Variable Product Fees And Charges Are Under Attack–What To Do?
Fees and charges for variable insurance products are under attack.
The Securities and Exchange Commission staff has long been skeptical about these costs but now it seems the plaintiffs bar is zeroing in, too.
The old Willy Sutton bromide–”because thats where the money is”–probably explains the new development. As for the SEC staff, it probably still hasnt fully accepted the changes effected by the National Securities Markets Improvement Act of 1996. (NSMIA amended the Investment Company Act of 1940 to delete prior limits on variable insurance product charges and regulate them using a reasonableness standard attested to in a representation in the registration statement.)
This article looks at the types of attacks that are cropping up and also offers some strategies for coping in this environment.
A number of the attacks involve litigation. These take various forms and are based on various theories.
For instance, over 20 nationwide class actions have been brought in state courts attacking the disclosure relating to “modal premiums.”
Such cases claim there was no explicit disclosure of the fact and amount of “interest” charged when a purchaser pays his or her premium in installments. Further, they assert that the buyer pays more when paying in installments. These claims have been brought, even though the variable contract documents do show the amounts of the annual premium and the model premiums (whether monthly, quarterly, or semiannual).
Further, such cases charge interest rate disclosure is inappropriate and confusing because there is no loan.
The outcome? These cases have already resulted in settlements in the millions–this, even though it is hard to imagine that anyone in our culture is unaware that when you buy on installment you are charged more.
Another type of class action alleges violations of the Employee Retirement Income Security Act–because of so-called revenue sharing by the underlying funds with the insurer and its retirement products distributor.
Yet another class action complaint, filed recently, takes a different approach. The insurer had imposed an average premium tax charge, rather than assessing state specific premium tax charges. The complaint alleges that this amount is in excess of that assessed in the state, that the insurer was unjustly enriched, and that the cash values of the affected contracts would have been greater but for this excessive deduction.
Yet another example: The Court of Appeals for the Second Circuit has reviewed a case alleging that a variable annuitys mortality and expense risk charges were unreasonable, and violated Sections 26(f) and 27(i) of the ICA. You should also know that, in this case, the SEC did submit an amicus curiae brief; this brief asserted that Section 47(b) of the Investment Company Act provides a great remedy, so the court doesnt have to address the private right of action question.
What is significant here is that the Court of Appeals decision contains both good and bad news for the variable product industry.
The good news is, the court specifically declined to address the SECs position by upholding the lower courts decision that there is no private right of action under Sections 26(f) and 27(i) of the ICA. The bad news? The SEC brief reflects its support of private rights of action under another section.
There have also been various regulatory initiatives. For instance, revenue sharing arrangements in the brokerage world are coming under scrutiny. Specifically, fees and charges and revenue sharing are a focus of concern and scrutiny by the staff of the SECs Office of Insurance Products, Division of Investment Management, in the context of substitution applications.
The SECs inspection program is also looking into these arrangements.
So, you ask, what can be done? There are no easy answers to the question of how to protect against these various attacks. However, a few measures can be suggested.
Preventive measures derive from the statute. For instance, Section 26(f)(2)(A) of the ICA calls for a representation in the contracts registration statement concerning the reasonableness of the products fees and charges.
This statute does not require documentation. But the history, and favored practice in the industry, has been to prepare and maintain documentation supporting the representation regarding the reasonableness of charges under variable products.
In light of the increased regulatory and litigation scrutiny of revenue sharing and service fee arrangements, I believe insurers should consider preparing documentation of the reasonableness of the charges, including revenue sharing, well in advance of any litigation or SEC inspection.
Reasonableness documentation, contemporaneous with the insurance product design, could be helpful in resisting rescission remedy actions suggested in the SEC amicus curiae brief.
It could even help in the unregistered products arena, when fees and charges are under attack. Documentation of the fee determinations, beyond the required submissions to the states, might help.
In addition, disclosure regarding charges and revenue sharing in the registration statements for registered products, and in the marketing materials for both registered and unregistered products, can help repel attacks.
The point is, dont give plaintiffs or the SEC a chance to attack after-the-fact justifications as being self-serving.
Joan E. Boros, Esq., is a partner in the Washington, D.C. law firm of Jorden Burt LLP. Her e-mail: JEB@wdc.jordenusa.com.
Reproduced from National Underwriter Life & Health/Financial Services Edition, April 8, 2002. Copyright 2002 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.