DOL and the impact of regulation
by James W. KerleyMr. Kerley is Chief Membership Officer for LIMRA and LOMA. In this role, he delivers LIMRA’s thought leadership and global research to the broad insurance and financial services community. Visit limra.org
I imagine there might have been a conversation at the White House some time ago, that went something like this:
“We need to do more to protect the retirement nest eggs of our fellow citizens, especially those who buy annuities. While we are at it, let’s ensure the consumer’s interest is a top priority too.”
“Can someone call Secretary Perez over at the Department of Labor and see what his team can come up with to solve this problem.”
Like it or not, what the U. S. Department of Labor (DOL) came up with is an outstanding use of innovation to cause far-reaching disruption within the financial services sector. Upon closer examination, let us consider what actually happened.
Innovation, as defined by Merriam-Webster is a “new method, idea, product, or device;” while disruption is defined as a “disturbance or problem that interrupts an event, activity, or process.” Clearly, the DOL rule is asking for new methods, and products, as well as interrupting events, activities and processes simultaneously. Was the intention the actuality here? Yes, but with far more reaching consequences than many recognize.
What the DOL launched is disruptive innovation. As Clayton Christensen defines it in his book, The Innovator’s Solution, disruptive innovation is “an innovation that creates a new market and value network, and eventually disrupts an existing market and value network, displacing established market, products, firms and alliances.” In the book, Christensen suggests that the disruptive process can take a long time, but once it is deployed in the market, it achieves much faster penetration and high degree of impact on the established markets.1
This latest regulation might be the single greatest example of “disruptive innovation” within the financial services sector, since the passage of the Employee Retirement Income Security Act (ERISA) of 1974. Moreover, while this latest chapter is a long way from written, the ultimate outcome of the ruling, may be purely coincidental to the changes currently being played out within the financial services sector.
Where will disruptive innovation take place?
Distributors clearly will feel the force of disruptive innovation on their business models. First, think about the increased fiduciary-based sales processes that advisors of all types will be required to follow. Broker-dealers, investment advisors, insurance agents, and plan consultants, will be under the watchful eye of the DOL fiduciary requirements, as they transition from suitability standards to the best interest of the customer.
Second, watch for the creative and innovative ways insurance carriers, financial institutions, industry vendors, and industry trade associations – including LIMRA – will take to respond to the training and supervisory needs of advisors. Consumers, regulators and executives would agree that a better-educated salesforce serving the best interest of the customer is a preferred outcome. In addition, the regulators will see new ways of tracking “best interest behavior” to ensure compliance to the new rules.
The type of agents or advisors serving customers today may shift over time. Fixed-indexed annuity (FIA) distribution is one channel that may feel the greatest impact of disruptive innovation. Based upon the recent ruling of the Dallas Judge, Barbara M. G. Lynn, FIA distributors are now fully impacted. Judge Lynn supported the DOL’s contention that FIA products must be included in the Best Interest Contract Exemption (BICE). With that said, this channel is comprised of the most entrepreneurial agency owners I know. They will figure it out and evolve!
Registered investment advisors are in a much better position to comply. Charles Schwab is an example of a company who is taking advantage of this time of disruptive innovation. Recently Charles Schwab ran a full-page advertisement in a financial service trade publication that stated, “Fiduciary: It’s the word independent advisors live by.” The ad also tells us “Charles Schwab is committed to the success of over 7,000 independent financial advisors who are passionately dedicating themselves to helping people achieve their financial goals.” They are not alone in the search for individual advisors, who want to provide contemporary, well-founded advice to the consuming public. I think we will see these types of statements from financial institutions more often.
Fee-only compensation models are examples of disruptive innovation applied to product development. These compensation models are not new ideas. They are simply being applied to a very large segment of financial services sales people, who have lived on a commission-based model for many years. Innovation is necessary here. If it becomes necessary, our industry will learn to operate under the BICE. We will adapt.
Incentive and sales recognition meetings will also need to be redefined. Gathering the wholesaling teams and sales teams for annual planning meetings will continue to be fundamentals of the business. In future meetings we should watch for richer educational components, more focus on developing sales and customer communication skills, and more in-depth opportunities to understand product application. Again in this instance, everyone will benefit from contemporary and well-educated advisors.
Disruptive Innovation and the Consumer
Most importantly, in the center of all this disruptive innovation is the customer. With these changes, they should win in a number of ways. Companies and advisors are working hard to improve consumer’s access to information, education, tools and strategies to help them make better choices. More robust websites and blogs will lead to expanded chat and video conference access as well as to new sources of online professional expertise. New apps and robo-tools will provide self-directed consumers information, advice and product solutions in new ways.
Will consumers benefit, no matter which way the ruling on this comes out? I believe that in the final analysis, the answer will be “yes.” As noted already, companies and the well-informed advisors are working hard to improve the consumer experience. We have already begun to see how the use of robo-advice allows customers to start investing, and over time seek recommendations of a trusted advisor.
Consumers will win, not because of the DOL fiduciary rules themselves, but rather as a result of the application of other disruptive innovations coming into our space. Companies are continually looking for ways to access new consumer segments, who want and need our products – annuities, investment products and life insurance, as well! Together we are learning how to serve customers, who simply want to purchase in technology enabled ways.
Investors from across all income levels should benefit from innovation in product design. As annuity companies redefine their go-to-market strategies, they will learn more about the retail consumer’s needs and preferences. They will have a better understanding of generationally driven buying preferences. Omni-channel purchasing habits may also be used to improve sales to lower and middle-income consumers. While many believe that advisors will not be able to afford to serve this segment of the market, other industries have proven that a segmented approach to both customers and sales representatives can be mutually beneficial. I believe it can serve our industry well, too.
Over the years, many forces have influenced how our industry operates, and of course, regulation is always at the top of the list. Today, regulation, social media access, consumer preferences, technology, and the global economic environment are just a few of the demands that our industry must manage.
The Investment Advisors Act of 1940 established a fiduciary standard of care and required advisors to insure each investment recommendation be in the customer’s best interest. Seventy-seven years have passed since those standards were established. It must have felt then, as it feels now. The world would never be the same, because of some crazy disruptive innovation.
Somehow, the financial services industry adjusted to the many regulatory changes over the years, and from my point-of-view, we have been serving our customers very well. I wonder if someone from the White House called the Department of Labor back then too… ◊
1. “Inhibitors of Disruptive Innovation Capability: A Conceptual Model,” European Journal of Innovation Management, 2006