“Suitability” In The Sale of Fixed Insurance Products:



“Suitability” In The Sale of Fixed Insurance Products: A Look At Some Of The Murkier Issuesby John L. Olsen, CLU, ChFC, AEPThe question of "suitability", as it relates to recommendations about insurance or investment products, has always been a difficult one. The term itself represents a value judgment, and attempts by regulators to define when a product recommendation is or is not "suitable" have rarely been successful. At the present time, there is no real precision in the rulemaking of most regulatory agencies; few rules offer any intentional definitions (that is, specifications of the necessary and sufficient conditions that must apply if a given transaction is to qualify as "suitable") or ostensive definitions (providing examples). Indeed, until recently, some state regulations dealing with suitability in annuity transactions were simply self-recursive (that is, they defined a suitable annuity transaction as one that is suitable). In recent years, however, regulators at both the Federal and state levels have attempted to clarify what annuity transactions (meaning, generally, sales recommendations) would be acceptable.In this article, we will focus on "suitability" as it relates to sales recommendations of fixed insurance and annuity products – those not registered as securities - that may be sold by agents licensed to sell insurance and fixed annuities, but not variable products or securities (hereafter referred to as “insurance only agents”). A note on “Standards of Care”At the present time, there exist two standards of care governing recommendations of financial products:The “suitability” standard generally applies to insurance agents and registered representatives and to recommendations by these individuals of either fixed insurance or annuity products or securities (including variable insurance or annuity policies).The “fiduciary” standard generally applies to "investment advisors" and to individuals who may not be registered as such on either the Federal or State level, but who may be deemed to be acting as such. This is a "higher" (more stringent) standard and requires, not only that recommendations be "suitable", but that the advisor, in making such recommendations, must hold the client's interest above his or her own. It imposes a fiduciary duty upon such advisors.One of the murkiest aspects of litigation involving the sale of a fixed insurance or annuity product is the standard of care that ought to apply. All such sales must be suitable, but might a given sales recommendation also be subject to the fiduciary standard? The answer is often unclear. Insurance and annuity complaints typically (in the author's experience) allege breach of fiduciary duty on the part of the selling agent but insurance agents are not, under most state laws, generally subject to that duty. A complaint alleging breach of fiduciary duty must establish that this duty is properly applicable.Is the product in question a “security”?A separate, but related, issue that sometimes arises is whether the product in question is a security. Ordinarily, this is fairly easy to determine. If that product is registered as a security in the state in which the sale was made, it is one. In that situation, the sale will be subject to both state securities regulations and the rules imposed by the SEC and FINRA. However, some state regulators have taken the position that even a non-registered insurance or annuity product may be subject to that state's securities laws in certain situations.Are Index Annuities “Securities”?The question of whether index annuities are "securities" has been addressed at both the federal and state levels. Regrettably, the conclusions have been so inconsistent that a practical answer might be only "It depends upon whom you ask”.Federal law:SEC Rule 151A, announced in 2009, had deemed index annuities to be "securities", subject to its jurisdiction. After a Federal court vacated the rule in American Equity Investment Life Insurance company, et al. v. Securities and Exchange Commission (No. 09-1021 – D.C. Circuit), the Commission withdrew the rule in October, 2010.Section 989J of the Dodd-Frank Financial Reform and Consumer Protection Act addresses the issue of whether index annuities are "securities" indirectly, by declaring that the SEC shall treat as "exempt securities" (exempt from registration as securities) any insurance or annuity contract "the value of which does not vary according to the performance of a separate account", so long as it satisfies the suitability laws of the state in which it is issued and, as of June 16, 2013, the suitability requirements of the NAIC Suitability in Annuity Transactions Model Regulation (#275) of 2010, which Sect. 989J effectively required states to adopt.State law:The Cooper case (Illinois)In 2011, in a case involving, among other issues, the sale of indexed annuities by an Illinois agent, the Illinois Dept. of Securities issued an order that appeared to characterize index annuities as “securities”. In that case, the Department declared that "each of the above referenced investment plans is an investment contract and therefore is a security as that term is defined pursuant to Sect. 2.1 of the Act”. To what did “the above referenced investment plans” refer? To many observers, it appeared to refer to index annuities sold by the agent.The Illinois Dept. of Securities retreats from its position in the Cooper caseThis position, that index annuities are "securities" for purposes of Illinois law, drew a great deal of critical response. One issuer of index annuities (Fidelity & Guarantee Life Insurance Company) requested a statement from the Illinois Department of Securities that it would take no enforcement action with respect to sales of index annuities in the state of Illinois by agents of that company. David Finnigan, Senior Enforcement Attorney for the Department, replied in a letter dated January 10, 2013, that the Enforcement Division would not recommend enforcement action against that company’s agents in that situation. The letter stated that it “should be treated only as a statement of the staff's enforcement position" and that it was not binding upon the Secretary of State of the State of Illinois.The Kelly case (Missouri)In July, 2011, the Missouri Dept. of Securities issued a Consent Order declaring that an insurance agent had acted as an unregistered investment advisor in selling index annuities to a Missouri consumer. While the Order did not state specifically that index annuities are "securities" under Missouri law, the Department, in its investigation, requested from the agent “any exemption from registration or exception from the definition of investment advisor upon which the firm relied in offering investment advice in connection with the sale of equity index annuity products in the state".Even if an index annuity is not a "security" under state law, might its sale be subject to state securities laws anyway?Most state securities regulators have not taken the position that index annuities are "securities". But this does not mean that they will never assert jurisdiction over the sale of an index annuity.When the agent selling a fixed product offers “investment advice” as part of the sales presentation If an agent, in selling an index annuity or any other fixed insurance or investment product, is considered to have given investment advice, state securities regulators will typically assert jurisdiction over that sale. In that situation, the agent will generally be required to be a registered representative (often, and erroneously, referred to as “holding a securities license”), if not a registered investment advisor (or “advisory representative”).The Miller case (Illinois)In February, 2011, the Illinois Department of Securities charged an insurance agent with acting as an unregistered investment advisor. It declared that the agent "engaged in providing investment advice by recommending the sale of specific securities in order to purchase what was purported to be a safe product".The Utley case (Illinois)In July of that year, that same Department issued an Order of Prohibition, fining another agent and permanently prohibiting him from offering or selling securities in the state of Illinois. The Department held that “by recommending and advising [the consumer] to sell her variable annuities in order to purchase the aforesaid fixed indexed annuities, the Respondent was acting as an investment advisor as that term is defined pursuant to section 2.11 of the Act."Arkansas declares that recommendations to replace securities constitute “investment advice” (Bulletin 14-2009)In 2009, the Arkansas Department of Insurance issued Bulletin 14-2009, in which it stated that “the recommendation to replace securities such as mutual funds, stocks, bonds and other investment vehicles defined as securities under the Arkansas Securities Act is the offering of investment advice. It is unlawful to offer investment advice unless one is registered (licensed) with the Arkansas Securities Department as an investment advisor or investment advisor representative".Does this mean that only “investment advisors” may recommend the replacement of a security?The Arkansas Bulletin 14-2009 and the Miller and Utley cases might lead one to conclude that only an investment advisor (or investment advisor representative) may ever make a recommendation to replace a security. But such a conclusion poses some interesting and difficult questions: Does a recommendation by a registered representative who is not an RIA (or RIAA) to buy a particular security, where that representative is aware that the funds to purchase that security will come from the liquidation of another security, violate this rule? Is such a recommendation not "solely incidental" to that representative's normal business activities, falling within the “Broker/Dealer Exclusion” of SEC Rule 202(a)(11)(c)?Would a recommendation of an indexed annuity, which is not a “security”, in that situation, be acceptable because the recommending agent is both licensed to sell both fixed annuities and securities?Stipulating, for the sake of discussion, that the recommendation to a client by an “insurance only”agent that the client sell a security in order to purchase a fixed annuity or insurance product constitutes the unauthorized giving of "investment advice", does the mere knowledge, on the part of that agent, that the annuity will be purchased with dollars coming from a securities account amount to the same thing ("recommending the sale of a security")?This last question involves what is often called the “Source of Funds” issue. May an “insurance only” agent ever recommend a fixed annuity or insurance product if he or she knows that it will be purchased with dollars from a liquidated security? The answer to this question is not at all clear. To the author's knowledge, no state insurance regulators have taken the position that an agent’s mere knowledge of the source of funds requires either registered representative or RIA status. The cases cited above all dealt with clear recommendations. But does an agent's knowledge, when recommending that the client purchase a fixed product, that it will be purchased with "securities money", constitute not only a recommendation to purchase (the fixed product) but a recommendation to sell (the security)? Some may say that it can scarcely be otherwise. A sales recommendation inevitably entails a recommendation to reposition the purchaser's money. The purchase price must come from somewhere. Where the source of funds is known to be a securities account, an agent making a purchase recommendation must, by this argument, also be recommending liquidation of (or from) that securities accountIf we believe that this is true, and that such an agent must be authorized to recommend “the sale of securities” (which, in some states, requires investment advisor status), we must conclude that an "insurance only" agent, licensed to sell a fixed insurance or annuity product, may do so only if he or she is certain that it will not be purchased with dollars coming from a securities account. The implications of this conclusion, both for agents and for consumers, are troublesome indeed. Many Americans own securities-in their retirement plans or in "non-qualified" accounts. Shall they be permitted to purchase life insurance or fixed annuities from insurance agents experienced and expert in these products only if they do so with "non-securities dollars"? Must consumers wishing to use "securities dollars" to purchase such products be forced to do so only from investment advisors (many of whom do not even hold insurance licenses and cannot sell insurance or annuity products)? The present regulatory environment in many states is one of dangerous uncertainty. "Insurance only" agents wishing to abide by the rules cannot do so with confidence because the rules are often unclear. In the absence of clear regulations, stating what an agent who is not also an investment advisor may and may not do, agents are forced either to forgo certain activities (for example, to stop serving clients with investment accounts), to continue in those activities, hoping that they will not violate regulations that may not even be written down, or to become a registered investment advisors, even if they do not wish to work as investment advisors.The first and second alternatives are, in this author's opinion, in no one's best interest. The third alternative is being recommended by some commentators as the most practical course of action for an insurance agent who wishes to avoid lawsuits. In this author's opinion, this makes sense only if that agent truly wishes to work as an investment advisor and has the skills, expertise, and resources to do so properly. An agent who "becomes an RIA" solely for defensive purposes, whose sales are almost always fixed insurance and/or annuity products and who intends to continue marketing in that way, is probably making a serious mistake.The Mitchell case (Missouri)In December, 2010, the Missouri Department of Securities issued a "cease and desist" order to Tracy Wayne Mitchell, an investment advisor representative (IAR) who sold indexed annuity products. The Department found that Mitchell engaged in prohibited conduct "by using his IAR registration to lend credibility to his annuity recommendations and sales". Mitchell and his firm" used Mitchell's IAR as a marketing tool to attract new insurance clients, and Mitchell continued to concentrate on EIA sales as his primary source of income". The Department’s investigators were unable to find any evidence that Mitchell recommended any products or investment options "such as fixed or variable annuities, CDs, or mutual funds to his clients; instead, Mitchell only recommends EIAs to his clients".In every state, investment advisor status brings with it fiduciary duty. An advisor who recommends to his clients only one type of product, who is authorized to recommend other types of investments but consistently fails to do so to any clients, may be found to be in breach of that fiduciary duty. In several of the cases cited in this article, regulators found that to be the case.A proper solution to this murky "source of funds" problem lies, in the author's opinion, not in agents’ abandoning clients or continuing to sell products without any assurance that they’re not violating some unclear or unpublished rules by doing so. Nor does it lie in agents’ acquiring the status and liabilities of investment advisers when they have no desire (and, perhaps, no qualifications) to do so. The solution lies with state regulators. They have only to make clear to "insurance only" agents, agents with securities registrations, and investment advisors what they may and may not do, and provide clear guidelines.The solution to the problem of “Source of Funds” rulemaking – Iowa’s Bulletin 11-4The regulators of one state have already done so, and very well. In 2011, The Iowa Department of Insurance issued Bulletin 11-4. Its Introduction provides a clear description of the “source of funds’ issue. Since Iowa’s adoption of the NAIC Suitability in Annuity Transactions Model Regulation of 2010, it says, “questions have arisen as to where the line is drawn between providing insurance advice and securities advice. The answers to these questions have become increasingly important because suitability laws at the state and federal level have evolved to the point where any recommendation to a consumer of either an insurance product or a securities product requires an extensive financial analysis of the consumer's financial affairs and a discussion of broad financial trends. I'll information received from the consumer is applied will be different depending on whether it is an insurance transaction or a securities transaction because of the differing requirements of insurance and securities laws" [emphasis added].The Bulletin was issued to provide guidance to insurance producers, investment advisor representatives and securities agents about “the permissible and prohibited activities of ‘Insurance-Only Persons’ and “the permissible and prohibited activities of ‘Securities-Only Persons’“. Among the permissible activities of Insurance-Only Persons” are the following:"The Insurance-Only Person may discuss with the consumer the consumer's risk tolerance, financial situation, and needs. This may include a discussion of the consumer's:financial experiencefinancial objectives, including whether the consumer needs to earn a guaranteed rate of interest, needs a guaranteed minimum increases in guaranteed values, or wishes to have available a minimum lifetime income stream;risk tolerance, including need for principal protection or protection from market risk;need to balance and diversify risk, including need for product or issuer diversification that may support an insurance position within a consumer's financial plan;tax status, including whether the assets used to purchase the annuity or life insurance are or need to be tax-deferred;existing assets, including an annuity, investment, and life insurance holdings;financial resources generally available for the funding of the annuity or life insurance;liquidity needs and liquid net worth, including whether there are funds other than those being used to purchase the annuity or life insurance, that will be available during the surrender period of the annuity or life insurance for emergency or urgent needs, and where those funds are located;financial time horizon; andintended use of the annuity or life policy.An Insurance-Only Person may discuss with the consumer the stock market in general terms including market risks and recent or historic economic activities that are generally known to the public and regularly discussed in public media….In his or her general discussion with the consumer, the Insurance-Only Person may discuss and complete suitability, replacement, and exchange or transfer forms as required by Iowa insurance regulations…An Insurance-Only Person may have general discussions about balancing risk, diversification, etc., that support an insurance position within a consumer's financial plan.”In this author's opinion, the guidance provided in this Bulletin is precisely what agents in every state need and deserve. Having such guidance, insurance-only agents may continue to serve consumers, including those consumers with assets in securities accounts, knowing what they may and may not do, and consumers will benefit from having access to these professionals. The author strongly suggests that insurance agents in every state, insurance companies, and consumer advocates urge insurance and securities regulators in every state to adopt standards and publishing guidance about those standards as their Iowa counterparts have done.John L. Olsen, CLU, ChFC, AEPOlsen Financial Group131 Hollywood LaneKirkwood, MO 63122-2901314-909-8818Jolsen02@ ................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download