Why Is The SEC Inquiring Into Insurers

Asset Allocation Programs?

BY

Last November, the staff of the Securities and Exchange Commission sent a letter of inquiry to many insurance companies concerning the commonplace asset allocation programs available to owners of variable annuity and life insurance contracts.

While the details differ from company to company, under these programs, contract owners typically are provided with model portfolios to assist them in allocating their contract values among available investment options in accordance with their goals and risk tolerance.

Frequently, these programs are coupled with the contracts rebalancing features, so that the contract values periodically are reallocated to conform to the selected model.

The questions asked by the SEC staff clearly demonstrate how far the SECs views of the programs diverge from industry views and those of variable products practitioners. The SEC staff is actively reviewing the responses and presumably formulating a position.

It is unknown when the staff will release its interpretations, although the staff has conveyed informally that it will be sooner than later.

The legal focus of the questions is twofold. The first issue is whether an asset allocation program entails the provision of investment advice, by either the insurer or the third party responsible for creating and updating the allocation models. The second issue is whether the pool of assets invested according to a particular model constitutes a management investment company or a fund-of-funds that requires registration under the Investment Company Act of 1940. A subsidiary question relates to whether the program qualifies for the “safe harbor” of rule 3a-4 under the 1940 Act, the so-called “mini-account” rule.

While the responses to the commissions letter of inquiry were tailored to specific insurers programs, the responses shared many compelling points as to why neither the third-party designer of the models nor the insurers were acting as investment advisers to contract owners.

Among other things, the insurers pointed out that the “advice” was not personalized, the insurers were not compensated for it, the third-party providers were identified as registered investment advisers, the models were guidelines rather than recommended or exclusively methods for achieving the customers risk exposure goals, and the models were intended to be used by customers in conjunction with their agents or other financial advisors.

As to the investment company issue, in addition to the foregoing arguments, insurers pointed out that the programs typically are not discretionary, since the customer is responsible for selecting a model and at all times retains full ability to select a different model, modify a model or discontinue using the models entirely.

While the industry and this practitioner appreciates the SEC staffs vigilance in protecting investors, it is unclear why it has chosen this benign topic for scrutiny. It is also unclear why the staff has interrupted the provision of useful models by refusing to accelerate registration statements that included them.

At this point, it seems as though the insurance industry cant do right with the SEC.

On the one hand, the industry and its sales forces are under regulatory pressure to provide appropriate ongoing suitability review and recommendations.

On the other hand, the asset allocation models, which seek to address this concern, also have been challenged. The asset allocation models are designed to assist the contract owner and the owners registered representative in evaluating the available investment choices and in selecting an appropriate allocation among them. They also are designed to seek to ensure that an insurers and its principal underwriters obligations are met.

These programs are said to be immensely popular among variable product purchasers. The reason most cited is that customers regard the programs as a useful educational tool for understanding the investment risks and benefits of the array of investment options under the variable insurance contract they are considering.

Moreover, many of these programs have been described in variable insurance product prospectuses for years, and have been the subject of prior discussions with the SEC staff.

It would be more than unfortunate, both for the companies and the customers, if these programs had to be abandoned.

Joan E. Boros, Esq., is a partner in the law firm of

Jorden Burt LLP, Washington, D.C. Her e-mail address is

JEB@jordenusa.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, March 25, 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.