The right fit: in the past year, life insurers, their associations and regulators have worked hard to protect buyers of annuities from inappropriate sales. One positive result is that the Insurance Marketplace Standards Association has adopted its strictest suitability standards ever.

Key Points

* The variety and complexity of regulatory authorities in the United States have not been well-suited to oversight of annuity sales.

* A high level of cooperation this past year among regulators and the annuity industry, particularly with regard to equity-indexed annuities, has helped the situation.

* The Insurance Marketplace Standards Association has used the cooperative environment to implement new standards for the sales and marketing of EIAs and other annuities.

* The IMSA work represents a national consistency of standards rather than of regulatory laws, but should result in better marketing and sales and may lead to more consistent regulation.

The business of monitoring the suitability of annuity sales always has been unwieldy, but this year both regulators and insurers have made unusual progress in protecting buyers.

Effective oversight has traditionally been hampered by the number and overlapping duties of regulatory authorities. Fixed annuities have been the jurisdiction of state insurance regulators. Variable annuities have fallen under the purview of both insurance regulators and federal and state securities regulators. And equity-indexed annuities, a fixed product that credits interest based on a link to one or more stock indexes, have generated regulatory controversy since their sales rose to some $23 billion in 2004, a 66% increase over the previous year.

This year, regulators of all stripes and the insurance industry itself undertook several initiatives to clarify the murky regulatory atmosphere and foster better relationships and cooperation. An important result is a major new set of annuity suitability standards adopted by the Insurance Marketplace Standards Association, the one organization that has a comprehensive and national reach even though the standards apply only to its voluntary members. IMSA was set up by the industry 10 years ago and is now independent. Its members constitute about 60% of the life, annuity and long-term-care business in the United States, so its enactment of new standards will likely have profound and immediate effects.

"We're extremely pleased that within a year we've been able to bring about very meaningful suitability standards that will apply across the country irrespective of state or federal regulation," said Brian Atchinson, IMSA's executive director. "We're cautiously optimistic this achievement will be recognized for what it is: pro-company and pro-consumer.... At the end of the day, companies lose and consumers lose if there isn't clarity on what the standards are and how high they are."

Annuities are a big part of all investor complaints, according to results of a survey released at the Seniors Summit hosted in July by the U.S. Securities and Exchange Commission. The survey of state securities regulators showed that an estimated 44% of all investor complaints are made by seniors and that unregistered securities, variable annuities and equity-indexed annuities are the most pervasive financial products involved in senior investment fraud. The North American Securities Administrators Association conducted the survey.

Negative stories about annuities sales--not always fair or accurate, according to the National Association for Fixed Annuities--have been numerous in the national media for the past two or three years. And when consumers complain or file lawsuits, they usually claim that a producer misrepresented the product to them, said Leon Roday, who in October was the outgoing chairman of the IMSA Board of Directors and is senior vice president and general counsel at Genworth Financial. That is why the new IMSA standards require, in addition to a suitability analysis, significant disclosure about product features and costs. They also address producer training.

Another catalyst for this year's developments appears to have been the National Association of Security Dealers' Notice to Members 05-50, issued in August 2005, on the sales of EIAs, the vast majority of which are not registered under the federal securities laws. The notice provided guidelines to member firms on the supervision of the sale of unregistered EIAs by their producers. That included producers who sold EIAs in their capacity as insurance agents as a business activity outside the purview of the firm. The NASD noted that EIAs are complex products and said it is "concerned about the manner in which associated persons are marketing and selling unregistered EIAs, and the absence of adequate supervision of these sales practices." Some sales materials did not fully describe the features and risks of the product, it said.

The notice may have essentially changed the way many dealers conducted business; EIA sales have fallen since the third quarter of last year and were down 14.2% in the second quarter of 2006 from the second quarter of 2005, according to market-tracking firm Advantage Compendium. Market factors, including rising interest rates, probably also contributed to the sales decline.

In December 2005, the National Association of Fixed Annuities responded to what it saw as "inaccurate, one-sided stories in the consumer and business media," class-action lawsuits and the NASD action. It argued that most seniors are not "duped" into buying an annuity. "There is a small minority of agents who have used unscrupulous or misleading sales methods, and their misdeeds have fueled the fires of criticism," said the Board of Directors in a prepared statement. "NAFA does not agree with the implication that these activities are widespread or endemic. The vast majority of entirely appropriate sales should not be vilified when there is no consumer evidence to support it."

Taking Charge

There appeared to be enough adverse publicity, however, to cause the Iowa Insurance Division in March to ask IMSA to work with its Iowa domestic insurance companies to explore developing standards for sales and marketing practices of indexed products. Insurance Commissioner Susan Voss said Iowa-based companies have a one-third market share of EIA sales and that insurance is the second-largest industry in the state. Allianz Life Insurance Co., just across the border in Minnesota, also had a one-third market share.

Voss originally found that writers were "all over the board" on suitability and marketing practices.

"In addition to regulators in the securities area, we wanted to get a handle on this right away," said Voss. "We saw there was starting to be a problem, and I think we addressed it." Voss said her division's take has been that it is better to work and partner with the industry instead of being a "regulator saying you must do this or that." Iowa had previously issued a bulletin saying it would consider IMSA certification when conducting market-conduct exams.

The ensuing talks involved not only the insurers and IMSA, but division staff members and regulators from neighboring states. Voss said the NASD and NASAA also willingly worked with her division. As a result of the Iowa meetings, IMSA for the first time created a standards advisory committee that met periodically and included people from rating agencies, consumer groups, and the regulatory and producer communities, said Atchinson. Represented were the National Association of Insurance and Financial Advisors, the NASD, Standard & Poors, A.M. Best Co., the AARP and the National Association of Insurance Commissioners, according to Roday.

"We worked really closely with IMSA," Voss said. "We were certainly not telling them what to do. They were meeting with the industry and they were looking at the NAIC suitability model, and we thought that maybe, if this works in the indexed annuities field, they can be a best-practices facilitator in other lines in the market."

The model law to which she referred is the Senior Protection in Annuity Transactions Model Regulation, which the NAIC adopted in September 2003. In June, the NAIC adopted the Suitability in Annuity Transactions Model Regulation, which applies not just to seniors, but to all annuity buyers. As of October, only 14 states had adopted it into law, 10 of which applied their laws only to senior buyers. IMSA's new standards correlate closely with the new model law. "My job now, along with other commissioners, is to really push it in the states," Voss said. She maintains a list of who has passed the model regulation into law and who has not. "I'm committed to getting this passed in as many states as possible," she said.

"I feel really good about the discussions we've had this past year," Voss said. "I have to credit everybody for trying to step up to the plate and make something work instead of just pointing fingers."

IMSA's work led to adoption in June of tougher standards for indexed annuities. Those standards became mandatory on Oct. 1. On Sept. 30, the IMSA Board of Directors approved the 34th and final draft of the new IMSA Assessment Handbook, which applied the indexed-annuity standards to all annuities on a voluntary basis until Jan. 1, 2008, when they become mandatory.

Meanwhile, the NASD and Minnesota Department of Commerce in May hosted an Annuity Roundtable for securities and insurance regulators and industry executives. State regulators and members of the NAIC, SEC and IMSA attended. They set a goal that annuity buyers should be comparably protected regardless of which regulatory regime covers the product they buy. "With the round table, we have established a network to promote the establishment of comparable rules for the annuity sales among all regulators to better serve the interests of investors," said Robert Glauber, NASD chairman and chief executive officer, and Glenn Wilson, Minnesota Commerce Commissioner, in a statement.

In July, the SEC hosted a Seniors Summit. Its focus was on coordinating efforts by regulators and others to protect older Americans from investment fraud and abusive sales practices, but it did not focus on annuities.

Atchinson said the work of the standards advisory committee was "extremely valuable" in producing the Assessment Handbook and its new annuity standards. "In terms of best practices, when we harvested those, none of our companies were doing all of these things," he said. "Many were doing many of these things, and all agreed they would raise the level of their game."

New Requirements

A big change is that every future sale must be based on a meaningful determination of suitability for that individual, said Atchinson. "The responsibility starts with the company and goes down through those selling on its behalf," he said. "It requires ongoing supervision and monitoring by the companies of those selling on their behalf. It's a concept familiar to those who work with registered products and variable annuities, but it's less familiar for those who just work with state-regulated products. We're making sure this applies across the board to IMSA-qualified companies; we consider that a best-practice."

Another big change is in education and training, whether companies are working through independent broker-dealers (whose producers are generally securities-licensed) or marketing organizations (whose producers may only be insurance-licensed and may sell only one or two products). "Companies now have the responsibility and incentive to ensure that the education and training being provided is meaningful and being taken advantage of by the producer community," Atchinson said.

Thirdly, there is a lot of room for improvement in disclosure. "It's one thing to say we have a disclosure document, but is it really a document that normal people can read and understand?" asked Atchinson. "It has to be meaningful disclosure."

Roday said the achievements of the past year are significant, particularly what he referred to as "the Iowa example" of the regulator reaching out to the industry compliance organization and of IMSA bringing together companies and in short order promulgating new standards. "This was a terrific example of how this thing can work, and how the insurance industry can deal quickly with a provocative problem," he said.

The fact that the new IMSA standards are so similar to state laws based on the NAIC model is also important, said Roday. "Now when regulators look at our companies, they will give the companies more credit, we hope, for all of the great work they are doing,' he said.

Roday also said the new standards and assessment handbook signal a higher development in the evolution of IMSA. There was no assessor handbook in the beginning, and assessors "could judge companies based on their own kind of view," he said. "Now we say that if you're going to be the police person, then everybody has to have a set of standards to understand how to do that work. To me, that's a very natural evolution when you create an organization that has hundreds of members. There are bound to be some gaps, and we continuously work on filling them."

"Overall, we provide a verifiable, systematic compliance system that requires monitoring and tracking," Roday said. "It puts companies in a place where executives can sleep better at night knowing that it's being done. It also puts companies into a position where outsiders can say, 'OK, they've got this, so at least I know they've got a good level of commitment to compliance.'"

IMSA also provides a national consistency, which is "very needed here in the U.S.," said Roday. "It's not a national consistency of laws ... but it provides a national consistency of standards."

Insurers have evolved as well. Ken Kalis, one of 43 independent assessors certified by IMSA, said compliance became an important part of corporate structure in the late 1990s, but it and marketing departments were in figurative silos. "Marketing looked at compliance as sales prevention, and compliance looked at marketing as a crook," he said. "Then they began to work more together."

In recent years, the better companies have understood that marketing and compliance aren't separate anymore, Kalis said.

RELATED ARTICLE: Tracking advances in ethical selling.

September 2003

NAIC adopts the Senior Protection in Annuity Transactions Model Regulation, which set suitability standards for sales to seniors. Few states adopt it.

August 2005

NASD issues Notice to Members 05-50, which toughens supervision of producers selling equity-indexed annuities.

December 2005

NAFA issues response to NASD notice. It is intended "to set the record straight."

January 2006

ACLI supports NAIC suitability model that covers all annuity customers, not just seniors.

March 2006

Iowa Insurance Division asks IMSA to work with its Iowa domestic member companies and regulators to explore developing standards for indexed products' sales and marketing practices.

May 2006

NASD holds Annuity Roundtable attended by more than 20 securities and insurance regulators and industry executives, including the NAIC, SEC, IMSA, and state regulators. They agree that annuity buyers should be comparably protected regardless of which regulatory regime covers the product they buy.

June 2006

NAIC adopts the Suitability in Annuity Transactions Model Regulation, which replaces the original model law that applied only to seniors. The new model regulation seeks to protect buyers of all ages.

June 2006

IMSA adopts tougher standards for equity-indexed annuities.

July 2006

SEC hosts Seniors Summit. NASAA warns that investment fraud among seniors could grow significantly in coming years.

September 2006

IMSA Board of Directors approves P34th and final draft of the IMSA Assessment Handbook, which makes EIA standards mandatory on Oct. 1 and extends the tougher EIA suitability standards to all annuity products, effective immediately but mandatory on Jan. 1,2008.

Sources: NAIC, NASD, NAFA, Iowa Insurance Division, SEC, IMSA

RELATED ARTICLE: IMSA's use of 'could' versus 'must'.

In conducting market-conduct examinations, state regulators have long debated whether to give weighting to IMSA certification. Several states do, but others question whether IMSA standards have enough "teeth."

IMSA members develop their own compliance plans. As long as independent assessors certified by IMSA approve them, the organization certifies membership.

The new standards covering suitability, disclosure and agent training specifically mention types of information or training that companies can use in qualifying for IMSA, but companies are not required to use them. Instead, companies "could" include them, according to the new IMSA document. That language, however, does not weaken the meaning of IMSA certification, said Donald J. Walters, senior vice president, general counsel and secretary.

"All of our standards include information about how a company can go about complying, but the manner in which you comply has some degree of flexibility," he said. "The standard itself is a 'must.'"

For example, a qualifying company must have policies and procedures that require producers--or the insurer where no producer is involved--to gather information about the customer when conducting a needs-based analysis for indexed annuities. The types of information must include financial status, tax status and financial objectives. But IMSA allows each company to decide how it will achieve those requirements.

Each company must have policies and procedures in place, and the company must demonstrate to its assessor that it has assigned someone to communicate with its staff internally and externally, to affirm that the policies and procedures are consistently used, to demonstrate that they are regularly monitored, and if defects are found, that corrective action is taken, said Walters.

IMSA Indexed Annuity Standards

The following provides examples of what information insurers could gather or require for purposes of meeting the new indexed annuity standards:

To ensure a product is suitable, a company could require this client information from a producer:

* annual income

* net worth, including percentage of net worth product represents

* risk tolerance 

* source of funds

* liquidity needs

* time horizon

* financial experience

To ensure suitability, a company could also use:

* sampling of applications

* sampling of acknowledgment forms

* interviews with producers

* review of producer files

* technological review systems

* new business review procedures

* customer survey results

Companies could require producers to provide customers information about:

* surrender charges (full surrenders or partial surrenders)

* how the cash surrender value is calculated

* how the market value adjustment, if any, is calculated

* how interest is calculated and credited including:

* index used to calculate interest

* indexing method

* index cap, if applicable

* index participation rate, if applicable

* indexing period

* bonus interest/premium bonus

* withdrawal provisions

* minimum guaranteed surrender values 

* annuitization payout options

* riders

* how the death benefit is calculated

Companies could choose to require training for producers about:

* product benefits

* product limitations

* product guarantees

* product costs

* product values

* product charges; and

* company policies and procedures.

Source: IMSA

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Genworth Financial

A.M. Best Company # 69555

Distribution: Independent financial advisers, brokerage general agents, securities brokerage firms, banks, other independent organizations

Allianz Life Insurance Company of North America 

A.M. Best Company # 06830

Distribution: Broker-dealers, independent agents, marketing organizations

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