Sheryl Moore on Fixed Indexed Annuities and the SEC Proposed Rule 151A

The Securities and Exchange Commission’s (SEC) proposed Rule 151A would change the securities status of indexed annuities from fixed insurance products to registered, securities products.

The proposed rule would have a significant impact on their entire industry landscape.  SEC 151A would affect the way in which insurance companies develop fixed indexed annuity (FIA) products, how distributors sell the products, and ultimately the manner in which consumers purchase FIA products.

Sheryl Moore is the President and CEO of a company called AnnuitySpecs.com.  AnnuitySpecs.com is the premier information and market intelligence source for the indexed annuity industry. 

Sheryl is intimately familiar with 151A and she was kind enough to share her thoughts with us.

Annuity Digest: Why should the normal consumer who either has or is considering a FIA care about 151A?

Sheryl Moore: 151A is important from consumer standpoint because if the Securities and Exchange Commission (SEC) obtains ability to regulate fixed indexed annuities (FIA) as securities then consumers will have less access to these types of products than they do at the moment.

Insurance agents will have more overhead with broker-dealer registration requirements.  This will result in increased distribution costs for indexed annuities, which will ultimately result in the costs being passed down to the consumer. Again, the result is that fewer financial advisors in the space will result in fewer choices for consumers.

Also,there will be fewer insurance companies in fixed indexed annuity (FIA) space.  The number of FIA insurance carriers has decreased from 59 to 44 in the past year.  The number of indexed annuity products has declined from 333 to 266 during that same period. The bottom line is that 151A will result in fewer carriers, fewer products and less product diversity. 

Overall this will create a situation where this is less competition and product diversity which is clearly bad for the consumer.  In my opinion, there is absolutely no way SEC can prove that 151A will enhance competition to the benefit of the FIA consumer.

Also consumers should know that there are protections in place through the existing regulatory structure that is run by state departments of insurance.  The fact is that insurance regulation of fixed indexed annuities provides consumers with remedies for unsuitable sales.  This (backstops or remedies for unsuitable sales) would not be the case if FIAs are regulated by the Securities and Exchange Commission.

All annuities are essentially a commoditized product- whoever can offer the highest potential for gains to the customer prevails. If FIA regulated as securities, then FIAs as we know it will disappear.  Insurance companies will realize that FIAs are being regulated as a VA-type product, but look entirely different from a VA. The insurance companies that develop the products will reduce or eliminate the minimum guarantees, in an effort to pass on greater interest crediting to the consumer. This will give them an advantage when competing against fixed or variable annuities. In quest to see who can offer highest upside potential, carriers will let minimum guarantees slip away.  Lines between VA and FIA will blur.

Annuity Digest: Where did it actually come from and how did it evolve?

Sheryl Moore: This is an interesting question.

The Financial Industry Regulatory Authority (FINRA) issued notice to members in August 2005.  This notice to members—referred to as NTM 05-50—was really the technical inception of 151A. This notice suggested that Broker Dealers treat indexed annuities as if they were securities products, despite their fixed insurance status. Furthermore, it advised Broker Dealers to maintain a list of “approved” indexed annuities, from which their registered reps could sell from.

In addition, Mary Shapiro who is head of SEC and formerly head of FINRA is on record as a proponent of greater securities-related oversight of insurance products.  FINRA (which was formerly NASD) had—prior to 151A—always made a lot of noise about a need to regulate fixed indexed annuities.

At a higher level, though, 151A was driven by the prevalence of negative and inaccurate media regarding fixed indexed annuities.

Annuity Specs has tracked relevant media for years, and we have seen a consistent pattern of biased, negative media from well known, established publishers.

A critical turning point for 151A involved the Minnesota Attorney General contacting Dateline NBC with a hot story.  Dateline NBC then ran an “expose” on fixed indexed annuity sales and that resulted in widespread coverage and broad public reaction.

At that time, the #1 company in the indexed annuity market had been involved in a number of lawsuits, alleging unsuitable annuity sales to seniors. This company’s top-selling indexed annuity was a two-tiered product, which did not credit the 10% bonus nor any of the fixed or indexed gains unless the client held the product in deferral for a minimum five-year period, and then annuitized for a minimum 10-year period. This meant the client did not receive their 10% premium bonus unless they kept the annuity for a minimum 15-year period, and this was not prominently advertised in the product brochures. Although this top-selling product from this top company was very popular, it was not representative of other indexed annuities.  In addition, the distribution of this company was not properly trained on the products’ features, and were thus unable to properly communicate the product features to consumers. This is a case of one bad apple spoiling things for the entire barrel, as other companies in the indexed annuity market didn’t have similar issues with product miscommunication. However, this company’s problems made big headlines. Those unfamiliar with indexed annuities considered that this one problem must be an issue with the entire FIA industry.

The point of the story is that securities regulators reacted to the perceived consumer complaints. Lawsuits and complaints related to unsuitable annuity sales lead to securities regulators commenting on rising levels of unsuitable FIA sales.

In essence, regulators capitalized on media and broad public perception to broaden their jurisdiction.  In other words, the securities regulatory body sought to expand its authority by declaring an insurance product as a security.

All of the above said, our data show a large disconnect between what is portrayed in the media and the facts.

Annuity Specs research shows an average of 4 FIA complaints per insurance company in all of 2007.  Complaint levels actually went down in 2008 to 3.85 complaints per company.  For comparison purposes, 2007 variable annuity complaints averaged 5.88 per company and increased in 2008 to 7.13 per company.

The reality is that most actual issues are at point of sale with agents rather than how the products are actually manufactured and work.

Annuity Digest: What would proponents claim as the driving need or basis for 151A?

Sheryl Moore: The argument for 151A would boil down to the following: the fixed indexed annuity customer is at risk and SEC has a greater ability to protect consumers from these risks. 

The SEC would likely say that departments of insurance (DOI) are more focused on solvency issues than serving as an effective consumer watchdog.

Annuity Digest: Who are the natural advocates or proponents of 151A and why?

Sheryl Moore: As we have discussed, the SEC is certainly a key advocate.

FINRA which is essentially charged with the regulation of broker-dealers would also fall into the advocate camp.

In addition, some insurance companies such as New York Life and Hartford support 151A.  These companies are subject to the negative media exposure and they also happen to sell products that compete directly against FIAs.  Insurance and financial companies with vested interest in competing products are natural advocates of 151A.

Annuity Digest: Which segments of industry are naturally opposed and why?

Sheryl Moore: Product manufacturers and distributors of FIAs are opposed.

Some fixed annuity insurance companies are also opposed.

Some indexed life and universal life insurance companies are also opposed to 151A because they perceive that their products might be “next” in terms of securities oversight.

Really, though, FIA distributors and marketing organizations are especially threatened by 151A.  Ninety percent of FIAs are sold by independent agents, so independent marketing organizations (IMOs) that serve these agents are hugely at risk.  The indexed market is more IMO-driven than any other market—the average independent agent is contracted with 12 different insurance companies and 6 IMOs. 

Annuity Digest: What would proponents say are the upsides for consumers?

Sheryl Moore: They would argue that securities regulation of FIAs would result in greater consumer protection.

The Court has ruled that the SEC is correct in questioning the issue of market risk with FIAs.  In other words, a fundamental consideration is whether FIAs are technically investment products that are exposed to market risk.

The reality is that there is no real market risk with FIAs.  The products provide protection of principal with some upside potential depending on the market’s performance.  The whole thing around risk and the semantics of what constitutes an investment has the potential to open a sort of wormhole for many other insurance products that presumably have an “investment” profile.

Suitability of annuity sales has been put in the spotlight over the past few years, and improvements can be made with fixed, indexed, and variable annuity sales. Ultimately, the protections that the insurance industry has put into place with the Suitability in Annuity Transactions model act have resulted in far fewer suitability issues. However, I am not opposed to additional training being mandated for those selling indexed insurance products. Some states, such as Iowa, have adopted a mandatory 4-hour continuing education course that all producers must take, if they wish to sell indexed annuities or indexed life insurance. This is a great example of how this state is ensuring that their agents are properly equipped to sell these products.

Annuity Digest: Where is 151A actually at?

Sheryl Moore: The Court has told the SEC that they must go back and prove that securities regulation will improve competition, efficiency and capital formation.

Assuming the SEC is able to make this case, 151A will become law January 12^th 2011.

The FIA industry has gone to Congress and identical bills exist in both the House (2733) and Senate (1389).  Both are sitting in committee at the moment.  The title is “The Indexed Annuities and Insurance Products Classification Act of 2009.” 

In this regard, things look favorable for the FIA industry at this point.  If the FIA bill passes then there is nothing that the SEC will be able to do to prove these products need to be regulated as securities.

Annuity Digest: What, in your opinion, does the future hold?

Sheryl Moore: I do not think 151A will go into effect.  I believe the bills in the House and Senate will succeed and result in what they are intended to achieve.

Also, the current environment is not a favorable one for the greater ambitions of the SEC.  The Madoff case and the SEC’s involvement (or lack thereof) do not lend support for the SEC’s role as a consumer watchdog.

That said, the fixed indexed annuity industry has been forever changed by 151A and things will never be the same. Securities regulators have already “won” to some extent, as FINRA now oversees sales of all indexed annuities for their registered representatives.

The damage was done as soon as FINRA issued its notice to members.  Almost half of all FIA sales are now through some form registered rep, and so one can assume those sales are going through a broker-dealer unless the rep is selling away. Broker-dealers develop lists of FIA products that their reps can sell. This naturally results in limited carriers and product options—not at all a positive for the consumer. 

At the end of the day, only 8% of insurance agencies sell fixed indexed annuities and only 2% of consumers know about the products.  The mission of Annuity Specs is to have people know the facts about these very interesting products.  We will do our part in making sure that consumers do not lose access to these products that offer protection of principal plus upside potential.