It's been a long five years since the NASD, now FINRA, first issued the infamous 05-50 warning broker-dealers not to sell indexed annuities and the security industry's strategic and targeted campaign to discredit and eliminate the product line began. Unfortunately, this negative campaign culminated with the promulgation of SEC Rule 151A -- a blatant and transparent attempt to eliminate a competitive product and its distributors from the marketplace.
The fixed indexed annuity was just a decade old and was an evolution -- not revolution -- of the traditional fixed annuity that offered the potential of slightly higher interest using a market index. During good economic times the indexed annuity participated in the increases and during bad times it promised -- simply but importantly -- a zero interest floor. Study after study of the actual interest credited during the past 15 years has shown that the concept works, and on the whole, people have in fact earned a slightly better interest rate than those from a declared-rate annuity while at the same time enjoying the same insurance guarantees.
Many in the mainstream media, for the most part, were simply the mouthpiece for the misstatements and distortions that security advisors and security regulators cultivated. NAFA -- the National Association for Fixed Annuities -- was at the forefront of the industry's response to these developments. We worked to inform regulators, legislators, reporters, and consumer groups about the benefits of fixed annuities and repeatedly corrected the biased stories and disinformation. The association also worked to assist and support the efforts of carriers, marketing organizations, and agents who care about fixed annuities and who want to make sure they continue to be available to consumers who could benefit from them. This negative campaign was extremely harmful to consumers who were directed or persuaded away from fixed indexed annuities and usually into risk-based products that subsequently cost them billions in savings during the economic crisis.
A little over a year ago, a phenomenal and historic thing happened -- the insurance industry with its various and competitive parts joined forces to fight Rule 151A. The Coalition of Indexed Products filed a lawsuit against the SEC and Rule 151A, and NAFA hired a lobbyist to help forward a bill in Congress -- a bill that would repeal the Rule and clarify and codify the insurance status of indexed annuities and other current and future fixed annuities that had non-traditional methods of crediting interest to benefit consumers.
But this battle is over! The insurance industry and consumers won! Earlier this month, the U.S. District Court ruled to vacate 151A and on July 21, President Obama signed the "Restoring Financial Stability Act" (also known as the Dodd-Frank Bill), which includes the Harkin Amendment, named after Senator Thomas Harkin (D-Iowa) that gives states explicit authority to regulate indexed annuities.
This was and will remain an incredible achievement that brought competitors at every level of our industry together working hard to make calls, write letters, fly to D.C. to educate Congressman, and unselfishly contribute to the efforts, both financially and with human resources. Blair O'Connor, NAFA's Legislative Affairs Chair, said to us recently, "Our industry threw heart and soul into an old fashioned roll-up-your-sleeves red-white-and-blue grassroots effort. It's a glorious moment -- one that fills us all with a sense of awe and humility."
Focus on suitability
We are all feeling extremely proud, grateful and relieved, but what's next? What does this victory mean and what lies in store for independent insurance distribution and the fixed annuity product line?
First and foremost we must remain diligent. The securities industry's complaint about the marketing of fixed indexed annuities is a gross exaggeration as demonstrated by the NAIC data which tell us that the FIA is the only product where complaints have been reduced consistently over the past three years while FINRA reports a 43% increase in complaints about security products. Regardless of the FIA positive track record on marketing, we must continue to improve and remain focused on suitable and appropriate sales.
The NAIC and its leadership went to great lengths to demonstrate to Congress and the SEC the power and effectiveness of state insurance regulation and oversight. They will remain focused and diligent to ensure suitability rules are followed, sales are reviewed for suitability, and replacement, disclosure and marketing do not run afoul of state laws.
The Harkin Amendment codifies this with three tests for the insurance status of a fixed annuity and any insurance or endowment policy or annuity contract. The test criteria are:
1) The annuity's value does not vary according to the performance of a separate account (i.e. the annuity is a general account product).
2) The annuity satisfies standard nonforfeiture laws or similar requirements.
3) The annuity is issued in a state that has adopted the NAIC 2010 Suitability Model 275 or similar suitability rules, or is issued by a company domiciled in a state that has adopted the model regulation, or by a company that adopts the practices of the model regulation and subjects itself to state audit to ensure compliance.
This means that suitability will be the driving issue in the marketing and issuance of fixed annuities. There are two key elements of the Suitability Model that are the most important for insurance agents and advisors to understand. The first is that they must gather the necessary suitability information from their clients, they must ensure that the recommendation is appropriate in view of their clients' other assets and the carrier must have a system of review for the suitability information and the education and training required before an agent can sell a fixed annuity.
The Suitability information includes:
1) Age
2) Annual income
3) Financial situation and needs, including the financial resources used for the funding of the annuity
4) Financial experience
5) Financial objectives
6) Intended use of the annuity
7) Financial time horizon
8) Existing assets, including investment and life insurance holdings
9) Liquidity needs
10) Liquid net worth
11) Risk tolerance
12) Tax status
"Reasonable grounds"
But this information will not be the sole determinant of the suitability review. The agent or advisor will also be required to compare and contrast the benefits of the new annuity when replacing, exchanging or transferring the value from another annuity or financial product. The model states that "the insurance producer shall have reasonable grounds for believing that the recommendation is suitable for the consumer..." The reasonable grounds include:
1) The consumer has been informed of the surrender period and charges, tax penalties, fees or expenses investment advisory fees (in the case of variable annuities), potential charges for and features of riders, limitations on interest returns, insurance and investment components and market risk.
2) The consumer would benefit from certain features of the annuity, such as tax-deferred growth, annuitization or death or living benefit.
3) The particular annuity as a whole is suitable for the particular consumer, based on his or her suitability information and the producer makes reasonable efforts to obtain the information.
4) With an exchange or replacement of an annuity, the following must be taken into consideration for a suitable recommendation if a customer will:
a. incur a surrender charge or new surrender period;
b. lose existing benefits (such as death, living or other contractual benefits);
c. pay increased fees or charges for riders and similar product enhancements;
d. benefit from product enhancements and improvements
Also, the consideration must include the fact that the consumer has not had another annuity exchange or replacement and, in particular, an exchange or replacement within the preceding 36 months.
The suitability information and considerations will be extremely important in the carrier's review of the suitability determination of the producer or advisor. The understanding of these elements and how each individual consumer's information plays a unique role in the suitability of the final product recommendation will be critical to a smooth and efficient sale. The partnership and effective communications between the producer/advisor and the insurance company and vice versa will be instrumental to the sales process and policy delivery.
Certification course
The education and training elements of the Suitability Model will also be new to many agents and advisors. The Model requires that by Jan. 1, 2011, all agents must take a four-hour certification course related to the fundamentals and material features of fixed annuities.
NAFA has created a course that is compliant with the Model requirements and is in the process of filing the course for approval with various insurance departments around the country. The association, along with the significant efforts of its trade partner NAIFA, worked extremely hard to ensure this CE requirement was included in the existing state CE requirements and not added to the existing state CE requirements (e.g., if a state requires 24 hours annually, this course was included in the 24 and not added to them make the total 28).In addition to the four-hour "general" continuing education requirement, the Model also requires that:
An insurance producer shall not solicit the sale of an annuity product unless the insurance producer has adequate knowledge of the product to recommend the annuity and the insurance producer is in compliance with the insurer's standards for product training.
Various groups within the industry are working on how to address this requirement and provide the product-specific training. With more than 200 FIAs and 2,000 non-indexed fixed annuities available in the marketplace, this is a considerable and daunting task. NAFA held a meeting in late July in Des Moines to discuss with its members how to address both training elements of the new Model. The NAIC is meeting in August to discuss the audit and review parameters for the Suitability Model. The information that comes out of that meeting will be instructive as to how NAFA and its members will provide annuity training to comply with the Model and meet the standards for review.
What lies ahead
Over the past few years, we have seen a dramatic increase in state insurance and security regulatory activity around fixed annuities in general and fixed indexed annuities in particular. There is every reason to believe this will continue. Suitability review, replacement consideration and training have always been a focus of the NAFA and its membership and these issues will remain at the forefront long into the future.
Product changes and enhancements will continue to evolve and NAFA sees commissions, surrender charges, and riders for long-term care and income all impacted by those changes and enhancements. Increasingly, as baby boomers continue to retire, defined-benefit pension plans become extinct, and Americans live longer and retire earlier, producers and marketing organizations will focus on strategies of packaging and leveraging of various annuities to accommodate both longevity and income needs.
As marketing and product improvements are introduced, we expect more regulatory and legislative scrutiny. Both government and industry have a common interest to ensure the public is well-served by our products and that only suitable sales are made. Unfortunately, sometimes government efforts have had a chilling effect on consumers and our industry. NAFA will remain vigilant and involved by educating and informing regulators, legislators, the media and the general public to ensure the fixed annuity value proposition of insurance guarantees, tax deferral and premium protection remains strong and viable for today's retirees and those planning for retirement.
Kim O'Brien, CFP, MBA, is Executive Director of the National Association for Fixed Annuities (NAFA), a Milwaukee-based national trade association exclusively dedicated to promoting the awareness and understanding of fixed annuities. NAFA's membership of fixed annuity carriers and independent marketing organizations represents over 200,000 agents and registered representatives selling fixed annuities. For more information visit www.nafa.com.
