The Basics

Regulation

Who regulates this product?

Fixed, Indexed, and Multi-Year Guaranteed Annuities are fixed insurance products, and therefore regulated by state insurance laws and the insurance commissioners that enforce them. Insurance agents who desire to sell Fixed and Indexed Annuities must obtain a life insurance license in the state where they are practicing. The insurance commissioner oversees the financial regulatory practices of the insurance industry as well as the solvency of the companies selling the products. Insurance companies, salespeople, and annuity purchasers go through their local state insurance department when they have questions or concerns about Fixed, Indexed, or Multi-Year Guaranteed Annuities.

Variable Annuities are securities products, and thereby regulated by the Securities and Exchange Commission (SEC). Salespeople wanting to sell Variable Annuities must obtain a life insurance license in the state where they are practicing, as well as pass a securities exam(s). The insurance commissioner ensures the solvency of companies selling Variable Annuities. However, insurance companies, salespeople, and annuity purchasers go through the SEC when they have questions or concerns about Variable Annuities.

In the securities industry (where products such as Variable Annuities are sold), salespeople that are licensed to sell the products are regulated by the Financial Industry Regulatory Authority (FINRA) as opposed to the state insurance commissioner. FINRA is a self-regulatory organization that oversees the financial regulatory practices of the securities industry. In a nutshell, if you hold securities license, you must abide by the rules of the FINRA as well as the SEC, while the insurance commissioner oversees the solvency of the insurance companies you do business with.

Note that in the past, there have been a handful of Fixed and Indexed Annuities that have been filed as securities products and registered with the SEC, despite the fact that they are fixed insurance products. An insurance company’s logic behind doing this may be for several reasons. One reason an insurance company may register a fixed product as a security is to accommodate a distribution that is used to selling securities products (and the prospectuses that come with them). As a comparison, historical sales of registered Indexed Annuities have been nominal in comparison to total Indexed Annuity sales. Today, there are only three registered Indexed Annuity products available for sale.

Both fixed and variable insurance products have tight regulation, and rules that the insurance companies and salespeople must abide by. The insurance company’s products, advertising materials, disclosures and training brochures are diligently reviewed in both the fixed and variable insurance markets. Salespeople are required to be properly licensed to sell both types of products. The market conduct of the marketing organization, broker/dealer, and salesperson are all carefully monitored, whether she/he is selling the Fixed, Indexed, or Variable variety of annuity.

The Battle Over the Securities Status of Indexed Annuities

Click here for a detailed timeline of the SEC’s efforts to regulate Indexed Annuities as securities products.

SEC QUESTIONS IF INDEXED ANNUITIES SHOULD BE SECURITIES- PART I

In 1997, just two years after Indexed Annuities were introduced, the SEC first explored whether the products should be treated as securities (and subject to SEC regulation), as opposed to being treated as insurance (and therefore regulated by the NAIC). The primary motivation for this inquiry was the SEC’s lack of information on the products; they earnestly didn’t know if Indexed Annuities were, or were not, securities. The SEC issued a concept release, requested promotional materials explaining the products, and ultimately took no action on the matter. At the time, the insurance industry assumed the lack of action to mean that the SEC had decided that Indexed Annuities were not securities. This was furthered by the insurance industry’s understanding of the products’ regulatory framework. The purchaser’s principal and gains were protected from any losses due to stock market volatility in an Indexed Annuity, unlike securities products. In addition, Indexed Annuities met the three criteria for the SEC’s Section 3(a)(8) exemption from securities regulation. This exemption was determined eight years before Indexed Annuities were ever introduced and indicated that a product was not subject to SEC regulation if: (1) the annuity contract was subject to supervision by the state insurance commissioner; (2) the insurer assumed the investment risk under the annuity (as opposed to the purchaser); and (3) the annuity was not marketed primarily as an investment. For these reason, it was believed that Indexed Annuities were fixed insurance products, not securities- particularly when the SEC took no action in 1997.

FINRA’S NOTICE TO MEMBERS 05-50

Several years later, in August of 2005, FINRA (then known as the National Association of Securities Dealers, or NASD) issued the “Notice to Members 05-50.” This notice suggested that broker/dealers (B/Ds) treat Indexed Annuities as if they were securities, despite their fixed insurance status. FINRA justified their notice based on their belief that Indexed Annuities might one day be treated as securities, despite the fact that they were treated as insurance at the time the notice was issued. For salespeople not selling securities products, NTM 05-50 did not affect their sales practices. Alternatively, annuity salespeople with securities licenses were forced to change their sales practices in regard to Indexed Annuities. All sales of Indexed Annuities were to go through their broker/dealer forthwith. This meant that a salesperson’s B/D needed to approve the fixed insurance product that he wanted to offer his client, despite the fact that FINRA had no regulatory authority over Indexed Annuities. Regardless, salespeople holding securities licenses must abide by the rules of FINRA. Therefore, B/Ds began the task of overseeing Indexed Annuity sales for their registered representatives in August of 2005, and still oversee them to this day.

SEC QUESTIONS IF INDEXED ANNUITIES SHOULD BE SECURITIES- PART II

In June of 2008, the SEC began a second inquiry on the matter of whether, or not, Indexed Annuities should be regulated as securities with proposed Rule 151A. The SEC’s proposition was the result of years of negative and inaccurate media being published on Indexed Annuities.

One of the primary reasons that Indexed Annuities have received negative media attention is because of their perceived complexity. In an effort to differentiate the many products that are available for sale today, insurance companies have invented new methods of calculating potential interest crediting. At times, these methods are overwhelming to both the salesperson and the annuity purchaser. However, 99.8% of the crediting methods available on Indexed Annuity products are based on very simple math (point-to-point, monthly and daily averaging, and fixed strategies). It’s the other 0.2% of the strategies out there that get folks confused once in a while.

Adding fuel to the media fire is that fact that some annuity salespeople have used Indexed Annuities in the course of bad behavior. These individuals’ suggestions of unsuitable annuity products resulted in some annuity purchasers being taken advantage of. Overall, this resulted in observers making the inaccurate assumption that all Indexed Annuities are “bad,” or used to take advantage of seniors.

**It is worth noting here that all financial services products have been used on the course of bad behavior on the part of the salesperson. It is also worth mentioning that the tool of the bad behavior is not the problem in such situations. (I liken this to a serial killer using a hammer to murder his victim and the government subsequently outlawing the use of hammers. That would make it difficult to complete tasks such as building homes and hanging pictures, but it would certainly eliminate people bludgeoning their victims with the tool.)**

Mistakenly, the insurance industry did not foresee media outlets’ disparaging and erroneous statements to be an immediate threat to Indexed Annuities; it was merely considered the newspapers and magazines’ attempts to cater to their advertisers. These advertisers sold securities products (such as mutual funds and stocks), therefore no one expected the media the sing the praises of products their advertisers competed against. This folly, coupled with a lack of publicly-available, credible information on Indexed Annuities, eventually resulted in the SEC declaring that the products should fall under their purview per Rule 151A.

After a two-year battle waged with regulators, litigators, and legislators, the insurance industry secured the fixed insurance status of Indexed Annuities indefinitely. In the end, it was an act of Congress that settled the matter. In July of 2010, President Barack Obama’s signed the Dodd-Frank Wall Street Reform and Consumer Protection Act, which contained Senator Tom Harkin’s (D-IA) Congressional amendment detailing and dictating Indexed Annuities’ permanent insurance regulation.

CLOSING THOUGHTS

Now you should understand what an annuity is, who can sell them, and who regulates them. You should also understand quite clearly, what an annuity is not. Fixed, Indexed, and Multi-Year Guaranteed Annuities are not alternatives to Variable Annuities, stocks, bonds, or mutual funds; these products are “risk money places.” Fixed, Indexed, and Multi-Year Guaranteed Annuities are more accurately classified as “safe money places,” and generally viewed as an alternative to CDs, or other fixed-rate savings instruments. Is an annuity right for you? Only YOU can decide.