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Reaction Fires Up To NASD Notice On EIAs

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Index annuity executives are questioning the purpose, usefulness and effect of new guidance on equity index annuities (EIAs) issued by the National Association of Securities Dealers, Washington, D.C.

The NASD guidance, delivered in an Aug. 8, 2005, Notice to Members 05-50, does not define whether an EIA is an insurance or a security product. Rather, it raises “concerns” the NASD has about marketing, supervision, disclosure and investor protection issues that registered broker-dealer firms may confront when selling EIAs that are not registered as a security with the Securities and Exchange Commission. (See box for highlights).

Immediate reaction to the Notice has been varied. John Heine, from the SEC press office, declined to comment, explaining “we don’t comment on circulations by self-regulatory organizations.”

But National Association of Fixed Annuities, a Milwaukee-based association of fixed annuity insurers and marketers, put out a statement the next day, saying the Notice raises “undue concern over the securities law status of index annuities.”

Michael Tripses, executive vice president and chief actuary at Creative Marketing International Group, an EIA marketer in Shawnee Mission, Kan., was sharper: “It’s very negative and looks like a hatchet job on index annuities. It paints a brooding picture of the products.”

Some people see inter-agency squabbling in the mix.

“By issuing the Notice, the NASD effectively slapped the face of the SEC,” contends Jack Marrion, president of Advantage Compendium, a St. Louis annuity consulting firm. That slap was for failing to clarify whether the SEC considers index annuities to be securities, he says.

“The NASD is effectively trying to do the SEC’s job,” adds Tripses.

Not so, according to Herb Perone, a spokesman for the NASD. “The SEC knew of the contents of the Notice. They saw it before posting and said it was OK.”

The NASD is a self-regulatory organization, under the SEC’s oversight, Perone says. The NASD does believe EIAs should be declared a security, and it did send a letter saying that to the SEC in 1997, he adds. However, the SEC did not so determine, and “we don’t have the authority to declare that.” Therefore, he says, NASD issued the Notice to ensure that registered firms are supervising the sale of the product in an appropriate way.

“Because of the uncertainty concerning the status of the product, there has been uncertainty about what rules apply,” he adds.

In its statement, NAFA faults the Notice in several areas, such as for:

o Depicting indexed annuities as complex investments. Rather, says NAFA, EIAs “are guaranteed insurance products accompanied by full and fair disclosure as assured by extensive state fair trade and insurance department regulations.”

o Seeming to encourage “the idea that indexed annuities should be treated as securities by reminding firms of the potential risks and perils associated with treating them otherwise.”

o Taking index annuity marketing statements out of context, creating “maximum concern without the requisite perspective.”

o Casting shadows that work to create “a general fear of involvement in the product line” among NASD member firms and reps who may want to sell the products outside of their practice. Consumers who might benefit from the product may go elsewhere “as firms struggle to interpret the release,” it adds.

o Being issued without first undergoing “the authoritative and principled route of filing a Rule Proposal, which allows for public comment and response from the SEC.”

“We don’t think the Notice promotes clarity,” sums up Michael H. Ebmeier, chairman of NAFA.

That is partly due to the fact that it was issued without public discourse and also because it repeatedly states the potential pitfalls of not treating EIAs as securities without mentioning other points, says Ebmeier, who is also president of Producers Choice East, Forest Hill, Md.

“It is written in as negative a way as possible.”

To illustrate, he criticizes the Notice for identifying surrender charges and other features as reasons why the product may not be suitable for some investors. [Examples: The Notice says many non-registered EIAs "permit investors to participate in only a stated percentage of an increase in an index"; many impose a "cap rate" and "do not provide for investor participation in the dividends accumulated on the securities represented by the index"; EIAs have "other features that contribute to their complexity"; and unregistered EIA sales materials "do not fully describe the features and risks for the product."]

Taking surrender charges as an example, Ebmeier says the Notice does not point out that these are also present in other long-term insurance products. “That doesn’t mean the products are subject to market risk,” he says.

The immediate impact will depend on what member firms do, predicts Ebmeier.

It’s a Notice that expresses “concerns,” not a rule or promulgation, points out Tripses, the marketing executive. But if broker-dealers heed those concerns, “it’s possible they will come up with a recommended list of index annuities to sell, maybe just one product, and sell only that.”

The response of reps is key, too, says Ebmeier. “Anecdotally, we already are hearing that the reps who don’t do a lot of securities business will let their securities licenses lapse” and just sell index annuities.

Advantage Compendium’s Marrion confirms that trend. Industry estimates now suggest 4% of index annuity producers have given up their securities licenses, he says.

By the way, he adds, “roughly 50% of index annuity producers have no type of securities registration at all. For them, this Notice is a non-event.”

There is no word, as yet, whether state insurance commissioners are developing a response.

One area where the Notice may have “major impact,” according to Marrion, is at marketing companies that derive over 50% of income from index annuity sales. The impact would be big, if a large percentage of this income is generated by reps in the broker-dealer channel, or if the B-D wants some compensation for selling a particular product, he says.

But the biggest impact may lie in whether the SEC decides to clarify the status of EIAs, say several experts.

“The insurance industry would rather see index products be left alone entirely,” says Ebmeier. However, in view of NASD’s “heavy caution” on index annuities, he says NAFA now welcomes broader SEC inquiry into EIAs.

“We are encouraged by news that the SEC has been requesting marketing material from index annuity carriers,” he says. “We want deliberation, because we think this will contribute to increased public and industry education on the products.” That assumes that reason prevails, he adds.

Currently, only 3 index annuities are registered products, reports Marrion, the annuity analyst. The remaining 235 are non-registered products–i.e., fixed annuities regulated by state insurance departments.

He offers one solution to the guidance issue: “Why doesn’t the insurance industry set up its own regulatory body for B-Ds that sell insurance and index annuity products?”

‘It’s very negative and looks like a hatchet job on index annuities’

NASD Notice 05-50

What Broker-Dealers Should Consider When Selling EIAs

o The Notice applies to NASD member firms selling non-registered EIAs–products the NASD describes as complex.

o The Notice addresses NASD concerns about marketing, supervision, disclosure and investor protection issues related to these sales.

o Determining whether a particular EIA is an insurance or security product is done on a case-by-case basis; the Notice does not spell out the circumstances.

o Consider maintaining a list of acceptable unregistered EIAs and prohibiting sale of any other unregistered EIA without the firm’s written confirmation that the sale is acceptable.

o Consider whether additional supervisory procedures would help protect the firm’s customers–e.g., requiring all unregistered EIA sales be processed through the firm, subject to the same supervision as applies to securities.

o Properly train brokers who sell any unregistered EIA through the firm, to ensure they understand the features and the extent to which the EIA meets the customer’s needs.

o NASD suitability rules apply to any recommendation that a customer liquidate or surrender a registered security for the purpose of purchasing an unregistered EIA.

View the entire notice at:


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