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Regulatory Moves Crumble Walls Between Fixed and Variables

Could the walls between fixed annuities and variable annuities be vanishing? Well, yes. And, well, no.
During a recent conference call of state insurance commissioners, a few commenters alluded to how the walls between those types of annuities “don’t really exist.”

This was in the context of a discussion about a third type of annuity, the contingent deferred annuity (CDA) – essentially an income guarantee attached to securities not owned by the insurer.

The conversation centered on regulating CDAs like any other annuity in key regulatory areas (such as producer licensing and suitability), as opposed to regulating them separately from fixed and variable annuities.

Might this thinking affect the annuity future for advisors? It could, depending on the direction it takes.

A Puzzle
The “walls” part of the discussion might puzzle annuity producers, because their business licenses allow them to sell specific products.

A fixed annuity producer needs a life insurance license. Those who sell variable annuities need both a life insurance license and a securities license (because the products are annuities that are registered with the Securities and Exchange Commission [SEC]).

In view of the distinct licensing requirements, how can the walls between annuity types be nonexistent? The answer has to do with how state regulators are approaching regulations regarding annuities, said Jim Mumford, deputy insurance commissioner in the Iowa Insurance Division and securities administrator in the Iowa Department of Commerce.

State and federal regulators are sharing knowledge and arriving at meetings of the minds in ways that are becoming increasingly important as annuity product development evolves, he indicated in an interview. Mumford alluded not only to CDAs but also to “collared variable annuities” as examples of new forms of annuities that regulators are seeing.

This regulatory sharing is removing certain barriers in annuity regulation, he said. Or at least it is putting doors in the walls that have kept certain parts of annuity regulation separate and distinct.

It Started With the CDAs
The trend started with the arrival of the CDAs, the regulator said. (The earliest versions popped up in the latter part of the last decade.) The first-blush view was that these products were essentially a wrap on a portfolio of stocks, he recalled. As such, they should be regulated as a security and registered with the SEC.

But insurance regulators looked at the reserve issues related to the annuity guarantees, the market conduct issues, sales and many other factors, Mumford recalled. From an insurance standpoint, they wondered, were these fixed or variable annuities? How should they be regulated at the state level?

As it has turned out, state insurance regulators have decided “that CDAs are neither fixed nor variable annuities, but they are annuities,” he said. “They are in their own category.”

But do CDAs need their own set of regulations? Because the products are annuities, can existing regulations apply to them? These questions no doubt still sit on some regulatory tables. But they have also opened up awareness of regulatory walls that complicate things for annuities, and for the business that depends on consistent and effective regulation.

For example, state insurance regulators initially considered adding language related to CDAs in certain model insurance regulations that affect annuities. But the thinking has now turned toward approaching the products as annuities (i.e., with no separate distinction) and treating them as such from a regulatory standpoint in certain insurance regulations. This approach focuses on the commonality between the products, keeps existing model regulations largely intact, and builds on what is already known and understood.

As for CDA specifics, the regulators are developing guidelines for state insurance regulators to consult, complete with references to existing model laws. The guidelines raise regulatory points about CDAs without unraveling the existing annuity regulation order.

Mumford traces some of this more unified way of thinking back to the early 2000s, when annuity carriers started adding guaranteed living benefits to their variable annuity policies.

Up to that time, state insurance regulators had been reviewing variable annuity forms for compliance with state laws, Mumford recalled. The SEC handled oversight via review of the prospectus, and the state securities departments looked at compliance with state investment laws, licensing of the salespeople, and protection against fraud and scams in mind.

Those were the walls for variable annuities back then. But with the arrival of guaranteed living benefits in variable annuities, state insurance regulators saw that they needed to start looking at more than the product forms. They needed to look at the reserves that carriers had available to support the guarantees, he said.

As approaches for this developed, the National Association of Insurance Commissioners (NAIC) began having meetings with the SEC and later with the Financial Industry Regulatory Authority (FINRA), he said. These connections led to a more clear understanding of what areas the various regulators were looking at. That led to sharing, and that led to some coordination and/or common ground.

Suitability Example
One example has to do with suitability. The states had their own suitability regulations for life and annuity sales, and FINRA had its own set for sales in the broker/dealer channel including annuity sales, even fixed annuity sales.

Those were the walls. However, it’s different today. For example, in many states, if a fixed annuity is sold through a broker/dealer, the suitability process of the B/D (as provided for under FINRA) “is OK by the states,” Mumford said.
 That’s even though the fixed annuity is not a security. The NAIC model says this is acceptable suitability review, he said.
What about suitability reviews of fixed annuity sales that go through insurance channels rather than B/Ds? The suitability is regulated by the insurance department of the state where the annuity is sold.

The shared approach to oversight is spreading into other areas. Right now, Mumford noted, NAIC and FINRA are working on developing common social media rules.

Developing common approaches to annuities, or other regulatory areas, is a process, he cautioned. It requires “both sides to develop an understanding about what the other regulators are looking at. That takes time.”

But it could have positive outcomes for the industry. “For both carriers and producers, it is generally preferable to have one uniform set of regulatory requirements than different and possibly inconsistent federal and state standards that apply,” Stephen E. Roth said in an email. Roth is a partner at the Washington law firm of Sutherland Asbill & Brennan and has deep annuity expertise.

“To the extent there is a trend toward one regulator deferring to or recognizing the regulatory framework of another regulator,” Roth said, “that trend generally should operate to create more effective and efficient compliance.” In turn, that should benefit all concerned, including consumers, Roth said.


Linda Koco, MBA, is a contributing editor to InsuranceNewsNet, specializing in life insurance, annuities and income planning. Linda can be reached at [email protected] [email protected].

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