SEC's indexed annuity plan riles the industry

WASHINGTON--Major life insurers, insurance agents and state insurance regulators are challenging a Securities and Exchange Commission proposal that would redefine most indexed annuities as securities rather than insurance, significantly changing regulations that include agent licensing.

Insurance industry objectors say the proposal, which the SEC argues is needed to protect consumers from fraud, is a serious threat to their respective operations and assert it is unneeded because state insurance regulators have toughened sales standards in recent years.

Some observers see the proposal as a turf war between insurance regulators and brokers who are trying to fight off securities regulators and securities firms that want part of the expanding marketplace.

The SEC said life insurance companies began offering the indexed annuities in the mid-1990s, a business that grew to $24.8 billion in 2007. "In 2007, indexed annuity assets totaled $123 billion, 58 companies were issuing indexed annuities and there were a total of 322 indexed annuities offered," the SEC reported.

The change is needed to shield seniors and other investors "from fraud and abusive practices," according to an SEC statement. "Equity-indexed annuities are often sold to seniors, for whom they may be unsuitable investments due to substantial early surrender charges that lock up older investors' money for many years," it said.

"Working with the North American Securities Administrators Assn., the SEC has made cracking down on fraud in this area a top priority," SEC Chairman Christopher Cox said in a statement shortly before the proposed rule was published July 1 in the Federal Register.

Despite dozens of insurance industry requests for an extension, the SEC kept its Sept. 10 deadline for comments on the proposal.

Under the SEC's proposal, the terms "annuity contract" and "optional annuity contract" would be redefined under the Securities Act of 1933, which exempts certain contracts.

The proposal would modify federal securities rules for indexed annuities, under which payments to contract holders depend on the performance of a securities index, such as the Dow Jones Industrial Average.

Section 3(a)(8) of the Securities Act exempts certain annuity contracts and optional annuity contracts. The SEC proposal would effectively remove the exemption by defining indexed annuity contracts as being outside the insurance exemption "if the amounts payable by the insurer under the contract are more likely than not to exceed the amounts guaranteed under the contract."

That definition "would cause almost all current indexed annuities to be included in the new class" of securities, the Washington-based American Academy of Actuaries said in its comment letter.

Under the proposal, securities regulators that include the SEC, state securities regulators and the Rockville, Md.-based Financial Industry Regulatory Authority would oversee such contracts--not insurance regulators. FINRA was created in July 2007 through consolidating the National Assn. of Securities Dealers and the member regulation, enforcement and arbitration functions of the New York Stock Exchange.

In addition, the sellers of indexed annuities would have to be registered securities representatives. Insurance agents seeking to meet the new requirements would have to become licensed as securities brokers or arrange to cooperate with them. In addition, insurance agents would have to meet requirements for disclosure, sales material review and suitability determinations similar to those for securities.

The staunchest proponents of the proposal include securities regulators whose authority would be expanded under the plan, while state insurance regulators have stated their opposition.

Equity-indexed annuities "are extremely complex investment products that have often been used as instruments of fraud and abuse," said Karen Tyler, president of the Washington-based North American Securities Administrators Assn. Inc., in her comment letter.

"Contrary to insurance industry claims, EIAs impose significant risks upon investors, including fluctuations in the applicable equity index and potential loss of principal," said Ms. Tyler, who is the securities administrator for North Dakota. "The sales abuses associated with EIAs have been thoroughly documented over the years" in regulatory warnings, governmental enforcement actions, private lawsuits and media accounts. Many often used "free lunch" seminars to attract seniors, she said.

"State insurance laws alone cannot protect the public from the abuses associated with the EIAs. The safeguards they provide are no substitute for the investor protections contained in the federal securities laws," Ms. Tyler said.

Also, "attempts to disparage the rule as part of a regulatory 'turf' battle are also wrong," she added.

One major opponent of the proposal is the Kansas City, Mo.-based National Assn. of Insurance Commissioners.

"This rule is not needed," the four top officers of the NAIC said in their comment letter in which they asked that the SEC withdraw the proposal. They are NAIC President Sandy Praeger of Kansas, President-Elect Roger A. Sevigny of New Hampshire, Vp Jane L. Cline of West Virginia and Secretary/Treasurer Susan E. Voss of Iowa.

"We agree that there have been terrible abuses in the sale of indexed products. Some of these transactions clearly were not in the best interest of the customer," Ms. Voss said in a statement after a summer meeting with Mr. Cox. However, "we believe we have addressed those problems with our revisions," she said.

State insurance officials emphasize that numerous laws protect consumers by regulating advertising, disclosure, suitability, producer licensing and continuing education. Earlier this month, the NAIC adopted a model regulation to protect seniors from unscrupulous sales practices by establishing standards before titles such as "senior adviser" can be used in the marketing of annuities.

In the past few years especially, the NAIC has made progress in getting states to adopt those laws. Consequently, "we aren't getting the complaints" that securities regulators have cited previously, said Ms. Voss, who favors are more collaborative approach to regulation. She is an attorney and oversees both insurance and securities matters in Iowa, which is the leading U.S. domicile for insurers writing equity-indexed products.

"I don't think (securities regulators) have a picture of what is going on in the market right now," said Ms. Voss. "I don't think (NASAA members) have enough to do," she added.

Securities regulators often attempt to justify their involvement in insurance products since a component of the policies' income potential is tied to the growth of the investment markets. "That's like saying that if your ham sandwich contains a slice of lettuce, it's a salad," Ms. Voss said in the statement.

Many insurers and insurance industry organizations also oppose the SEC's proposal.

Among opponents is Aviva USA Corp., a unit of London-based Aviva P.L.C., which is a major issuer of indexed annuity products in the United States. The proposed rule is "a dramatic departure" from previous judicial and commission precedent, said Michael H. Miller, executive vp, general counsel and secretary in Des Moines, Iowa. It is also "fundamentally flawed" for many reasons, including its failure "to recognize the robust guarantees provided by insurers."

Allianz Life Insurance Co. of North America said the SEC proposal may regulate "fixed-index annuities," which is neither necessary nor appropriate, said Stewart Gregg, managing senior securities counsel for Allianz in Minneapolis. Such products should continue to be defined as insurance. Also, "sales practices have evolved significantly over the last three to five years" to emphasize suitability, disclosure and agent practices, he said.

Many opponents also say the proposed rule would reduce competition because of new burdens on agents as well as insurers.

Requiring insurance agents to become registered broker/dealers may reduce the number of agents selling equity-indexed products and the number of insurer-issuers, especially if the product represents a small part of the insurer's business, Aviva's Mr. Miller said.

The rule would have an "enormous" impact on agents and issuers of fixed indexed annuities, according to Allianz, which had $40 billion in such assets under management at the end of 2007.

Members of the Alexandria, Va.-based Independent Insurance Agents & Brokers Inc. "strongly" oppose the rule as being "unwarranted and counterproductive," Charles E. Symington Jr., senior vp-government affairs, wrote in a comment letter.

The agents' association predicted that adoption of the SEC proposal may result in fewer agents selling annuities due to new licensing requirements and the need to associate with a broker/dealer, "who may impose contractual terms, conditions and sales quotas that make it practically impossible to continued to sell indexed annuities."

Like many other opponents, the IIABA disagrees with the SEC's characterization of equity-indexed annuities, which the agent group stresses "are savings and financial protection vehicles" for the consumers who purchase them. "As with other fixed annuities, there is simply no risk to principal (barring the surrender of the annuity) and a guaranteed rate of return regardless of whether the stock market produces positive returns," Mr. Symington said.

The SEC's proposal also raises questions about related issues, including whether general-account life insurance products and traditional fixed annuities are covered by the proposal, according to executives of the Falls Church, Va.-based Assn. for Advanced Life Underwriting.

A few insurers have endorsed the SEC's primary objective, but say it goes too far and may sweep in similar but unrelated products that the SEC is not targeting. Insurers expressing such concern include New York-based AXA Equitable Life Insurance Co. and Hartford, Conn.-based Hartford Financial Services Group.

If adopted, the new definition would apply prospectively and take effect 12 months after publication in the Federal Register.

Also, the SEC proposed exempting insurance companies from filing reports related to indexed annuities and certain other securities that are registered under the Securities Act and regulated as insurance under state law.

The recent financial crisis, however, likely will delay SEC consideration of this topic, Ms. Voss said.

Given the amount of insurance industry opposition to the proposal, "I'd be very surprised" if this proposal gets through, Ms. Voss said. With all the other Wall Street-related activity that is demanding the attention of federal regulators "they may just have to table this," she said.