Lighting the Fuse
June 28, 2011 by Arthur D. Postal
Will market conduct concerns in
Florida and Illinois put equity indexed annuities into a new regulatory hurt
locker?
Marketing of equity indexed annuities continues to run into compliance headwinds despite a go-ahead from Congress and the courts as well as a commitment from the industry to clean up its act.
The two latest controversies involve a regional consumer advocacy group’s harsh criticism of equity indexed annuities—noting that Florida public employees should think twice before investing in them—and a decision by Illinois securities regulators to revoke the license of a Champaign, Ill. investment firm and the husband-and-wife couple who ran it because of market conduct transgressions the couple made while selling equity indexed annuities.
Both incidents have unfolded almost simultaneously, and bring to mind the kinds of criticism that initially prompted the Securities and Exchange Commission in 2008 to issue its Rule 151A, an effort to regulate equity indexed annuities as a securities product, rather than an insurance product. The EIA industry immediately countered with a grassroots political campaign to get EIAs specifically exempted from the then-in-development Dodd-Frank financial
services regulatory bill, as well as with a legal challenge to Rule 151A itself
in the case of American Equity Investment Life Insurance Company, et al, v.
the Securities and Exchange Commission, No. 09-1021.
After an extensive legal battle, Rule 151A was defeated in court in July 2010, when the D.C. Circuit of the U.S. Court of Appeals held that while the Securities and Exchange Commission had authority to regulate EIAs as securities, the agency had “failed properly to consider the effect of the rule upon efficiency, competition, and capital formation.”
Earlier that month, a congressional conference panel reconciling differing House-Senate versions of the Dodd-Frank financial services law approved a provision that EIAs would remain state-regulated— so long as they were governed by standards developed by the National Association of Insurance Commissioners, Kansas City, Mo., as state-regulated insurance products.
Both the legal victory and the Dodd-Frank exemption occurred almost at the same time, prompting the SEC to drop Rule 151A altogether in what was seen as a major David-versus-Goliath victory for the EIA industry.
Despite the NAIC standards to govern equity indexed annuities, Barbara Roper, securities advisor to the Consumer Federation of America, said the CFA remains very concerned about abusive practices associated with the sale of these products.
“Indeed, with the threat of securities regulation largely removed by the Dodd-Frank Act and the court throwing out proposed Securities and Exchange Commission Regulation 151A, there is a real concern that insurance regulators will start backsliding on their recent efforts to strengthen regulations in this area,” Roper said.
She added that rules on the books are meaningless if they are not effectively enforced, and that only time would tell if state insurance regulators will take tough enforcement actions against abuses.
“Given how hard they worked to get these products exempted from securities regulation, the onus is on the state insurance regulators to provide strong consumer protections,” Roper said.
Florida Flashpoint
With the regulatory battle over 151A still fresh in the memory of the EIA industry, equity indexed annuities received perhaps its sharpest criticism in more than a year, when the Consumer Federation of the Southeast issued an alert on June 3 advising public employees to not invest in “unvetted indexed annuities.”
The CFA alert echoed a similar alert issued last year by Jeff Atwater, Florida’s new chief financial officer. In warning people in the state to be careful when buying EIAs, Atwater said, “as their popularity grows, equity indexed annuities are coming under increasing scrutiny by regulators.”
Walt Dartland, executive director of the Consumer Federation of the Southeast, said his group issued the alert because third-party administrators are sending people into Florida to sell EIAs to teachers who are reeling from new legislation requiring them to contribute to their pension plans and healthcare. This, after five years of no salary increases.
“This makes them vulnerable, upset at their reduced pensions and more concerned than ever about their future,” Dartland said.
“We find that they are a good target for sale of EIAs because of a lack of knowledge, their trust in presenters and an inability to follow-up with another opinion as to what is available.”
In his comments, Marrion said based on data from the Securities and Exchange Commission, the Financial Industry Regulatory Authority and the National Association of Insurance Commissioners, there were 114 securities complaints for every one annuity complaint.
He said he also examined Florida records, going through the files of the 1,791 actions taken against insurance and securities registered people in Florida from January 2009 through August 2010. Of these, he said only 15 of these actions involved indexed annuities.
But Dortland defended his comments, saying his concerns were prospective, not retrospective.
He said most people do not complain because they don’t know who to complain to. “In reality,” he said, “EIAs are extremely complex investment products and can contain many detrimental features such as hidden penalties, costs, fees and massive, multi-year surrender charges,” Dartland said.
But Jack Marrion, who provides research into EIAs through Advantage Compendium, Inc., in St. Louis, defended the industry.
He said complaints about sales of EIAs has plummeted 70% from 2007 to 2010 because carriers are doing a better job of educating their agents.
And while the business is relatively large, it has recently suffered ups and downs.
According to data released by the National Association of Fixed Annuities, fixed indexed annuities broke sales records in 2010, according to the Beacon Research Fixed Annuity Premium Study. (Sales figures for this study do not include structured settlements or employer-sponsored retirement plans.) Annual indexed annuity results climbed 6% to an estimated $31.4 billion. Income annuity sales grew 2% to $8 billion. Each product type also claimed its largest share of sales in the study’s 8-year history—48% for indexed and 11% for income annuities.
But, according to Marrion, indexed annuity sales for the first quarter of 2011 were $7.1 billion, according to results released from LIMRA and Beacon Research, off 15% from the previous quarter.
He said indexed annuities are now in their second consecutive quarterly decline. While first quarter sales were up about 5% from the first quarter of 2010, those same sales were the lowest since 2008, so the bar was low.
“Based on our research, this was the greatest quarter-to-quarter decrease in index annuity sales ever—in both dollars and percentages—so it is a significant event,” Marrion said.
Illinois vs. the Coopers
Meanwhile, a separate market conduct situation in Illinois both underscores long-standing criticisms of how EIAs are sold, as well as a curious reading of the law that some feel could re-open the door to regulating EIAs as securities rather than as insurance products.
According to the filing by the Illinois Securities Department, the agency acted after examining 12 cases involving clients of Senior Financial Strategies, Inc. d/b/a Pinnacle Investment Advisors, a firm run by Susan and Thomas Cooper, a husband-and-wife team of insurance agents who, until 2009, had sold annuities on behalf of Aviva USA.
The Illinois Securities Department alleged that the Coopers had liquidated annuities or IRAs to fund the purchase of fixed-indexed annuities from Aviva.
Under the Illinois Secretary of State ruling, the Coopers had both their personal investment advisor licenses and firm registrations revoked. They were also fined $10,000 for allegedly violating Illinois securities law.
According to David Finnigan, senior enforcement lawyer with the Department of Securities, effective immediately, neither is allowed to offer or sell securities in the state.
The ruling does not affect the Coopers’ insurance business, but only if they are engaged in financial advising and selling insurance.
The order held that the Coopers advised clients to sell certain annuity contracts and to buy equity-indexed annuities, which caused some clients to suffer surrender charges and other fees while the Coopers earned commissions on the sales. The state action was based on an investigation that began in 2008, when several clients filed a complaint with the state.
The ruling was based on a finding that in selling the annuities and purchasing EIAs in their stead, the Coopers provided “fraudulent advice as investment advisors.”
The transactions go back to 2006. The investigation dated from 2008. The order said state securities regulators analyzed 12 cases involving sales of EIAs. In all cases, the purchases were made by exchanging EIAs for annuities or IRAs.
The 12 investors averaged 73 years old. Surrender charges from the liquidation of annuities totaled $122,630, according to the evidence.
The Coopers filed an appeal June 1 in the Circuit Court of Sangaman County through their lawyer, Tom Kelty. He also represents their firm, Senior Financial Strategies and Pinnacle Investment Advisors. Their company is based in Champaign, Ill., and has other offices in Normal, Peoria and Bradley, Ill.
David Finnigan, a lawyer with the state Securities Department, said the department has 30 days to file an answer which consists of the record from the hearing (e.g., transcripts, pleadings and exhibits) and a response to their complaint.
In the appeal filed by the Coopers through Kelty, the lawyer said that if the ruling by the Illinois Department of Securities stands, “it establishes law that excludes any insurance agent in Illinois from writing any state-regulated annuity because it will now be classified as a security, and an insurance agent is not allowed to sell a security.”
“The decision also flies in the face of a decision by a panel of the U.S. Court of Appeals for the D.C. Circuit,” Kelty said.
But Fred Bellamy, a partner at Sutherland, Asbill & Brennan, Washington, D.C., said the federal issues, including the court decision and the Dodd-Frank provision, do not apply to the Illinois decision.
“They are completely separate issues,” he said. “Neither federal decision is applicable.”
“The other thing to keep in mind is that under state law, there could be 50 different answers and, in fact, the Illinois securities laws are a very small minority of the way they define securities,” Bellamy said. “Most state securities laws define a security to exclude an annuity contract. Illinois is one of a small minority of states that doesn’t have that exclusion in its state securities laws.”
He said the Illinois administrative decision does not apply to whether EIAs are securities under federal law and it legally does not apply outside Illinois.
In most states, so-called “blue sky laws” defining state securities, “when they define what is a security, the definition of security does not include annuities,” Bellamy said. But, he said, the Illinois of security does not have that exclusion, “so this is Illinois-distinct.”
The Coopers appeal also alleges that the issuing company, Aviva USA, based in West Des Moines, failed in its obligation under Illinois law to block the transfer of the subject securities based upon their unsuitability for the market.”
But Kevin Waetke, Aviva USA director of public relations, said that Aviva USA is not a party to the action.
However, Aviva USA noted that it is aware of the administrative
ruling by the Illinois Securities Department against Susan and Thomas Cooper.
“Aviva terminated its relationship with the Coopers in 2009,” Waetke said. “As
the Illinois Securities Department regulates registered investment advisers—and
not insurance providers—the ruling does not impact us.” Marketing of equity indexed annuities continues to run into compliance headwinds despite a go-ahead from Congress and the courts as well as a commitment from the industry to clean up its act.
