The roughly 350 independent marketing organizations that distribute fixed indexed annuities will need considerable cash on hand to operate as financial institutions under the Labor Department’s fiduciary rule.

Labor released a proposed class exemption that would qualify IMOs as financial institutions under the rule’s Best Interest Contract Exemption. The financial institution designation is required to sell commission-based investments like FIAs to IRA investors.

As proposed, the exemption requires IMOs to have sold at least $1.5 billion in FIA premiums in each of the last three fiscal years.

They will also need 1 percent of the average amount of premium sales over three years set aside in cash, bonds, and fiduciary liability insurance.

That means an IMO that meets the $1.5 billion sales threshold would need $15 million in cash reserves and insurance policies to qualify as a financial institution.

In crafting the class-wide exemption, Labor considered the applications of 22 IMOs. Some disclosed their revenues to regulators.

The proposal says those that did “generally indicated” premiums sales of $1.5 billion or more.

Under the proposed sales and reserve requirements, it is possible that no IMOs would be able to qualify as a financial institution, says Sheryl Moore, (pictured) CEO of Moore Market Intelligence, which provides analytics tools to the insurance industry.

“Given what the DOL knew about the revenues of the applicants, you can’t tell me they didn’t know the $1.5 billion sales threshold will obliterate the IMO distribution channel,” said Moore.

Of the approximately 350 IMOs operating throughout the country, Moore estimates that perhaps 12 could comply with the $1.5 billion revenue threshold. Of the 22 IMOs that applied for individual exemptions to the Labor Department, she says maybe one-third meet the revenue requirement.

Even the handful of IMOs that meet the $1.5 billion threshold will struggle with the 1 percent cash reserve requirement, says Moore.

“How many IMOs do you think have $15 million in the bank? I would say one, two at the very most,” said Moore.

“The reserving requirements will create a monopoly in the market,” she added. “I’m not sure DOL really cares that this will mean IMOs will wither on the vine.”

Labor’s reasoning

In its lengthy proposal, much of which is a rehash of the finalized fiduciary rule, the Labor Department said the inherent complexity of FIAs warrants the high bar it has proposed for IMOs to qualify as financial institutions.

“In the Department’s view, the complexity and conflicted payment structures associated with fixed indexed annuities heighten the dangers posed by conflicts of interest when advisers recommend these products to retirement investors,” according to language in the proposal.

The proposal acknowledges the role IMOs play in providing marketing, and in some cases, compliance support to independent insurance agents. It also suggests IMOs will be able to continue to operate in the market without qualifying for the financial institution exemption by contracting with insurance companies to help distribute FIAs to the independent agent channel.

In proposing the $1.5 billion threshold, the Department questions whether IMOs below that level of sales have the resources to adequately monitor conflicts of interests in the commission-based marketplace, “particularly without the history of oversight and supervisory experience that characterize other financial institutions, such as banks, insurance companies, and broker dealers,” the proposal says.

“Labor has a point—they are insecure over the fact that IMOs don’t have a regulatory body,” said Moore. “But the reality is the thresholds they set may leave no IMOs with the ability to comply.”

Labor asks for more information from IMOs

The Labor Department has opened a 30-day comment period on its proposal, which closes on February 18. The Department is proposing making the exemption available on April 10, the first implementation date for the fiduciary rule, but is offering transitional relief for IMOs through August 15, 2018.

Among the areas of clarification it’s seeking, Labor is asking for more information on carriers’ ability to change the terms of FIA contracts during the life of an annuity. The Department is considering limiting the financial institution exemption to the sale of FIA that don’t materially change the terms of contracts.

“Odd” timing

Doug Meyer, managing director at Fitch Ratings, also thinks the proposed thresholds are unrealistic for IMOs.

“Given how IMO revenues are configured, they are going to struggle with this,” he said.

There is a silver lining for IMOs. “We see the rule getting delayed and ultimately revised under the Trump administration,” said Meyer. “I would expect these capital requirements for IMOs to be part of those revisions,” he said.