The law, set to go into effect in April, would put small-brokerage and insurance agents out of business
The Labor Department under Secretary Thomas Perez is a prime example of federal regulatory overreach. Over the past seven weeks, federal courts have put holds on the department’s new regulations relating to overtime, federal contractors and confidential legal advice for employers.
Another power grab is Secretary Perez’s attempt to regulate small brokerages and insurance agents. The “fiduciary rule,” as it is known, was issued in April 2016, and is set to take effect in April 2017. The rule would put hundreds of thousands of small brokers and insurance agents out of business.
This rule is supposed to discourage investors and purchasers of life insurance away from commission-based products and toward products that have an up-front fee. This is because the department believes that commission-based products encourage financial representatives to overcharge consumers.
Small savers may not be able to afford the up-front fees that fee-based, non-commission insurance carriers and advisers will charge.
No matter that some people cannot afford up-front fees and prefer to pay on commission, and that few complaints have been received about the current system.
The alleged rationale for the rule is a report by the Council of Economic Advisers. Based on academic studies, CEA suggests that savers receiving commission-based advice earn returns that are roughly 1 percentage point lower each year, adding up to a loss of $17 billion a year. Yet the CEA staff did not analyze data, and the report’s authors state that “such analysis is subject to uncertainty.”
The proposed regulation would outlaw the commission-based approach for adviser compensation unless the adviser and the investor enter into a special “best interests contract.” This contract would include lengthy disclosures of commissions, speculative projections of future fees and cost for mutual fund securities, and greater exposure of the adviser to lawsuits by investors who are unhappy about their portfolios’ returns.
The brokers, registered investment advisers and life insurance agents targeted by Secretary Perez are already regulated by other entities, such as the Securities and Exchange Commission, FINRA and state regulatory bodies.
Particularly troubling is the effect of the new rule on life insurance products. Even though the Labor Department says that 31% of IRAs include some investments in annuities, it did not calculate the costs of the rule on people who purchase those products.
Under the new rule, carriers and insurance marketing organizations that sell fixed-rate annuities and fixed-indexed annuities (whose return varies with markets) would be regulated by the Labor Department as well as by their state regulators. These would all face a loss of revenues as insurance sales shrink due to regulation.
Currently many investors who purchase open IRA accounts or roll over old 401(k) retirement savings accounts rely on banks, stockbrokers or other financial professionals. These advisers are popular because they require no up-front fee for their services, but are compensated by commissions on the securities they sell to the investor. Wealthier clients can use fee-based advisers who charge the client a flat fee for advice, usually 1% to 1.5% of the total account, regardless of which securities are chosen.
Small savers may not be able to afford the up-front fees that fee-based, non-commission insurance carriers and advisers will charge. The result will be that many of those most in need of advice will go without.
The retirement financing landscape has changed since 1978, when employer-provided defined-benefit pension plans accounted for nearly 70% of all retirement assets. These plans provide a guaranteed income stream in retirement for the life of the retiree.
Now firms have gradually opted for defined-contribution plans, where they match a certain amount of employee contributions and let their employees direct their own retirement portfolios, within limits. By the end of 2013, 401(k)s, common defined-contribution plans and IRAs accounted for more than half of all retirement assets.
As defined-contributions accounts have grown in popularity, the last 40 years have witnessed the advent of index mutual funds, discount brokerage, exchange-traded funds and life insurance products.
While it is easy to assume that lower returns in retirement portfolios might be due to self-interested financial advisers, this is not always the case. Lower returns could be due to advisers’ recommendations for a more conservative portfolio, one that places a greater share of the assets in low-performing, but less volatile, Treasury bills or bonds. Returns are positively correlated with risk and variance, and some people prefer lower returns and less risk, especially as they approach retirement.
Just as Americans wanted to be able to keep their health plans, they also want to be able to keep their pensions plans. Rolling back the Affordable Care Act requires congressional legislation. Fortunately, rolling back the fiduciary rule just requires a new Labor Department rule making — one that the new Trump administration will be able to do after Inauguration Day.
This piece originally appeared on WSJ's MarketWatch