The Mutual Fund Trading Scandal
Are Insurers Next?
By Jim Connolly
When insurance industry observers look at the current travails that mutual funds are experiencing, do they see a foretaste of what the insurance business is in for? The answer, after a wide-ranging series of interviews, is that such a scenario is conceivable but not necessarily so.
After months of findings of illegalities and alleged wrongdoing among mutual fund complexes that run the gamut from after-hours trading and market timing to not adhering to policies stated in fund prospectuses, the Securities and Exchange Commission on Dec. 3 proposed some reforms.
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Among these is a rule requiring that fund orders be received by 4 p.m. in order to receive that days price. The commission also approved a rule that will require funds and advisors to establish compliance procedures and designate a compliance officer who will report to the board of directors.
Additionally, the SEC also proposed enhanced disclosure requirements.
These actions also followed reports of an SEC request that insurers provide information on variable annuities.
During the last few months, New York State Attorney General Eliot Spitzer has assailed brand-name fund families such as Putnam, an asset management division of insurance broker Marsh & McLennan, to Invesco mutual funds.
Spitzers office declined to comment on whether the insurance industry faces similar issues, but many familiar with the business offered their view on a potential ripple effect.
Interviews suggest that the question needs to be looked at from a number of perspectives: the implications for subaccounts in variable products; for insurers own family of funds; for defined contribution plans offered by insurers; and any potential effect on revenue and volatility of earnings.
While late trading and market timing activity could surface in variable annuity subaccounts, Robert Riegel, managing director with Moodys Investor Service, New York, says VAs are, by and large, retail, not institutional, money, which makes it less likely for abuses to be as prevalent.
However, he notes, similar abuses are not impossible to imagine. “A year ago people thought the mutual fund industry was pristine,” Riegel says. “No one could have envisioned what has come out in the last 6 months in the mutual fund industry.”
The problems of the asset management businesses of insurers are not likely to spill over into the insurance operations, he adds. However, if problems do develop in a unit, it could have an impact on the amount and volatility of earnings, Riegel continues. This would be particularly so if the division contributed significant earnings to the insurer, and those earnings were reduced by settlement and restitution costs or lower fees resulting from redemptions and thus, smaller asset totals under management, he says.
There are 2 types of considerations for insurers, says Steven Buller, national director of asset management services with Ernst & Young, New York. The first would be whether there was a violation by an insurer and the second consideration, he continues, would be whether a hedge or mutual fund that the insurer used in its product was involved in an infraction.
An insurer can limit market timing in variable annuities by establishing restrictions such as redemption fees, minimum holding periods and limits on the number of exchanges within a given time period, Buller adds. However, for contracts already in existence, an imposition of new restrictions could be considered a violation of the original contract, he explains.
There are certain actions insurers can take that will help them avoid wrongdoing, Buller says. Insurers can make sure their variable products are in compliance with prospectuses, and they can make sure there is good disclosure to consumers, he emphasizes.
Insurers will see some of the same issues mutual funds are experiencing, but they just havent surfaced yet, according to Geoff Bobroff, president of Bobroff Consulting, Warwick, R.I. Some VA providers, particularly smaller insurers with their own captive sales force may be less likely to have market timing activity because it will be more readily noticeable with smaller portfolios.
Bobroff offers two solutions to the problems that have surfaced: Treat investors fairly and uniformly.
Proper disclosure in a prospectus followed by adherence to the guidance in a prospectus is important for insurers, says Norse Blazzard of Blazzard, Grodd and Hasenauer, a law firm in Fort Lauderdale, Fla.
Blazzard says market timing within a variable account is not illegal and if companies put more restrictions in place, the contract owner could be placed at a disadvantage.