Insurers and producers are eating a lot of pot luck supper and chuck wagon stew these days as they attempt to restructure their business and sales practices to comply with the suitability mandates enacted in many states. Complicating matters is the combined force of the Securities and Exchange Commission, the National Association of Securities Dealers, the National Association of Insurance Commissioners, the National Conference of Insurance Legislators, the Insurance Marketplace Standards Association and the National Association for Variable Annuities, which have all generated their own set of suitability standards for annuity transactions.
Many states have adopted the suitability standards set forth in the NAIC’s Senior Protection in Annuity Transactions Model Regulation. Other states have implemented more rigorous suitability standards that are based on the NAIC’s Suitability in Annuity Transactions Model Regulation, which extends suitability protections to all consumers regardless of age. IMSA’s standards—which attempt to assimilate the best elements of state and NASD regulations—apply only to voluntary IMSA members, but those members constitute about 60 percent of the life, annuity and long-term care business in the United States. NAVA’s straight-through processing initiative—which is an attempt to get annuity commerce to become more electronic while building in suitability protections—includes 24 standards for managing new variable, fixed and indexed annuity business electronically, thereby adding another ingredient layer to an already complicated soup.
NASD Notice to Members 05-50 sets up another compliance hurdle. According to NTM 05-50, if an equity-indexed annuity is an insurance product, then a firm is obliged to treat equity-indexed annuity sales by its brokers as an outside business activity. If the equity-indexed annuity is a security, the firm must supervise the sale as a private security transaction. Examples of the significant impact that NTM 05-50 is having on indexed annuity products range from a 25 percent decline in sales since NTM 05-50 came out to the imposition of outright prohibitions by broker-dealers who don’t want their reps selling index annuity products. Selling the product as an outside business does not offer any kind of a safe harbor, as this approach still entails due diligence, supervision, surveillance and training. Many also suspect that the NASD is actually talking about the sale of all insurance products in the broker-dealer, and not just indexed annuities.
The NASD’s proposed Rule 2821, which was originally filed with the SEC in Dec. 2004, incorporates the most troublesome and controversial set of standards. Entitled “Members’ Responsibilities Regarding Deferred Variable Annuities,” Rule 2821 would create recommendation requirements (including a suitability option), principal review and approval requirements and supervisory and training requirements tailored specifically to transactions in deferred variable annuities.
The industry’s reaction to proposed Rule 2821 was both swift and unfavorable. In its SEC filing, the NASD reported receiving 1,095 member comments that opposed the rule, a mere 14 comments that offered full support and an additional 20 comments that gave partial or qualified support. These statistics are hardly surprising given the effort the industry has already given to developing numerous safeguards involving appropriate sales practices, reporting and supervision, training and disclosure methods.
NASD Rule 2310, entitled “Recommendations to Customers (Suitability),” which has historically governed variable annuities by the same criteria that are applied to recommendations regarding all other securities, adds one more difficult wrinkle. Industry groups support appropriate enforcement of the existing NASD suitability rule as the solution to abusive practices in the variable annuity marketplace and continue to voice strong objections to proposed Rule 2821’s imposition of a specific suitability requirement for the sale of variable annuities that duplicates existing NASD standards.
OnWallStreet magazine reported on Aug. 1, 2007 about the NASD’s fine-tuning of proposed Rule 2821 over the past three years. A particular sticking point is the timing of principal review. The new version gives principals more time for review as opposed to earlier proposals that gave as little as two business days for a principal to make a determination about whether to approve or reject an annuity contract for a client.
The current seven-day requirement poses another set of problems because this timing provision conflicts with other NASD and SEC rules that require broker-dealers to promptly transmit, deliver and forward client funds. The NASD has expressed concerns about creating a review period following contract transmittal that could theoretically allow insurance companies to issue contracts before a broker-dealer’s principal has begun—let alone finished—a transaction review. OnWallStreet further reports that the NASD is hoping to resolve this problem by not holding firms in violation of its own conflicting rules and asking the SEC to take no action in these situations.
Additional objections are raised by several significant deviations that exist between the principal review requirements in proposed Rule 2821 and the general supervision requirements in NASD Rule 3010. NAIFA believes that this aspect of proposed Rule 2821 presents a bias against variable annuity products that will lead to constant second guessing of investment advice and recommendations and ultimate harm to consumers by causing such products to become less available to individuals who could benefit from them.
National Underwriter reported on a LOMA conference held in Schaumburg, Illinois in May 2007, at which Lord, Bissell & Brook, LLP, Atlanta attorney Eric L. 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. Clearly that has not yet happened. In the meantime, insurers, producers and broker-dealers are being force-fed a virtual smorgasbord of suitability standards –and they can’t avoid kissing an awful lot of cooks!