DOL's Fiduciary Rule May Lead to Retirement Product Changes

Advisers will increasingly choose technology platforms to deliver advice, and insurance product pricing may become more like mutual funds, Cerulli Associates anticipates.

The Department of Labor’s (DOL’s) proposed conflict-of-interest rule (fiduciary rule) will force a period of product and platform innovation in the United States, according to Cerulli Associates.

Cerulli anticipates large broker/dealers (B/Ds) will use developing technology to serve smaller accounts on a flat-fee basis, and insurance companies will be forced to lower variable annuity expenses and commissions to be in line with other financial products.

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The DOL’s proposal creates a new type of prohibited transaction exemption, referred to as the best interest contract exemption (BIC), which is a contract that the investment advice provider must present to a potential client in the case that the adviser will have an opportunity to earn a variable commission or fee in servicing that client. Specifically, Cerulli notes in its first quarter 2016 issue of The Cerulli Edge – Retirement Edition, the financial institution must disclose any variable compensation that the adviser receives for the advice and any resultant product sales, whether by the adviser or a colleague in the firm, along with comparative examples of compensation they would have received for other products.

Cerulli anticipates there will be unexpected changes to the retirement and wealth management industries and, to a degree, this cultural evolution is what the proposed rule is hoping to affect. According to Cerulli, in a speech at the Brookings Institution, Secretary of Labor Thomas Perez said, “I believe, in fact, that the new rule will be a catalyst for further innovation in the industry, as more firms devise new tools and strategies—assisted by modern software and new technology-based tools—to accommodate even those with only a few thousand dollars to invest.”

The continuing move to robo-advisers will be a result of the DOL’s proposed rule, Cerulli believes. These platforms offer scalable trading technology, algorithmic portfolio construction, and heavy use of low-cost exchange-traded funds (ETFs). “Digital adviser technology may provide a scalable solution for B/Ds to work with low balances in individual retirement accounts on a flat-fee and a fiduciary basis,” Cerulli says in its report.

NEXT: Changes to insurance company products

Cerulli says the fee and compensation disclosure requirements of the BIC will cause insurance companies to re-evaluate annuity pricing. It expects there will be a short-term hit to variable annuity sales as B/Ds grapple to comply with the requirements of the DOL rule.

Cerulli anticipates two primary evolutions to annuity pricing: First, pricing products for inclusion on fee-based managed account programs, and second, adjusting expenses and commissions to be more in line with mutual funds.

The crux of the challenge for insurance companies is that annuities must compete against other financial products on their value to the consumer and not compensation to the adviser. Insurance companies have been competing with each other over features and benefits. Cerulli believes this focus on product features has kept annuities from experiencing the same growth as other financial products, such as mutual funds or ETFs. “The conflict-of-interest rule may ultimately be a wake-up call for the insurance industry to evolve the way it does business,” Cerulli says.

However, while the proposed rule is a major event, Cerulli says its true effects may not be immediately felt, noting that Employee Retirement Income Security Act (ERISA) section 408(b)(2) and 404(a)(5) rules enforcing mandatory fee disclosure for retirement plans were hailed as a game-changer for the industry, but the first wave of fee disclosure mailings “was largely met with crickets.”

But, the retirement plan industry matured during succeeding years as plan sponsors benchmarked costs, interest grew in low-cost passive investments, and specialized consultants increased their control. “It may be that implementation of the DOL rule is a short-term non-event, but the effects will continue to creep into the retirement industry,” Cerulli says.

More information about Cerulli’s publications and how to purchase them is here.

Stock Purchase Plans Can Help with Financial Wellness

A different breed from stock in a retirement plan, ESPPs can encourage engagement and boost employees’ sense of financial well-being.

Companies can offer company stock to their employees in several ways. One—the employee stock purchase program (ESPP)—is a benefit, rather than a form of compensation. One thing it definitely is not is an employee stock ownership plan (ESOP), which seems to be trending slightly downward in popularity. 

The ESPP is a benefit similar to a discounted gym membership rather than a form of compensation, explains Emily Cervino vice president of stock plan services at Fidelity. The optional program means employees can choose to participate or not, and can usually choose to do so at a range of salary percentage between 1% and 10%.  

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According to Cervino, companies use the plans as an attraction and retention tool, and there aren’t any lawsuits. “These are not designed to be part of a retirement plan,” she tells PLANSPONSOR. “They are used strictly in the world of publicly traded companies.” At its most basic level, the plans provide an opportunity for employees to purchase company stock using regular payroll deductions. Stock is purchased on a predetermined schedule, generally at a discount, at the end of a contribution period.

Some plans offer stock with a look back, a feature that allows employees to “look back” at the stock price, comparing it from the beginning of the contribution period to the end. If, for example, the stock price was $10 at the beginning and $12 at the end, the employee would use the lower price to purchase stock.

Sometimes, Cervino, notes, the plan has a holding period of three, six or 12 months, during which participants are required to hold onto the stock, but most plans do not contain this condition.

Plan sponsors can find an advantage in offering an ESPP because it is an opportunity to share ownership with the entire workforce, says Cervino. “Most companies limit awards to employees at the higher end of the pay scale, but this is designed to be a broad-based program.”

NEXT: Employees who purchase company stock may receive unexpected extra benefits

The benefit may have other advantages, according to new research from Fidelity Investments. In addition to experiencing a sense of ownership and pride in the firm, employees who participate in an ESPP may have more confidence and control over their financial well-being.

Nearly half of employees (48%) who purchased company stock through an ESPP sold all their shares within two years, demonstrating the role company stock can play within an employee’s overall financial plan.

Despite the significant percentage of sellers, the findings showed very few people “flipped” their stock purchase: just 6% of employees who sold all their shares did so within 10 days of purchasing the shares.

Employees in ESPPs that offer a higher discount are more likely to sell sooner, Fidelity found: almost 40% of employees with a 15% discount sold all their shares within 90 days, compared with 25% of employees in plans with a 5% discount.

However, higher discounts contribute to higher employee participation rates. “Plans with a 15% discount have double the participation rates when compared to plans with a 5% discount.”

The research also found that age can impact how employees managed stock purchased through their ESPP. More than half (57%) of the employees younger than 30 sold all their shares within two years, while 58% of employees older than 60 held all their shares.

In addition to helping workers manage short-term expenses and financial needs, Fidelity found that employees who have access to an ESPP are less likely to take 401(k) loans. When faced with expenses that must be addressed quickly, cashing in shares from an ESPP may help to avoid the risks and implications associated with 401(k) loans, a move that can get in the way of reaching retirement goals and lead to reducing or stopping 401(k) contributions. Another advantage: the money does not have to be repaid if the employee changes jobs.

Offering employees a chance to purchase company stock can produce positive benefits for both workers and their employers, including improved productivity and morale, and a sense of ownership in the company, according to Kevin Barry, executive vice president of stock plan services at Fidelity. “Whether it’s covering short-term expenses, paying down debt, building an emergency fund, or complementing their 401(k), company stock plans can help improve employees’ overall financial wellness.”

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