The Era of Best Interest Standards for Financial Professionals

by FIG Marketing
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Updated on September 20, 2023, at 11:57 AM

We’ve experienced a lot of new things in the past year plus, haven’t we? The “new normal” is a phrase we’ve grown accustomed to in our lives. We typically hear this phrase when one is speaking about COVID-19 or COVID-related requirements. However, there’s a new normal emerging in the financial industry that we must get used to seeing. That new normal is an era of best interest regulations.

In the insurance industry, we see three converging regulations. Depending on how you serve your customers, whether as an insurance-only agent, investment adviser representative, or registered representative, you may have to juggle multiple rules and requirements at the same time!

Regulation Best Interest

On June 30, 2020, the SEC implemented Regulation Best Interest (Reg BI). Side note: we put together a list of answers to your Reg BI questions.

The SEC has jurisdiction over the securities industry. As such, Reg BI applies to broker-dealers and registered investment advisers (RIAs). Among other things, Reg BI brought forth new disclosure requirements, the need for managing conflicts of interest, and documentation requirements. All with the intent of supporting best interest recommendations made to customers.

Reg BI has arguably had a more significant impact on broker-dealers than RIAs since RIAs have always had to live up to most of the standards outlined in the regulation.

NAIC Model #275

In addition to Reg BI, the NAIC adjusted its Suitability in Annuity Transactions Model Regulation (Model #275) in 2020. The NAIC sought to enhance their annuity suitability model regulation when they saw the DOL’s work with the Obama-era fiduciary rule and what the SEC was doing with Reg BI. They, too, moved towards the best interest standard.

The NAIC’s model now speaks to the best interest standard through evidencing four obligations: care, disclosure, conflicts of interest, and documentation. Like Reg BI, the NAIC intends to set requirements for managing conflicts of interest. They’ll require various disclosures to the customer and documentation on how transactions are in their best interests. The NAIC wished to align its requirements to those of Reg BI as much as possible. The NAIC does provide safe harbor in scenarios where one is subject to Reg BI.

However, NAIC model rules are subject to state approval, which further complicates matters for financial professionals. At the time of this writing, Arizona, Iowa, and Rhode Island have implemented the rule and require full compliance. Many other states will follow throughout 2021 and into 2022.

Related: FINRA Reg BI Checklist: 20 Compliance Requirements [Infographic]

DOL Fiduciary Rule

Lastly, the DOL fiduciary rule came back from the dead, albeit in a much different way from its 2017 form. On February 16, 2021, the DOL’s new fiduciary rule reinstates what’s called the “Five-Part Test” along with the Impartial Conduct Standards and adopted a new prohibited transaction exemption to boot.

The DOL’s work is primarily directed towards advice involving a customer’s qualified retirement plan assets. In the insurance industry, rollovers come to mind as one of the largest impacted areas the DOL’s rule touches. In a nutshell, the DOL has set the need for disclosures involving conflicts of interest and how transactions meet best interest standards.

When we line them up, we see the common threads between all of these regulations. There are obligations to provide certain disclosures. There are obligations to mitigate, manage, or eliminate conflicts of interest. There are obligations to have supporting documentation that proves the transaction was in the customer’s best interests.

What We See From a Compliance Point of View

While all of the obligations within each regulation are important on their own, some may find that documenting the best interest recommendation may be one of the most challenging items to accomplish.

From a compliance perspective, insurance agents tend to have more difficulty maintaining an adequate documentation level within their books and records. However, we tend to believe this isn’t necessarily the fault of the insurance agent. Many insurance agents are independent business owners and don’t benefit from receiving guidance from a compliance department like a registered representative of a broker-dealer or an investment adviser representative of an RIA would.

Related: It Was the Best of Times, It Was the Worst of Times: Regulatory Changes from AG 49-A & Section 7702

In broker-dealers and RIAs, there are set criteria for documentation that provide a standardized method of gathering all needed information. Insurance agents often have to create these processes while interpreting rules and seeking limited guidance from various state regulatory agencies.

From a compliance perspective, documentation is your primary defense when it comes to the potential bad situations that could pop up in the future (for example, customer complaints, regulatory inquiries, and lawsuits).

Outside of the RIA space, most operating with commissionable products have only had to abide by a suitability standard and not the best interest standard. Evidencing a best interest recommendation through documentation is more complex. How do you prove that a particular product was in a customer’s best interest and not just a suitable recommendation?

First, most insurance companies are enhancing their application processes to ensure the requirements from these converging regulations are captured. However, to demonstrate the best interest recommendation, one has to dig deeper from a documentation standpoint and go beyond the standard forms an insurance company requires. There’s a need to include a comparative analysis between the various products presented to a customer. This analysis should show all of the pros and cons of each product and how the selected product best aligns with the customer’s needs.

Agents will be required to gather more financial background information on their customers further to evidence the financial need for the selected product. Outside of required standard insurance company documentation found in the applications, insurance agents should also keep a write-up in their books and records that details their conversations with the customer and how they arrived at their recommendation. This write-up should be thorough and describe all of the meetings between the customer and the insurance agent.

It may not be a bad idea to summarize this type of write-up and provide it to your clients, so you can show there was a mutual decision that the selected product was in their best interests. If the transaction ever came into question many years later, you might not recall the details of your recommendation. A detailed write-up may prove to be one of your greatest defenses.

Going Forward in the Era of Best Interest Standards

There’s still much to learn about these converging regulations and the long-term impacts on our daily business. As we move forward, we expect to see additional guidance come from external sources. Especially in the case of the DOL, we may receive some clarity from the regulators themselves. Many states still need to adopt NAIC Model #275.

Additionally, the DOL has a non-enforcement policy in place on their rule until December 20, 2021 (provided you’re complying with the Impartial Conduct Standards). We’ll keep our eye on these and any other emerging regulations going forward so that you’re informed.

We’re officially in the era of best interests. And they’re here to stay.

Keep Reading: Section 7702 Changes: The Sage Continues

This article originally appeared in FIG’s Spring 2021 edition of Connections magazine. You can read the full issue by clicking the image below.

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