SEC Issues Some Guidelines On Variable Annuity Exchanges

By

Washington

The Securities and Exchange Commission has issued guidelines for determining the “retail exception” to Section 11 of the Investment Company Act, arguing that some insurance companies may be interpreting the exception too broadly.

“We are very concerned with potential insurer violations of Section 11 because of the possibility that contract owners will be induced to make disadvantageous exchanges that result in the payment of additional sales charges and broker compensation,” the SEC says in a letter to three insurance trade groups.

The SECs interpretation was contained in a letter; it did not engage in a formal rulemaking process involving notice and comment.

SEC says it believes some insurers may undertake initiatives designed to encourage exchanges from one variable annuity contract to another from the same company, relying on the “retail exception” to avoid either seeking SEC approval or complying with Section 11.

“We wish to emphasize that we view abusive switching of variable annuity contracts very seriously,” SEC says.

“Section 11 provides important protections against the imposition of additional sales charges to contract owners, and we would be very concerned with any insurer initiative that is designed to encourage exchanges among variable annuity contracts without either complying with rule 11a-2 or seeking a Commission order approving the terms of the exchange offer,” SEC says.

In general, Section 11 bars insurers from offering to exchange existing VA contracts for other VA contracts issued by the same insurer, unless the SEC has approved of the terms of the offer or the offer complies with the rules governing exchange offers.

The purpose of Section 11, the SEC says, is to prevent exchanges offered solely to exact additional sales charges.

However, there is a limited exception to Section 11 called the “retail exception,” which, the SEC says, in general applies to communications between an individual broker and an individual customer.

It does not apply, SEC says, to a group or class of contract owners or to any exchange offer by an insurance company separate account.

But in recent years, SEC says, estimates are that up to 40% of new sales of variable annuities are attributable to contract exchanges.

This, SEC says, is due largely to the increasing popularity of bonus annuities, which add an up-front bonus usually ranging from 1% to 5% to the contract value.

A contract owner may not benefit from the exchange, however, because bonus annuities often have higher surrender and asset-based charges, as well as longer surrender charge periods, SEC says.

Nonetheless, SEC says, brokers who handle these transactions often receive substantial commissions.

To prevent any abuse, SEC is outlining several factors insurers should consider to determine whether an exchange offer qualifies for the retail exception (see chart).

The SEC says these factors are useful analytically, but are not intended to be exhaustive. Other factors may also be considered depending on the facts and circumstances, SEC says.

“We would expect any insurer that relies on the retail exception to monitor its exchange activity on an ongoing basis to evaluate whether this activity falls within the retail exception,” SEC says.

Carl B. Wilkerson, chief counsel for securities with the American Council of Life Insurers, Washington, says that while ACLI appreciates the clarification of SECs interpretive position, the Council would have preferred that the SEC staff engage in a formal notice and comment procedure.

This is a very important SEC interpretation, Wilkerson says. It is worth taking the time to do in a more deliberative fashion.

There is a dearth of legislative history surrounding the retail exception, he adds.

W. Thomas Connor, vice president and general counsel with the National Association for Variable Annuities, Reston, Va., agrees.

Indeed, he says, the SECs interpretive letter leaves significant open issues and areas of disagreement.

For example, Connor says, the letter leaves open the question of what communications to existing customers constitute exchange offers.

If a company sends a monthly newsletter to all its customers, he asks, and that newsletter talks about a new variable annuity contract, is that an exchange offer?

Connor also questions whether upgrades to existing contracts are as significant as the SEC suggests. He notes the SECs letter says the figure is around 40%. However, Connor says, there are no hard data, at least none that he has seen, indicating that level of exchange.

NAVA, he says, joined with ACLI in urging the SEC staff to obtain the widest possible comment before issuing its guidelines.

National Underwriter contacted the SEC to inquire about the procedures in issuing the guidelines, but the call was not returned by press time.


Reproduced from National Underwriter Life & Health/Financial Services Edition, July 6, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.


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