In the early days of variable annuities (the late 1970s and early 1980s), nontraditional salespeople began selling products previously thought to be in the exclusive purview of traditional insurance agents. The ensuing chain of events has now led to a development that has the life insurance industry confused.

The nontraditional VA sellers were primarily stockbrokers and banks. They were required to use entities new to the traditional life insurance business–broker-dealers. While many insurers already had B-Ds in their corporate families, these B-Ds were exclusively for the companies’ “captive” agents, operating merely as an adjunct to traditional agency operations. In fact, in those days, many insurers were, themselves, registered broker-dealers.

As nontraditional entities began selling variable life insurance policies, it was logical to assume the people and corporate entities involved would merely acquire state life insurance licenses and adapt life insurance sales practices to the regulatory requirements applicable to sales of “securities.” But almost immediately, jurisdictional problems arose. A number of states prohibited corporations from possessing life insurance licenses. Others prohibited B-Ds from being insurance licensed or prohibited insurance agencies from being B-Ds. In addition, the New York Stock Exchange prohibited its members from possessing insurance licenses.

In recent years, a number of these restrictions have been lifted, but they still apply in a handful of states. The NYSE also no longer prohibits its members from having insurance licenses. However, the procedures put into place to resolve these problems back then still exist today.

The industry’s leaders in those days came up with a simple solution: obtain “no-action” letters from the SEC staff that, in effect, permitted a life insurance agency or individual agent to receive compensation on variable insurance product sales without being a registered B-D.

These no-action letters were subject to the condition that the B-D principals had to be able to supervise the activities of persons selling the “securities” products and that the operational, financial and consumer-protection safeguards applicable to B-Ds had to be maintained. In addition, the arrangement had to be required as a result of inability to comply with the nuances of state insurance laws or regulations applicable to corporations or entities such as broker-dealers with respect to obtaining insurance agency licenses or as a result of the prohibitions of the NYSE against members having insurance licenses.

As a result of these no-action letters, it has been standard practice for over a quarter century for many B-Ds to use a procedure whereby all commission payments on variable insurance product sales are paid directly to an affiliated insurance agency or insurance agent, and then for the funds to be reallocated in accordance with normal business practices.

A major motivation for having this process was to avoid a “checkerboard” approach with respect to supervisory and compliance activities. The NASD apparently had no concerns about these practices, which have made the processing of business through nontraditional distribution channels faster, easier and less expensive than it would have been under strict jurisdictional boundaries.

Now, in the last month, the SEC staff has withdrawn at least one of the no-action letters. It also has placed the entire industry on notice that the limitations stated in previous no-action letters were to be strictly and narrowly interpreted. This was enunciated in a series of letters sent to counsel for companies that previously had received no-action letters on the subject.

These letters, in effect, gave notice that many industry practices used in paying compensation through insurance agencies rather than through B-Ds were invalid. In the letter withdrawing the no-action letters, the SEC staff said the current position of staff is enunciated in a Sept. 28, 1995, no-action letter to First of America Brokerage Service Inc. The staff said the First of America letter stands for the proposition that it is permissible to make:

“…the payment of commissions (or other transaction-related compensation) from insurance securities to an unregistered insurance agency but only if state law requires that such commissions be paid to an insurance agency licensed to sell insurance in that state, and regulatory impediments exist that prevent a particular entity from both registering as a broker-dealer and acquiring an insurance agency license.”

The SEC staff position on this issue came as somewhat of a surprise to industry leaders who to their knowledge were unaware of any reported abuses relating to the issue.

The position presents a number of expensive and time-consuming problems for the industry. Foremost is having to add insurance licenses to a broker-dealer where an affiliated licensed insurance agency already exists. Second is the administrative burden of maintaining at least two compensation systems–one for states where the law requires payments through an insurance agency and one for states that do not.

While enunciating this position may not, in fact, be a change in position by the SEC staff, it is difficult to see the evil that the restriction is intended to cure. Payment of variable product commissions through an insurance agency affiliated with a B-D, where all supervision, oversight, financial and consumer-protection requirements are met, does not seem to be a problem in search of a solution. It simplifies administration, reduces costs and expedites the entire process. That would seem to be a winning proposition for everyone involved.