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Battle Rages On The Suitability Of Current Annuity Regulation

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When state insurance commissioners adopted a model regulation to curtail the abusive use of senior designations recently, it highlighted the ongoing efforts regulators are currently making to ensure seniors are not victimized.

Those efforts come at a time when oversight of products sold by insurers such as indexed annuities has been criticized and when a proposal made by the Securities and Exchange Commission could whittle away state authority over indexed annuities.

The SEC’s proposed rule 151A is the most recent example of the tug-of-war going on over whether insurance oversight should be at the state or federal level. The original comment period for 151A ended on Sept. 10, but the SEC recently reopened the comment period, which will now end on Nov. 17, 2008.

Comments filed the first time around with the SEC by state regulators on 151A largely fell into 2 camps: state securities regulators who support the proposal and state insurance commissioners who oppose it.

Four state securities regulators filed comments saying the product needs to be treated as a security.

Eleven state insurance commissioners filed comments, including 7 who said indexed annuities should remain under the authority of state insurance regulators because they are insurance products that are well regulated by state insurance departments. Four asked for an extension of time to consider the issue as did the National Conference of Insurance Legislators, Troy, N.Y.

In addition, regulators pointed to efforts underway to safeguard seniors during discussions held at meetings of the National Association of Insurance Commissioners, Kansas City, Mo.

Those efforts include: the reopening of a senior suitability model for annuities; additional work on indexed annuity disclosure by states such as Iowa, Minnesota and Wisconsin; new work planned for annuity disclosures by the NAIC; consumer buyer’s guides; and a new consumer alert and bulletin to parallel passage of the senior designations model.

Products such as fixed and variable annuities are “bedrocks of financial planning” and need to have suitability requirements in place to monitor how they are sold, says Eric Dinallo, New York Superintendent and chair of the NAIC’s Life & Annuities “A” Committee.

Insurance is one of 3 pillars of a consumer’s financial plan that also include bank or savings deposits and investments, he notes.

New York does not currently have suitability provisions in place. Dinallo and members of a blue ribbon panel in New York have discussed suitability protections and the panel is looking at how to develop suitability guidelines.

Scott Rothstein, executive director of the panel, says there needs to be more of a holistic approach toward suitability. For instance, he explains, there needs to be suitability oversight over debt and mortgage products as well as insurance and related products.

Matt Gaul, the panel’s special counsel, says a suitable product need not be measured by a fiduciary standard of what is absolutely the best product but by a standard of whether the product is appropriate for the consumer.

When asked about 151A, Gaul says that even if it is approved by the SEC, the product would still be regulated by state insurance regulators as well as by state securities regulators and the federal government.

Dinallo says he wants to make sure that there is no duplication in suitability requirements among federal and state regulators, which can end up being burdensome. If 151A advances, he adds, state insurance regulators want to make sure they are closely coordinated with it to prevent duplication and regulatory gaps.

Sean Dilweg, Wisconsin insurance commissioner and the “A” Committee’s vice chair, says the suitability issue is going to become even more important than it is now because “Boomers are going to need to know they can safely put their money into annuities.”

And because of this, it is important that regulators continue to look into the suitability of products so that a person in their 80s is not being sold annuities with long surrender periods.

Dilweg says his department has seen a number of cases of unsuitable sales complaints. In some cases, he says, producers are trying to “bilk” clients, but a significant number of these cases result from agents who do not understand complex products.

Hopefully, red flags can be established in company programs to raise an alert when more agent training is needed, he continues. Dilweg says that although dedicated agents in companies can be more closely monitored, there are companies that have effective programs to monitor brokerages with which they conduct business.

Variable annuities are dually regulated and both insurance and securities regulators seem to work well together, he says. And, a number of states have combined financial services regulators, he notes. So, he says he believes it is possible for different regulatory agencies to work together to oversee indexed annuities.

He says he also recognizes that the suitability model is only in place in approximately 30 states, not all states.

But even if others argue that additional regulation is needed, proposed rule 151A is “too broad” and can draw in straight fixed annuities by interpreting parts of the contract such as an inflation rider to be a security, he notes.

Dilweg says, however, that a “broad-based” approach to regulation could apply and that all parties including trade groups interested in suitability should work together.

“While it is hard to comment on a proposal until we see how it plays out, in general, any increased attention to annuities is very good,” according to Brenda Cude, a NAIC funded consumer rep and a professor at the University of Georgia.

Any attempt to coordinate regulation of annuities is also a good thing, she adds. “As long as we continue to carve up regulation of annuities, regulation will be fragmented and consumers will get a fragmented message,” Cude says.

Jim Mumford, First Deputy Insurance Commissioner and Securities Administrator in Iowa, notes that suitability work at the NAIC will focus on company supervision requirements in the current NAIC suitability model and work on a disclosure model will, among other things, look at whether there needs to be a review of policy illustrations.

More agent training is needed, says Mumford. Market conduct examinations could be used to determine whether a carrier’s training programs are adequate, he continues. But, he adds, in the last 2 years, “states have come a long way” in regulating the sale of annuities.

Mumford says that if 151A becomes effective, it will cause problems for companies, producers and consumers.

“My problem with 151A is that this product [indexed annuities] came on the market 12-13 years ago and the SEC said nothing. Companies developed a system and now they are changing the rules and are saying that now these sales have to take place through a company’s broker-dealers.”

Mumford adds that if the proposal proceeds, “We will lose the momentum of what we have done in the last 2 years.”

The proposal would put indexed annuities under the scrutiny of the SEC, FINRA, and state insurance and securities regulators, he says. Some companies who are not big players in the market might decide to exit the market while other companies who sell a number of different types of annuities may decide to focus their efforts on variable annuities.

A lot of producers rely on indexed annuities for the bulk of their sales, Mumford continues. If a producer is in a small town with no broker-dealer, the product probably will not be available to a consumer, he adds.

Not everyone, however, feels as strongly that state regulators are effectively regulating insurance. Many of the 680 comments posted on the SEC website as of Sept. 30 favored the SEC stepping up oversight of indexed annuities.

Jeff Harring, a certified financial planner wrote in Sept. 17 comments that “we have individuals in their 80s who will not be able to access their funds for up to a decade without onerous charges.”

“…State licensed insurance agents (who are not registered representatives) do not have the training, knowledge or compliance structure to competently offer securities.” Harring maintains in his letter that “any asset that purports to use stock market returns as the basis of its returns ought to be considered a security.”

Those sentiments are supported by Stephen Franklin, MBA and CFP with LPL Financial Services, Louisville, Ky., who wrote on Sept. 22 that “the abusive sales tactics that I have seen are indescribable. The unsuitable sales that have taken place are countless, and they apply primarily to the nation’s seniors, a group that deserves better.”

Franklin also wrote that the SEC proposal will “force an army of unqualified individuals to either ‘belly up to the bar’ and subject themselves to reasonable levels of testing and supervision, or it will force them into other (potentially less damaging) lines of work. The big winner will be the nation’s seniors and investing public.”

Melody Caldwell, a financial advisor, wrote, “I have elderly clients who I feel are being preyed upon by the annuity salespeople. They are not being fully transparent with the clients on the fees, the surrender charges, the length of time for the fees, the real return, etc … This needs to be regulated for the safety and security of our seniors. Please close this loophole that is allowing non-licensed people [to] sell a very complex product.”

Still other comments criticized the proposal.

“In light of the recent meltdown of the financial markets and industry, including Bear Stearns, Fannie Mae, Freddie Mac, Merrill Lynch, AIG and the many others to follow in the months ahead, I find it funny and at the same time nauseating that the SEC is willing to dedicate valuable resources and time to this proposed rule,” wrote Kris Lin.

Gary Hughes, executive vice president and general counsel with the American Council of Life Insurers, Washington, says the ACLI has not taken a position on 151A.

However, in general, he continues, federal authorities should be responsible for what is regulated as a security and the states should be responsible for the rest.

But Hughes also notes the frustration many companies are expressing over what he says is the slowness of states to uniformly and widely adopt suitability models. “This is low hanging fruit and shouldn’t be a problem to get adopted.”

He also noted that the North American Securities Administrators Association, Washington, was the first to take up the issue of senior designations. “These are the sorts of things that states need to be doing if they want to maintain their franchise.”

There is a role for states in suitability issues, he says, “but states really have to pick up the pace a bit. Congress will be looking at the U.S. financial services industry and insurance will be a part of that. These are the sorts of things that states need to be doing if they want to maintain their franchise.”

Hughes adds that “there is plenty of room for state-federal coordination without getting into turf wars.”

Jim Poolman, a former North Dakota insurance commissioner who is now a consultant based in Bismarck representing indexed annuity companies, agrees that regulation with comments supporting continued regulation by state insurance departments.

State insurance regulators have made “enormous strides in a short time,” says Poolman. And, in the case of the just passed senior designations model, it can be put in place relatively quickly via bulletin or regulation, he adds.

When asked about a Dateline report that appeared earlier this year cataloguing abuses against seniors by indexed annuity agents, Poolman responds that the complaint ratio relative to the number of policies sold is very low. He adds that suitability legislation is in place in over 30 states to safeguard consumers. Poolman helped spearhead suitability legislation when he was commissioner.

Still, he says, “any complaint is one too many.”


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