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Securities Regulators Take Aim At VAs

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Securities Regulators Take Aim At VAs


The regulatory storm has moved over the variable annuity industry, but forecasters still are deciding whether it will topple financial services towers or simply muss the weathermans hair.

For a few months, most of the headlines about investigations of market timing and other problems with money management operations focused on mutual funds. Some of the fund companies involved just happened to be subsidiaries of insurance companies.

Companies that have disclosed that they have reported possible fund market-timing problems to regulators or received inquiries about possible problems from regulators include Massachusetts Financial Services Company, a unit of Sun Life Financial Inc., Toronto; Principal Financial Group Inc., Des Moines, Iowa; Prudential Financial Inc., Newark, N.J.; and Putnam Investments L.L.C., a unit of Marsh & McLennan Companies Inc., New York.

Milberg Weiss Bershad Hynes & Lerach L.L.P., New York, a law firm that often helps organize class-action suits, lists 14 suits on its Web site that involve allegations of mutual fund company market-timing problems. None of the suits names a VA issuer as the defendant.

But the U.S. Securities and Exchange Commission sent VA issuers a letter last fall that asked them about possible marketing timing problems.

Officials in the office of New York Attorney General Eliot Spitzer are declining to comment, even in the most general terms, about whether they are or are not looking at VA issuers as a group.

James Shorris, a deputy for enforcement at the NASD, Washington, says the self-regulatory body has reason to believe a dozen insurers may have VA market-timing problems. The 12 insurers “know that weve asked for information,” he says.

The NASD also is preparing to send variable annuity issuers inquiries that will deal with topics such as marketing practices, trading practices, compliance with anti-money laundering laws, the suitability of the products sold to particular customers, and the suitability of some sales that replaced one VA in a customers portfolio with another VA, Shorris says.

One company, Conseco Inc., Carmel, Ind., has disclosed that it received a notice from the SEC of an investigation of a VA unit that it sold to Inviva Inc., New York, in 2002. Conseco reports that, as far as it can tell, its old variable insurance unit did not break any state or federal law before its sale.

In any case, “we are no longer in the variable annuity business,” says Conseco spokesman Jim Rosensteele.

Several other insurers have reported receiving letters from the SEC, NASD or Spitzers office asking about their VA operations.

But “to date, were not aware of any evidence that market timing is a widespread problem in the variable annuity industry,” says Michael DeGeorge, general counsel of the National Association for Variable Annuities, Reston, Va.

Joan Boros, a partner at Jorden Burt L.L.P., Washington, says she and several colleagues have helped many insurers with their responses to the SEC request for information about VA market-timing information. When those companies looked at their operations, they found no evidence of market-timing problems, Boros says.

At this point, “I really think its too early to tell” whether there will be a serious problem with litigation related to market timing, Boros says.

Traditionally, the financial services industry has applied the term “market timing” to almost any effort to profit from predictions about short-term market fluctuations.

Regulators are accusing the big investors now under investigation of using more aggressive tactics. In some cases, the investors tried to pump large amounts of cash through funds in an effort to profit from small market inefficiencies, such as differences between the share prices of international stock funds and the underlying value of the stocks inside the funds.

VA issuers usually let ordinary investors shift assets from one subaccount to another every few months without paying commissions. Investors who keep assets in the contracts usually can move assets without worrying about tax consequences.

But many VA issuers limit investors ability to shift assets, because rapid asset changes drive up the companies trading costs and force them to keep large amounts of cash on hand to pay off flighty shareholders.

Spitzers investigators and other regulators say they are getting involved because some money managers negotiated secret deals to let big investors get around the funds own restrictions on market timing.

Regulators also are going after money managers that engaged in a related activity: letting big investors place orders to trade fund shares after 4 p.m. Allowing late trading lets favored investors profit from earnings announcements and other events occurring after the market closes, the SEC says.

Meanwhile, VA issuers also have to cope with regulators interest in other aspects of the VA business.

NASD, for example, has put out a release telling of its success at obtaining $9.5 million in restitution from Prudential Financial Inc., Newark, N.J., in a VA case that has nothing to do with market timing.

NASD says Prudential sales reps in New York state wrote in dates on customer forms themselves to get around a New York state regulation that requires sales reps to give customers a few days to think about exchanging one variable annuity for another.

Prudential emphasizes that it detected the problem itself.

“We found it through our controls and procedures process,” Prudential spokeswoman Mary Flowers says. “We promptly reported it to the proper regulators.”

Flowers notes that the dating case has no connection with the market-timing investigation. But many reports about the VA market-timing investigations, including this one, refer to the Prudential dating settlement because it has something to do with regulation of VA operations.

Insurance experts interviewed point out that, even though reports of investigations have been appearing for months, no regulators have filed market-timing charges against VA issuers.

“At this point, we think everybody should sit tight and wait for the results to come in,” says Carl Wilkerson, a chief counsel at the American Council of Life Insurers, Washington. “So far, there is no evidence of any systemic problem in the insurance industry.”

Boros says insurers might be able to affect the size of any potential storm. If a companys executives find that the company has committed a clear-cut case of wrongdoing, it should, of course, act quickly to make the affected customers whole, she says.

But, at this stage, Boros warns that settling an ambiguous case simply to avoid bad publicity is counterproductive.

“The current litigation is testing the waters,” Boros says.

If class-action lawyers find they have an easy time winning the first VA market-timing cases, they soon will be beating the bushes for more cases, Boros says.

But the experts interviewed all condemned the idea of insurers violating the law or their own rules to give big investors undisclosed advantages over smaller investors.

“Thats not the way its supposed to work,” Wilkerson says.

One open question is how much litigation the investigations against VA issuers might generate.

Some plaintiffs lawyers already are filing suits that deal specifically with allegations about marketing timing in variable annuities, not just the allegations about market timing in mutual funds, Boros says.

The class-action lawyers are filing the early suits in courts that, in the past, have been particularly hostile for defendants, Boros says.

Companies sometimes can ameliorate the effects of litigation by finding problems themselves and coming forward on their own to work out settlements with regulators on reasonably friendly terms.

Thats how Prudential handled the New York VA exchange dating problems, and thats how many insurers are addressing concerns about past race-based pricing practices.

Companies that belong to the Insurance Marketplace Standards Association, Washington, can hire independent assessors who have been approved by IMSA to verify that their operations abide by their own policies and procedures, says IMSA Deputy Director Don Walters.

But Wilkerson says he believes that managers of most VA operations are sophisticated people who have a good understanding of the operations and can detect most potential problems themselves.

“I think companies are being very diligent about evaluating their own operations,” Wilkerson says.

In most cases, VA company managers should be able to detect chronic market timing by looking at the trading records for transfers of assets between subaccounts, Shorris says. “Youll see short-term transfers back and forth.”

Reproduced from National Underwriter Life & Health/Financial Services Edition, February 6, 2004. Copyright 2004 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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