In our last review of developments concerning variable annuities and life insurance, Bates discussed the SEC’s issuance of a comprehensive new rule proposal intended to create a “layered disclosure approach” for regulating these products. That proposal was issued against the backdrop of an ongoing debate among state insurance regulators on revising model legislation on “Suitability in Annuity Transactions.” The National Association of Insurance Commissioners (NAIC) remains determined to create these standards and procedures for providing suitable recommendations to consumers, despite the likely impact and continuing uncertainty created by the unresolved SEC proposed Best Interest rulemaking.
In this article, we update the most recent SEC action on variable contract disclosure as well as some important private sector activity, notably Ohio National Financial Services’ (“Ohio National”) strategic decision to pull out of the market for variable annuities.
On February 14th, the SEC announced that it was offering a brief, one-month extension for market participants to provide comments on its proposal to change existing disclosure rules and allow issuers of variable products to fulfill certain compliance obligations by preparing and delivering a “reader-friendly” summary prospectus (see Release and Fact Sheet). The comment period was extended to March 15th .
To date, commenters have been supportive of the concepts of simple summary and layered disclosure. Most communicated that, for various reasons, an extension was warranted. The American Council of Life Insurers, for example, said it needed additional time to consider the “regulatory, structural and financial implications of the proposals for life insurers, salespersons and consumers,” and that “each of these considerations must be analyzed against unique fact patterns, business models, and organizational structures.” The independent, non-profit investor advocacy organization Better Markets expressed concerns about whether simplified disclosure would have any impact at all on investors.
Such a short timetable may or may not result in a commitment by the SEC to do more testing. But as this process continues in its ordinary course, other developments in the variable annuities market may also become a factor.
One of these factors may be the continuing fall-out from a move taken by Ohio National, a Cincinnati-based mutual insurance company. In September, 2018, Ohio National announced that after a“comprehensive strategic review of [its] businesses, taking into account the continuously changing regulatory landscape, the sustained low interest rate environment, and the increasing cost of doing business …the company will no longer accept applications for annuities or new retirement plans, while continuing to service and support existing clients in both businesses.”
Sheila Murphy, a Bates insurance regulation consulting expert, notes: “most annuity issuers did not anticipate the continued low-interest rate environment they find themselves in. Given the current market, it is likely that issuers will continue to look for ways, such as eliminating trail commissions, to reduce expenses and increase revenues. Such actions may have unforeseen consequences for both market participants and for customers. It won’t be long before a regulator will ask whether a broker will give the same level of advice on an annuity with no trail commission.”
Reportedly, the Ohio National decision already has led to concerns that other insurance carriers would stop writing new business in variable annuities and that advisers and broker dealer firms will not “honor obligations to distributors who selected a trail rather than upfront commission during an annuity sale.” The Ohio National decision is not going down easily. While there are varying opinions as to whether other issuers may or may not pull out of the variable annuities business, one thing is for certain: Ohio National’s attempt to replace the older contracts with new "servicing agreements" which exclude trail commissions is being met with legal resistance by some advisers. All sides are pressing for the courts to weigh in on the rights, duties, and liabilities of the parties.
The specific dispute over commission trails is raising a number of very serious compliance issues, including the regulatory dilemma created if advisers attempt to engage clients without a formal brokerage agreement or insurance relationship in place. More broadly, however, the dispute is serving to highlight some of the key issues regulators have been raising concerning the complexity over variable annuity products and whether investors have any idea what the costs of these products are. Alluding to the recent FINRA 2019 Examination Priorities Letter, one commenter described it like this: “The environment for high-commission variable annuities sales gets a little less friendly by the day…[as] regulators are looking for product sales where pricing and commissions appear excessive, and instances where advisors are doing costly swaps of clients’ existing contracts for new [variable annuities] that add little or no client benefit but generate new commissions and fees.”
Federal and state regulators are already at heightened attention on these investment products. They are (i) in the midst of new proposed rules on variable annuity products and suitability; they are (ii) communicating their concern through Enforcement Priorities Letters; and they are (iii) taking enforcement actions. (Note FINRA’s recent settlement in a case involving failure to supervise and train registered representatives concerning the recommendation and sale of share class variable annuities.) The Ohio National strategic decision and the consequent lawsuits over commissions and how they are handled are not tangential to regulator concerns. Bates will keep following the developments.