securities under Section 3(a)(8) of the Securities Act of 1933. As
the SEC staff acknowledge, “Not all indexed annuities are
regulated by the SEC. The SEC regulates only indexed annuities that
are securities.” Office of Investor Education Advocacy,
Updated Investor Bulletin: Indexed Annuities (July 31, 2020),
available at https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_indexedannuities.

2. According to FINRA, “While all annuities are
regulated by state insurance commissioners, variable annuities are
also regulated at the federal level by the U.S. Securities and
Exchange Commission (SEC) and FINRA.” FINRA, Investment
Products: Annuities, available at https://www.finra.org/investors/investing/investment-products/annuities.

3. LIMRA, “Secure Retirement Institute: Total U.S.
Annuity Sales Highest Since the Great Recession,” limra.com
(Mar. 10, 2022), available at https://www.limra.com/en/newsroom/news-releases/2022/secure-retirement-institute-investors-seeking-protection-and-greater-returns-propel-total-u.s.-annuity-sales-to-highest-since-the-great-recession/.

4It is estimated that by 2023, “93% of advisors
across all channels expect to generate at least 50% of their
revenue from advisory fees.” Cerulli Associates, “RIAs
Defend Marketshare with Service Expansion,” cerulli.com (Mar.
1, 2022), available at https://www.cerulli.com/press-releases/rias-defend-marketshare-with-service-expansion.

5In 2016, the DOL revised its five-part test, first
issued in 1975, describing what constitutes fiduciary investment
advice under Section 3(21)(A)(ii) of ERISA. Under the 1975
standard, broker-dealers could receive commissions and other forms
of compensation that are prohibited to ERISA fiduciaries because
they generally were regarded as not providing fiduciary investment
advice. Under the 2016 standard, however, broker-dealers were no
longer able to receive commissions, load fees, or 12b-1 fees for
their advice absent a prohibited transaction exemption. The 2016
standard was later vacated on appeal in 2018. See Chamber of
Commerce of the U.S. v. U.S. Dep’t of Labor, 885 F.3d 360 (5th
Cir. 2018).

6See, e.g., I.R.S. Priv. Ltr. Rul. 201946003, 2019 WL
6041780 (Aug. 6, 2019).

7Id.

8In 2015, FINRA reported 639,442 registered
representatives at year-end. By 2021, that number had declined to
612,457. See FINRA, “Statistics,” finra.org, available at
https://www.finra.org/media-center/statistics#reps.

9Investment Adviser Association, Investment Adviser
Industry Snapshot 2021 (2d ed. July 2021), available at https://investmentadviser.org/wp-content/uploads/2021/08/Investment_Adviser_Industry_Snapshot_2021.pdf.

10.Jackson National Life Insurance Company,
“Fee-based annuity solutions,” jackson.com, available at
https://www.jackson.com/ria-and-wealth-managers/fee-based-annuity-solutions.html

11. According to the North American Securities
Administrators Association (“NASAA”), most states will
allow an individual to substitute one of the following
certifications for passing the exam: (1) Certified Financial
Planner (granted by the CFP Board of Standards); (2) Chartered
Investment Counselor (granted by the Investment Adviser
Association); (3) Chartered Financial Consultant (granted by the
American College); (4) Personal Financial Specialist (granted by
the American Institute of Certified Public Accountants); and (5)
Chartered Financial Analyst (granted by the Chartered Financial
Analyst Institute). See NASAA, “Exam FAQs,” nasaa.org,
available at https://www.nasaa.org/exams/exam-faqs/.

12. NAIC, State Licensing Handbook (2020), available at
https://content.naic.org/sites/default/files/inline-files/State%20Licensing%20Handbook%20-%20Complete%20and%20Final.pdf.

13. These include Arkansas, California, Connecticut,
Georgia, Indiana, Kentucky, Louisiana, Maine, Maryland,
Massachusetts, Michigan, Montana, Nebraska, Nevada, New Hampshire,
New Jersey, New Mexico, New York, North Dakota, Oklahoma, Oregon,
Puerto Rico, Texas, Utah, Vermont, Virginia, and
Wyoming.

14. Depending on the jurisdiction, such requirements
might include one or more of the following: (1) the use of a client
contract that incorporates standard or mandated contract language,
(2) submission of a client contract template to the state insurance
regulator for pre-approval, (3) use of a mandated disclosure
statement with clients, (4) a license examination for individuals,
(5) experience qualifications and continuing education for
individuals, (6) bonding and errors and omissions insurance, (7)
record-keeping obligations, and (8) prohibitions against client
loans or simultaneously holding a producer license.

15. See General Instruction 2 and Item 9.B of Form ADV
Part 2A.

16. See, e.g., Nationwide, “Nationwide Advisory
Solutions Launches New Variable Annuity with Lifetime Income
Guarantee Designed Expressly for RIAs and Fee-Based Advisors,”
nationwide.com (Mar. 13, 2019), available at https://news.nationwide.com/nationwide-advisory-solutions-launches-new-variable-annuity-with-lifetime-income-guarantee-designed-expressly-for-rias-and-fee-based-advisors/
(“For RIAs who don’t hold an insurance license, Nationwide
Advisory Solutions provides a licensed insurance agent service
direct to the advisor and their client at no additional
cost”).

17. See, e.g., RetireOne, “Partner with Us,”
retireone.com, available at https://advisercounsel.net/2020/09/29/the-rise-of-fee-based-annuities-and-potential-licensing-issues-for-independent-investment-advisers/
(“Fee-only fiduciaries like you don’t need to have
insurance licenses to access our marketplace of no-load insurance +
annuity solutions. We’re the agent of record, and there’s
no additional cost to you or your clients.”); DPL Financial
Partners, “Solutions,” dplfp.com, available at https://www.dplfp.com/solutions/for-your-practice
(“RIAs join DPL to bring their clients’ insurance under
their fiduciary umbrella, provide solutions clients want and need,
and grow their business”).

18. “While we traditionally referred to those who
engaged in compensated solicitation activity under the current
solicitation rule [former Advisers Act Rule 206(4)-3] as
‘solicitors,’ we use the term ‘promoter’ in this
release to refer to a person providing a testimonial or
endorsement, whether compensated or uncompensated. . . . The
promoter may be an entity or a natural person.” Investment
Adviser Marketing, Advisers Act Release No. 5653, 86 Fed. Reg.
13024, 13025 n.6, 13048 n.293 (Mar. 5, 2021).

19. Certain states that have adopted the Uniform
Securities Act of 2002 define the term “investment adviser
representative” to include solicitors, which is what promoters
were called prior to the amendments to Advisers Act Rule 206(4)-1.
See, e.g., MCL § 451.2101a(f) (Michigan law).

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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