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Everybody's Getting Into the Act

New VA suitability rules will, in one form or another, eventually be adopted in most, if not all, states.

Judith A. Hasenauer, 11/04/2010

The late, great entertainer Jimmy Durante had a catch phrase that he used with hecklers and ad-libbers who spoke up when he was doing his act: "everybody's getting into the act," he would exclaim. It seems that the same is currently true when it comes to suitability requirements for annuities--both variable and fixed.

It has been many decades since the association that was the predecessor to FINRA, the NASD, first adopted suitability rules for the sale by member firms of all securities. As variable annuities became popular in the 1970s and 1980s, they became subject to the suitability rules as insurance agents became NASD registered representatives. State insurance regulators never adopted similar suitability requirements for fixed annuities or life insurance, but they generally looked approvingly at the suitability rules that applied to variable products.

Recently, the National Association of Insurance Commissioners has propounded model laws and regulations to apply suitability rules to all annuities. These suitability rules will, in one form or another, eventually be adopted in most, if not all, states. The state insurance regulators defer to FINRA and therefore de facto defer to the SEC when it comes to variable annuities. However, the NAIC suitability rules do, in fact, apply to variable annuities in some state areas. The state requirements that are applicable to variable annuities relate primarily to the requirements for training of sales personnel and supervision of such people. In most other areas, the NAIC models defer to the FINRA suitability rules where those rules are applicable.

The NAIC suitability rules apply to all fixed annuities including traditional fixed annuities, market value adjustment annuities and index annuities. They apply to both deferred and immediate annuities; whereas the FINRA suitability rules apply only to deferred variable annuities--immediate variable annuities generally get a pass from the FINRA rule (FINRA Rule 2330) that applies to deferred variable annuities. However, the general FINRA suitability rules (NASD Rule 2310) do apply to immediate variable annuities. FINRA also applies its suitability, training and supervisory rules to sales of fixed annuities that are sold through a registered representative's broker-dealer, even though these products are exempt from the federal securities laws.

There are many questions that have arisen with respect to sales of fixed annuities by registered representatives when such sales are not transacted through a registered representative's broker-dealer, but are treated as an "outside business activity" by the registered representative. More and more it seems that broker-dealers are unwilling to permit their registered representatives to sell fixed annuities as an outside business activity. Instead, many broker-dealers have adopted a policy that all annuity sales must come through the broker-dealer as a condition of continued registration with the broker-dealer.

With "everybody getting into the act," it becomes increasingly important that all parties involved take steps to ensure that they have complied with all the requirements of the various regulatory bodies involved. The simplest solution is to design a training, supervisory, and suitability program that combines the totality of all the requirements and then apply these requirements to all products, regardless of type.

For decades, insurers have deferred to the selling broker-dealers for all training, supervisory, and suitability requirements. This has been in recognition that, although registered representatives are technically "agents" of the insurer, the fact is that such representatives are subject more to the day-to-day control of their broker-dealers than they are of the insurer. This is going to change with the NAIC requirements. In fact, the practice of delegation by an insurer of these requirements to a selling broker-dealer will continue (and is permitted in the NAIC model); however, the insurer remains responsible for all transactions undertaken by the registered representative of the selling broker-dealer pursuant to the delegation. This is because these registered representatives are technically "agents" of the insurer. This means that the insurer must revise its selling agreements with selling broker-dealers to ensure that the responsibility has been effectively delegated and must also reserve the right to oversee the selling broker-dealer's program and individual transactions to ensure that all requirements have been met.

All broker-dealers, and particularly the large regionals and wirehouses, have jealously guarded their relationships with their registered representatives and have limited access to these key personnel insurers and other issuers of financial products. The new NAIC requirements will impose new responsibilities on insurers and will require all selling broker-dealers to incorporate the requirements that will be imposed on the selling process by insurers in compliance with state insurance laws. We do not believe that this will portend a rebirth of the old "captive agency" system, but it will require a different form of cooperation between selling broker-dealers and the insurers whose annuities these broker-dealers sell.

As with all changes to the regulatory structure applicable to our products, we will undoubtedly undergo a period of transition as regulatory examinations and litigation begin to create a visible framework surrounding the new requirements. In the meantime, there will probably be a long period of "overkill" where everyone's compliance people and lawyers impose stringent requirements while the final framework for the new procedures emerges and more flexible programs can be implemented.

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