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MGO Supervision May Be In Index Annuity Future

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The year 2010 is poised to be the year of index annuity regulation. Market watchers are predicting suitability standards will pressure the industry into a compliance and supervisory model similar to that used in the securities industry.

But such speculation requires clear understanding of past and present.

In the past, the Securities and Exchange Commission created Rule 151 as a Safe Harbor for index annuities.

Although a SEC decision regarding actual regulation of index annuities has been promised, it is doubtful this will happen in 2008. Though possible, changing position would require overturning multiple legal decisions and ignoring Safe Harbor Rule 151. It is more likely the SEC will clarify language in Rule 151. (See first chart.)

Rule 151 and court decisions interpreting the Rule specifically allow expenses (surrender charges) to be subtracted from annuity value. Additional restrictions on deductible expenses from index annuities may be applicable by 2010.

One version of the new approach is to use the 10/10 rule (the annuity should have no more than a 10% surrender charge in year one and no more than 10 years of declining surrender charges.) Non-forfeiture rules dictate these requirements which vary by state, but usually follow the model developed by National Association of Insurance Commissioners.

Prohibitions from marketing an annuity “primarily” as an “investment” may also see clarification. Currently, the word “primarily” is an undefined term, and can be confusing when applied to sales practices. “Primarily” implies that marketing literature and sales presentations are weighted heavily toward “investment” objectives. Meanwhile, court decisions interpret “investments” as necessarily encompassing growth and risk.

Complicating matters is that producers may discuss potential growth based on a formula linked to an external index. However, such selling points must be balanced with discussion of guarantees of principal and credited interest in the index annuity. Consumers must be helped to understand they are not purchasing actual stock of companies in the index.

If economists’ predictions of prolonged flat to moderate market growth prove out, the tendency to promise high returns may be curbed naturally. Instead of double-digit index returns, producers will highlight single-digit cap rates and preservation of principal during periods of zero interest.

This will be aided by the fact that, whether the market is up or down, the index annuity can not return below 0%; hence, it has no market risks.

Significantly, a federal district court decision has interpreted that “market risk” does not mean a client could have received a higher return with a different product. So, it is critical for the industry to emphasize traditional the index annuity’s insurance aspects such as guarantees and safety of principal and interest once credited.

Even if the states maintain regulation of index annuities, changes are coming. Currently, the Iowa Division of Insurance is promoting a pilot program with certain volunteer annuity carriers. The carriers agreed to use the NAIC disclosure model to unify annuity disclosures. Clear and concise disclosures are a key to future regulation.

In addition, Wisconsin Insurance Commissioner Sean Dilweg has said the state is preparing to require supervision of all annuity sales to coordinate with NASD Rule 3010. The state is also planning to work with NAIC’s new Suitability of Annuity Sales Working Group to review abusive sales tactics and develop supervisory standards for national adoption.

Supervision of index annuities may be the greatest change ahead for the industry. Unlike the securities industry, though, the product manufacturers and producers are significantly responsible for suitability. Also, the industry has no Office of Supervisory Jurisdiction (OSJ) or Financial Industry Regulatory Authority (FINRA, aka NASD) to supervise and regulate producers.

This is not to say the existing securities industry should supervise index annuities. (Some equate such a proposal to being like fixing a flat tire with a wagon wheel.)

Instead, a newly created compliance level of supervision between the general agent (or insurance marketing organization) and the carrier may curb abusive practices. Such a market guidance organization (MGO) would facilitate the compliance and suitability training of producers.

The MGO would also review index annuity business, and supervise producers to teach needs-based selling and compliant sale techniques. In addition, it would review marketing programs, seminar presentations, direct mail leads and performs audits. Producers would receive continuing education tailored to index annuities and compliant business practices. And the MGO would audit the IMO and supports compliant marketing initiatives.

In short, the MGO may be the wave of the future for the index annuity industry.

Danette Kennedy is president of Gorilla Insurance Marketing, Inc. Waukee, Iowa. Her e-mail address is [email protected]


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