Insurance and securities are increasingly intersecting, and the National Association of Securities Dealers is making moves to expand its regulatory response accordingly, panelists here at the Retirement Industry Conference indicated.

In recent times, for instance, the NASD has been applying regulatory tools like rules, regulations and Notices To Members (NTMs) to life settlements and index annuities, said Paul V. Bruce, principal of Waterside Enterprises LLC, Maple Grove, Minn.

That is in addition to oversight over broker-dealer sales of known “insurance security” products such as variable annuities and variable life insurance, he told the conference, which was co-sponsored by LOMA, Atlanta; LIMRA International, Windsor, Conn.; and the Society of Actuaries, Schaumburg, Ill.

Bruce and co-panelist Eric L. Marhoun, a counsel with Lord, Bissell & Brook LLP, Atlanta, reviewed some of the recent NASD actions and noted similarities in some.

Regarding life settlements and index annuities, for instance, the NASD wants its member broker-dealer firms to realize that life settlements involving variable products are securities transactions, said Bruce.

NTM 06-38 made that clear, he indicated, but the NTM also “foreshadows potential issues with transactions in the life settlements secondary market.” The notice does not come out and say that life settlements of non-variable policies are securities, but it does say that such settlements are subject to “outside business activity” requirements, he observed. Such activities are within the NASD’s jurisdiction, he indicated.

The message to broker-dealers? “Supervise it [life settlements] in the firm,” he said, adding that this applies to variable life policy settlements and “maybe all life settlements.”

Another NTM, NTM 05-50, takes a similar approach to index annuities. The document’s “strong language” effectively tells broker-dealers, “Don’t treat them [index annuities] as a non-security,” Bruce said.

NTM 05-50 cites uncertainty regarding the securities status of non-registered index annuities as well as general sales practice concerns as reasons for its comments.

B-Ds that do treat index annuity sales as a non-security “do so at their own risk,” Bruce said.

“Most people take the word ‘could’ [in the NTM] as ‘should,’” he commented.

In looking at settlements, the NASD is concerned about secondary sales of non-variable policies, Bruce said. Where index annuities are concerned, the NASD’s focus is on ancillary transactions, often those in which the client liquidates securities in order to have funds to use to purchase the index annuity.

With a settlement, the implication for B-Ds is that “you have best execution responsibilities.” If the settlement involves a VUL, a written agreement is mandated because of books and records; the Duty of Fair Dealing comes into play; and there will be outside business activity considerations or Private Securities Transactions.

Bruce said the developments raise “fundamental concerns” about the growth of the life settlement industry through the broker-dealer channel.

“Where the industry should go, and has to go, is toward disclosure and transparency,” he said. Clients should be informed, for instance, of the sources of the capital, he said. They should also be informed of the net and gross offer.

He read aloud from one B-D’s letter, which basically called for full disclosure of everything in the settlement. Effective January 2007, the letter said, the firm would not do any settlement without supervision and full disclosure.

For index annuities, the impact of NTM 05-50 is being felt in various ways. First, sales have declined by 25% since the NTM came out, said Marhoun. Some decline can be explained by the rising equities markets, he allowed, but not all of it.

Also, some broker-dealers are saying they don’t want their reps selling index annuity products, he added.

Selling the product as an outside business activity “is clearly not a safe harbor,” Marhoun explained, noting that this still entails due diligence, supervision, surveillance and training.

It seems clear that the NASD is actually talking about sale of all insurance products in the broker-dealer, not just index annuities, he concluded.

Marhoun predicted that the NASD, the state securities administrators and the state insurance departments will eventually come to some sort of accommodation on handling index insurance products, but that has not happened yet.

In another part of his talk, Marhoun explored how a different NASD regulatory move, Proposed Rule 2821, could impact the sale of variable annuities.

The proposed rule would impose recommendation requirements on broker-dealers, he said. It specifically requires that the selling rep have a reasonable basis to believe the customer has been informed of the VA’s features; the customer would benefit from those features; and the VA and underlying subaccounts are, as a whole, suitable. It would also require reps to consider certain factors when recommending a 1035 exchange (i.e., whether the customer will incur a surrender charge, whether the customer will benefit from a product enhancement, and whether the customer’s account has had another 1035 exchange in the prior 3 years).

“If this rule goes through, my hope is that the companies have the infrastructure in place to make these things happen,” Marhoun said.

Later, he noted that many firms are already gearing up for this rule, even though it is not yet adopted.

But doing that is not as easy as it seems, he cautioned. For instance, it will not be enough to say a sale is suitable because the product has a new rider or more fund options. “You need to understand why an annuity, why at age 80 (or whatever the client’s age), etc.”

The National Association of Insurance Commissioners is ahead of the curve on some of this, he said, referring to the NAIC suitability model for annuity transactions. Now adopted in over half the states, the model applies to all consumers, not just seniors. Marhoun said some requirements in that model are mirrored in Proposed Rule 2821.