In 2005, it was 05-50. Now, get ready for 151A.
If the National Association of Securities Dealers’ Notice to Members 05-50 three years ago was any hint that regulatory agencies were beginning to scrutinize index annuities, there can be no mistaking their intent today. On June 25, the Securities and Exchange Commission voted to propose a rule to treat some index annuities like securities. By a unanimous 3-0 margin, members of the commission proposed to create Rule 151A, which would affect Section 3(a)(h) of the Securities Act of 1933. Under the proposed rule, an annuity would be treated as a security if its performance were linked to a security, group of securities, or a securities index, and if the payout was likely to exceed the guaranteed terms of the contract. In turn, agents who sell them would have to be licensed to sell securities.
Rule 151A, if enacted, has the ability to change the insurance industry, impacting agents, marketing organizations, and insurance companies. While more specific details are still emerging and there are many more stages in the process, interested parties are already forming responses and honing strategies to deal with the potential impact of new regulations on index annuities.
While it might be easy to simply blame the SEC for the current regulatory environment, Robb Edwards, principal for AnnuityWorks, said that the industry itself should look in the mirror and take some responsibility for the situation. Specifically, he cites a sluggish response to 05-50 in 2005 as a missed opportunity for the insurance industry.
“We, as an industry — collectively — did not come together in August of 2005,” Edwards said.
“Apparently, there was some thought that this whole issue would dry up and go away.” He believes that the ambiguity of 05-50 also contributed to the difficulty of fashioning a clear response.
The proposal of Rule 151A wasn’t a surprise to Kim O’Brien, executive director for the National Association for Fixed Annuities (NAFA). But after working with the SEC through NAFA’s law firm for more than a year and providing them with a wealth of relevant information regarding index annuities, including existing state regulations, she admits to being somewhat taken aback by the timing.
“The timing of the proposal was very fast and very quick. They had not even received our final turnaround more than 24 hours before they had the hearing,” O’Brien said. “The timing of the hearing was surprising to us.”
O’Brien believes that at its heart, the issue is not just about index annuities themselves, but also about jurisdiction and deciding which regulatory agency has the responsibility to monitor the products. NAFA’s position is that the current state-based regulatory structure fits the industry best, meaning that the index annuity argument is actually a state issue rather than a federal one.
Addressing the issue on its Web site, NAFA stated, “The association is confident that the current state regulation and oversight of these products by insurance commissioners is not only appropriate but more effective in ensuring consumers understand the insurance elements of what they are buying and where to satisfy any concern, question, or complaint.”
O’Brien also said that agents should focus on the one thing they do best: Sell. “I believe that the more sales we have on the books from satisfied customers, the stronger our story is on the marketing appropriateness of this product,” she said. “They can help the story and the message by putting more suitable and appropriate sales on the books like they have done already.”
Additional sales would also help reverse a downward trend for a product that was once a significant growth segment. According to AnnuitySpecs, which provides independent, third-party market research analysis, index annuity sales peaked in 2005 with $27.3 billion, but that number fell to $25.19 billion last year. The first quarter of 2008 was just $5.77 billion, which would put the industry on pace for $23.08 billion this year.
According to Sheryl J. Moore, president and CEO of AnnuitySpecs, the downward trend actually began the quarter before 05-50 was released and involves a number of factors unrelated to increased scrutiny, including inaccurate reporting in the press.
“There has been a lot of negative media regarding index annuities over the past couple of years,” Moore explained.
She said that many news reports involving index annuities include interviews with stockbrokers or those who sell competing products, and they include what she calls fictitious information that leads to negative publicity, including inflated claims regarding commission payments and surrender charges. In reality, Moore stated that only two index annuities have a surrender period as high as 16 years, and the average commission on an index annuity is just 7.04 percent.
Moore believes that despite evidence that index annuities do not meet the definition of securities, the goal of the potential new regulation is to protect consumers from unscrupulous agents or poor industry conduct in marketing and selling them. While she said that there are ways to address valid concerns, she believes labeling index annuities as securities is not the answer.
“I do think that additional training is necessary in order to sell these products because the crediting mechanisms on them are obviously more difficult (to explain) than on a traditional fixed product,” she said. “But I don’t believe that throwing prospectuses at the issue is the answer. I can tell you right now, I don’t know a single consumer who has read through an entire prospectus.”
Moore said that the state of Iowa has developed a plan of action that could be implemented by the rest of the country: As of Jan. 1, 2008, the Iowa Insurance Division requires anyone wishing to sell fixed index life or annuity products to complete a four-credit training course that would follow continuing education guidelines.
What now?
It’s important, said Moore, for agents to remember that it is still early in the process and is no time to panic.
“I definitely wouldn’t go out there and drop your license because of this, and certainly I wouldn’t make the decision to go out and get additional licensure just because of this decision,” she said.
“Because of the fact that they’re not making this decision retroactive, there’s not cause for concern in that regard. Just continue to do your best due diligence and make sure you’re always informing the client of everything you need to disclose and make sure you’re always making a suitable suggestion and sale to the consumer, and you won’t need to be concerned.”
Perhaps the most important course of action is the one most experts advocate: Taking advantage of the SEC’s comment period regarding the proposed rule. Edwards believes that the industry should come out in full force to express the opinion that index annuities should not be treated as securities.
“There should be 20,000 responses at that Web site voicing their opinion on this topic,” he said.
According to SEC spokesman John Heine, an outpouring of comments from the industry would be welcomed by the agency.
“In all its rule-making, the SEC reads comments from the public with great interest,” he said.
Anyone interested in the topic is free to comment, and after the comment period ends on Sept. 10, the SEC’s staff will review them and prepare recommendations for further actions.
In addition, Edwards encourages all producers to contact their senators, representatives, and state insurance departments to voice their opinion on this matter.
What’s next?
It might be too early in the process to accurately forecast a conclusion, but experts have different levels of confidence on a positive resolution for the industry. O’Brien, for example, remains optimistic.
“Because I’m a positive person, I see it going in a positive direction,” she said. “In the end, we will have good clarity and good opportunities for the right products in this market for independent insurance agents.”
While Edwards would like to be optimistic about the outcome, he said it will depend on how the industry responds to this latest challenge.
“If we don’t get serious about this as an industry, and if our voices aren’t heard and we don’t make as loud a noise on this issue as possible, we may simply lose the product line because we failed to act,” he said.
To comment on proposed Rule 151A before the SEC’s Sept. 10 deadline, you can visit www.sec.gov/rules/proposed.shtml.
Michael Murillo is a freelance writer and frequent contributor to the Agent’s Sales Journal. He can be reached at vivamurillo@hotmail.com.