Trends in Regulatory Oversight – Part 1: “The Battle Over Standard of Care”
April 1, 2014 by Kim OBrien
Message From President
I have never been much of a conspiracy theorist. In fact, those who know me would probably peg me as a Pollyanna of all things positive. However, there is no doubt here at NAFA that our fight to protect the fixed annuity didn’t end with Rule 151A. And for those who think that the fight was “only” to protect indexed annuities, think again. While the Rule 151A battle was clearly a decision by the securities industry (through the SEC and FINRA) to curtail and control the mounting sales of indexed annuities, NAFA knew that it was only a matter of time before those same competitors expanded their federal control over all annuities. The current trends in federal and state regulation clearly suggest that our competitors haven’t given up. The proof is there in plain sight: the “uniform” fiduciary standard, the expanded and extra-jurisdictional interest in the IRA marketplace, the funding source of fixed annuities, and elder abuse, to hit just the main events. This CEO article, which appears in each edition of the Annuity Outlook magazine, will be the first in a series that explores these regulatory and government policy trends, explains NAFA’s position, and educates our readers on the role and arguments they can use to help in this ongoing battle.
Let us begin with the “uniform fiduciary standard.” NAFA contends that the real reason regulators, government agency employees, and some legislators are behind the fiduciary standard and the less-than-transparent purpose of proposing the standard is to create a single regulator or authority over those in the securities industry and those in the ERISA marketplace covering a large percentage of the retirement product and planning sector. We expect the argument that after “uniformity” has been accomplished, it will only “make sense” to expand it to all financial products (including fixed annuities) sold by all distributors (including insurance salespeople). The battle over a “uniform” standard of fiduciary will be of utmost importance to the industry, in order to protect the fixed annuity marketplace, product, and salespeople. Now that indexed annuities are solidly entrenched in the law and in the mindset of the financial marketplace as a fixed annuity, any change to the marketplace will impact all fixed annuity products regardless of the interest-crediting method they employ.
In January 2011, the Securities and Exchange Commission (SEC) released a study mandated by the Dodd-Frank Act, in which it recommended the adoption of uniform fiduciary standards for broker-dealers and investment advisors. The SEC has not exercised its discretionary rule-writing authority on this subject, but in a 2012 year-end report it noted plans to “move forward” with action in 2013. Additionally, the U.S. Department of Labor (DOL) is considering the adoption of a rule, under ERISA, that would expand the current application of the fiduciary standard to, among other things, the purchase of an annuity product when it is part of a pension plan or individual retirement account.1 While neither the SEC nor the DOL has yet to adopt this broader application of the fiduciary standard, NAFA is adamant that federal efforts to update or harmonize fiduciary standards for investment advice and asset management transactions in the securities arena must not be expanded to needs-based transactions. The insurance marketplace has a strong history of robust and effective state regulation. To further explain our position, NAFA has three significant arguments against imposing a fiduciary standard on the sales of fixed annuities.
1) The additional fiduciary standard is incongruous and inappropriate in the fixed annuity sale.
First, NAFA agrees that the fiduciary standard is an applicable and appropriate standard for those who are paid money to provide investment advice and/or actively manage an investment plan to achieve desired outcomes. When money is taken from a consumer by an investment advisor and that advisor has control of the asset and/or outcome of advice given, this control is a key element in the applicability of the fiduciary standard. But it is incongruent and without merit to extend that standard to sales which are transactional in nature, like the sale of a fixed annuity, when the interest earnings, contractual guarantees, and other contractual components of the annuity sold are out of the hands and control of the annuity salesperson. The sale of an annuity has always been recognized as different (i.e., exempt) from what constitutes investment advice or investment planning services.
2) The additional fiduciary standard will disrupt the fixed annuity marketplace.
Second, it would be extremely disruptive and harmful to the existing sales environment to remove the suitability standard from the sale and replace it with the fiduciary standard. Therefore, it’s more likely that the fiduciary standard will be IN ADDITION TO the suitability standard. The industry spent (and continues to spend) billions of dollars complying with the suitability rules, not to mention the cost of liability for the suitable recommendations made by its salespeople. Those expenditures in capital, including expensive human and technology resources, will likely double or triple if they are required to comply with a fiduciary standard.
3) The additional fiduciary standard is unnecessary to protect fixed annuity buyers.
Third, states apply the suitability standard of care to sales of fixed annuities and other insurance products, and the product “suitability” test clearly provides consumers with comprehensive, proven protection that is the most appropriate way to regulate such insurance transactions. The NAIC Suitability in Annuity Transactions Model Regulation (Suitability Model) was first adopted in 2003, and revised and enhanced in 2006 and 2010. With each Model revision, the standards, procedures, and responsibilities imposed on both the insurers and the insurance producers have been heightened to better ensure that the annuity product is wholly suitable to the consumer. In fact, there are requirements imposed by the 2010 Suitability Model that don’t exist in the sale of any other financial product. Congress has recognized the importance and appropriateness of applying the NAIC’s product suitability standard to fixed annuity sales instead of securities/investment regulations such as fiduciary requirements. Senator Tom Harkin sponsored an amendment to the Dodd-Frank Act, which was adopted in July 2010, confirming that fixed annuities are insurance products exempt from securities registration and regulation, provided that the 2010 Suitability Model (or comparable product suitability standards that meet or exceed the 2010 Model) is adopted and followed by June 16, 2013.2
As of this writing, 34 states plus the District of Columbia have adopted regulations based on the 2010 Suitability Model, and it’s anticipated that the great majority of the remaining states, if not all of them, will adopt similar rules in 2014. Even without state adoption, after June 16, 2014, only fixed indexed annuities sold under the suitability standard will be exempt from federal security regulation.
The fixed annuity industry has strived to remain ahead of the curve by adopting sales policies and practices that ensure that whatever annuity product is sold, it’s suitable for the specific needs of each client. The industry’s practices met or exceeded the 2010 Suitability Model’s standards and procedures for suitable annuity recommendations for many years prior to its adoption (since 2007 for most indexed annuity carriers).
The success of the Suitability Model and the fixed annuity marketplace can be easily seen by the latest reports of fixed annuity complaints. In 2012 (the latest reports available from all agencies and associations tracking complaints), there were 34,678 consumer complaints against representatives and advisors in the sale of securities, while there were only 563 on fixed rate annuities and a mere 54 on fixed indexed annuities.3 Add to that the trend of lower commissions and surrender charges4 as well as the fact that the latest Gallup Study5 on non-qualified fixed annuity sales tells us that 93% of their participants still own their first fixed annuity, and so our detractors and competitors must find it very difficult to say much, if anything, bad about the fixed annuity marketplace and also find it difficult to demonstrate a “need” for increased regulation. So they must change the subject to “uniformity” in the standard of care. NAFA’s goal is to ensure that any application of a fiduciary standard to broker-dealers or ERISA plans maintains an explicit and meaningful seller’s exemption that excludes fixed annuities and retains the demonstrated efficacy and consumer-centric suitability standard.
Stay tuned for “Trends in Regulatory Oversight – PART II – the Battle over IRAs”
1 http://www.gpo.gov/fdsys/pkg/FR-2010-10-22/pdf/2010-26236.pdf
2 Wall Street Reform and Consumer Protection Act, Pub. L. 111-203, § 989J, 124 Stat. 1376 (2010).
3 The Advantage Compendium, Jack Marrion, President, compiled using SEC, FINRA, NASAA, and NAIC data.
4 Moore Market Intelligence, Sheryl Moore, President.
5 The Committee of Annuity Insurers, Survey of Owners of Individual Annuity Contracts (The Gallup Organization and Mathew Greenwald & Associates, 2013).”
