Non-Insurance Regulators Close In On Annuity Sales

Time was when state insurance departments ruled the roost where regulation of insurance and insurance sales was concerned. But increasingly, non-insurance regulators are muscling in on the action with insurance-related administrative and enforcement actions of their own.

Why this is happening, and where is it going? The short answer is: Because they can. The long answer follows.

Of particular interest to the insurance community are probes by various state attorneys general and state securities regulators, especially involving annuities.

In some insurance quarters, these state-level moves are viewed as a follow-up to the broad probes of New York’s former Attorney General Eliot Spitzer, who made headlines by exposing and clamping down on deceptive bid rigging in insurance brokerage sales and who is now the new governor of New York. “Other state AGs and securities officials want to get on the bandwagon,” said one source interviewed for this article.

Indeed, in late December 2006, a 10-state “coalition” announced final judgments in another bid-rigging probe, this time led by the Texas AG’s office.

The state-level activity is in addition to continuing oversight of the Securities and Exchange Commission, which is now said to be examining sales of index annuities, and the National Association of Securities Dealers, which in 2005 clamped down on NASD member sales of index annuities in its controversial Notice to Members 05-50.

Insurance people tend to expect actions from the SEC and NASD, since both bodies are charged by law with supervising securities matters, including those involving insurance products having securities components (variable annuities, variable life, and the few index policies that are registered as securities).

State actions

But actions by state securities divisions and AG offices are another matter.

A recent example of the former is the December 2006 consent order that the Massachusetts Securities Division secured from Investors Capital Corp, a broker-dealer.

The order fined ICC $500,000 for allegedly letting its representatives use what it said were unregistered investment advisor services to sell equity indexed annuities (termed IAs in this article) to “unsuspecting elderly customers.” The 8-count order does not attack the IA product but rather how it is sold–an issue that is becoming increasingly common in the non-insurance regulatory circles.

Other securities bureaus are taking similar steps, says Jack Marrion, president of Advantage Compendium LLC, a St. Louis IA research firm. He says at least 5 state securities offices are currently “going after insurance agents for acting as investment advisors.” The states he named are Massachusetts, Rhode Island, Mississippi, Nebraska, and Washington.

A recent example of state AG actions is the Jan. 9, 2007, announcement that the Minnesota Attorney General Lori Swanson is suing Allianz Life Insurance Company of North America for allegedly selling deferred annuities to senior citizens that are unsuitable for seniors’ financial needs. (Allianz says it “strongly disagrees” with the allegations and will vigorously defend its products, practices and legal position.”)

Also, various state AG and securities offices have started filing actions involving replacement of variable annuity policies, notes Michael DeGeorge, vice president and general counsel of NAVA Inc., a Reston, Va., association focusing on insured retirement solutions (formerly the National Association for Variable Annuities). Several of these followed in the wake of NASD actions on the same issue, he indicates.

The AG offices have “broad powers to take actions over market practices,” DeGeorge observes.

Meanwhile, various state securities offices have been issuing warnings to the investing public about purchasing annuity products. Many such warnings point to information from the North American Securities Administrators Association, Washington, which in July 2006 released survey results linking annuities to senior investment fraud. NASAA said the survey found that “unregistered securities, variable annuities, and equity-indexed annuities are the most pervasive financial products involved in senior investment fraud.”

A number of state securities offices came out with their warnings well before the NASAA data.

For instance, on Feb. 16, 2006, the Texas State Securities Board published a list of “top 5″ investor traps. This list warns against “unlicensed individuals, such as insurance agents, selling securities.” It also cautions against allowing money to be redirected from “legitimate investments, such as stock brokerage accounts, insurance policies, deferred compensations plans and mutual funds” into products like annuities.

The Texas warning does say “annuity products are legitimate investments.” But it also cautions that “they are only suitable for a very small percentage of the investing public and generally are not appropriate for most seniors.” It gives no supportive detail.

The Tennessee Securities Division took a similar tack on Dec. 12, 2005, advising consumers against doing business with “bogus senior specialists” who “typically recommend liquidating securities positions and using the proceeds to purchase indexed or variable annuities products or other investments…”

Likewise, in 2004, the California Department of Corporations, Sacramento, launched a sweep of broker-dealer offices to stop alleged “illegal sales activity,” especially involving variable annuities. The same department also put VAs on its top 10 list of investment schemes and scandals, warning that sales people offering free financial planning seminars aimed at seniors “often employ bait-and-switch and other aggressive sales tactics to sell variable annuities.”

Who is regulating insurance

The role of the state insurance departments in these activities seems to be small or non-existent.

Some AG and securities offices do allude to having worked with their state insurance departments in developing their cases. An example is Massachusetts Secretary of the Commonwealth William F. Galvin, who, in announcing the consent order with ICC, did thank the Massachusetts Division of Insurance for assistance in the investigation.

But many others make no such references. And even when the insurance departments get a nod, it is little more than that. For instance, in the Massachusetts case, the consent order was signed by an official from the Massachusetts Securities Division, not the insurance department, and the announcement was made by non-insurance officials.

Similarly, in the California top 10 announcement, there is mention that the California Department of Insurance has jurisdiction over VAs. Still, the warning came from the Department of Corporations, not the insurance department.

Jim Mumford, first deputy insurance commissioner in Iowa, has not had that experience–because the insurance and securities bureaus are in the same department and they work together as a team. However, he is concerned about states where the non-insurance regulators seem to go solo.

The insurance departments have much broader authority over the insurance industry than do the other offices, Mumford explains. They regulate companies, products, advertising, market practices, solvency and more.

Additionally, he says, if a problem involves traditional fixed annuities or fixed IAs, the risk (of loss) is on the insurer, so the regulation needs to go there.

Even in VAs, that is starting to be an issue, he adds. Today, 80% or more of VAs contain guarantee features that put a floor on policy values, “so that moves the risk back on the insurance company,” he says. (By contrast, in VAs without such guarantees, the risk of loss of principal is on the investor, in the separate accounts.) When guarantees are present, insurance department involvement in regulation is important, he maintains.

The securities and AG offices can–and do–move on sales (involving insurance) that they don’t think are proper, he allows. But Mumford is concerned that many “don’t understand the products and the solvency issues of the companies.”

They tend to look at things from a securities perspective, he points out. That is to be expected, he adds, commenting that insurance regulators tend to look at things from an insurance perspective, too. The problem is, if the two don’t work together, “it makes it difficult to understand.”

People need to keep in mind that the state laws have a lot to do with which office governs what, points out Carl Wilkerson, vice president and chief counsel for securities and litigation at American Council of Life Insurers, Washington, D.C.

For instance, with regard to variable life and annuity contracts, the Uniform Securities Act of 2002 grants the insurance commissioner exclusive authority to regulate issuance and sale of these contracts and excludes variable contracts from the definition of security, he says.

Promulgated by the National Conference of Commissioners of Uniform State Laws, Chicago, the 2002 Act aligns with the U.S. Supreme Court’s determination that the federal government (via the SEC and NASD) should govern the securities aspects of variable products and the state insurance departments, the insurance aspects, he says.

Meanwhile, in the insurance codes, 48 jurisdictions grant the insurance department exclusive authority to regulate issuance and sale of variable contracts, he says, and 34 exclude variable products from the definition of security.

There are also unfair trade practices acts in place that can be used, he says.

In addition, “the state insurance departments have specific marketing rules, and they do enforce them–for instance, by removing agency appointments,” says Kim O’Brien, executive director of National Association for Fixed Annuities, Milwaukee. Their ability to pull insurance company licenses is a “big club,” too, she says.