NASD & Equity Indexed Annuities

[JMO Fan]

NASD treats all EIAs as securities.

NASD Issues Guidance Regarding Equity Indexed Annuity Sales; Concerns About Marketing, Supervision and Investor Protection Cited

WASHINGTON, Aug. 8 -- Expressing concerns about marketing, supervision, disclosure and investor protection issues, NASD today issued formal guidance to registered firms selling equity indexed annuities (EIAs).

EIAs are complex financial instruments in which the issuer, usually an insurance company, guarantees a stated interest rate and some protection from loss of principal, and provides an opportunity to earn additional interest based on the performance of a securities market index. Some EIAs are registered with the Securities and Exchange Commission (SEC) as securities. Many are not, based on a determination that they are insurance products that qualify for exemption under the Securities Act of 1933. The question of whether a particular EIA is an insurance product or a security is complicated, depends upon the particular facts and circumstances concerning the instrument offered or sold, and is determined on a case-by-case basis.

Notice to Members 05-50 does not take a position on whether a particular EIA is a security. Nevertheless, this uncertainty over whether a particular unregistered EIA may be a security complicates a broker-dealer's supervisory responsibilities. If an EIA is an insurance product, then a firm would have to treat sales of the EIA by its brokers as an outside business activity. If the EIA is a security, the firm would have to supervise the sale as a private security transaction. Because of this uncertainty, some firms require their brokers to obtain specific approval to sell unregistered EIAs. Still other firms maintain a list of approved EIAs and prohibit the sale of all others.

NASD's Notice says that firms should:

* Consider maintaining a list of acceptable unregistered EIAs and prohibiting their brokers from selling any other unregistered EIA without the firm's written confirmation that the sale is acceptable.

* Consider whether additional supervisory procedures would help protect the firm's customers. For example, a firm could require that all sales of unregistered EIAs are processed through the firm, meaning the firm must supervise the marketing material, suitability analysis and other sales practices in the same way it supervises the sale of securities through the firm.

* Provide brokers selling any unregistered EIA through the firm with the proper training to ensure they understand the EIA's features and the extent to which the EIA meets the needs of a particular customer.

The Notice also reminds firms that under any circumstances, NASD suitability rules apply to any recommendation that a customer liquidate or surrender a registered security for the purpose of purchasing an unregistered EIA.
Copyright © 2005 LexisNexis, a division of Reed Elsevier Inc. All rights reserved. Copyright 2005 PR Newswire

http://www.insurancenewsnet.com/arti...lnid=301306687

[JMO Fan]

Among comments to the SEC on this issue -- from an actuary

1. Considerations or premiums received on contracts which provide variable benefits or values are usually added to a separate account. Equity index products provide variable benefits or values (i.e., the benefits or values are not determined in advance, as the interest rate is determined in arrears), but no separate account is generally established for these forms. NAIC model and some states' definitions of "variable" contracts seem to depend upon the establishment of a separate account; failure to establish separate accounts seems designed to avoid the "variable" classification, which in turn affects their regulation under state filing, licensing, reserving, nonforfeiture, and disclosure laws.

2. To protect asset adequacy under diverse cash-flow scenarios, insurance contracts with indexed values may need specific matching assets. If assets are purchased to satisfy liabilities for a contract with variable values, it seems most prudent to hold them in a separate account. However, if such assets fit within the legal limits of the general account, some state insurance laws might not require a separate account. This could create inequities among insurers by size; those with more assets could have greater leeway with regard to investing in the types of instruments needed to hedge equity index product risk.

3. These contracts do not appear to qualify under SEC Rule 151 for exemption from Section 3(a)(8) of the 1933 Securities Act. The SEC discussion in its Rule 151 adopting release said, "an insurer which uses an index feature externalizes its discretionary excess interest rate, and thus shifts to the contract owner all of the investment risk regarding fluctuations in the rate. ... The insurer, therefore, would be permitted to specify an index to which it will refer, no more often than annually, to determine the excess rate that it will guarantee under the contract for the next 12-month or longer period." If the insurer fails to disclose the likelihood that this contract is a security, it may deceptively affect the risk purported to be assumed. Virtually all equity index products refer to the index to determine the excess interest rate to be credited for the previous period (often 12 months), not to fix the excess interest rate for the next 12 months.

It seems essential to consistent, adequate, and reasonable regulation for the SEC to take a firm stand regarding the securities status of equity index insurance products. Primary responsibility for determining whether an insurance product is a security rests with the insurer. However, many insurers (including those which have obtained opinions from outside counsel) seem unaware of the statements made by the SEC in its Proposing Release as well as the Adopting Release of Rule 151. The following opinion was provided by outside counsel for an insurer in connection with an equity index annuity form recently submitted to a state insurance department for approval: "[T]he current position of the SEC is that index annuities are not required to be registered. Only recently has the SEC begun to ask for comment from the insurance industry on whether index annuities should be registered." This opinion seems typical.

4. Referring to the index to determine the rate credited on existing funds shifts the investment risk away from the insurer, placing it squarely upon the policyowner. Retention of investment risk by the insured appeared to be the linchpin in the federal court decision in Otto v. VALIC (as well as Rule 151), which declared insurance to be a security when the excess interest rate was not guaranteed prospectively for at least 12 months. Virtually no equity index products guarantee the excess interest rate prospectively.

5. To avoid being misleading, deceptive, or false, policy forms and associated marketing, disclosure, and illustration material must adequately disclose important product features. When indexed values are included in an insurance product, marketers are likely to emphasize them in touting product advantages. State insurance departments are not in a position to determine whether such material will satisfy the marketing test of SEC Rule 151. But because the index is an integral part of those products, emphasis on it could violate the marketing test. Furthermore, state disclosure and illustration requirements for nonvariable products may be inadequate to regulate appropriate illustration of equity index features.

6. If product values or benefits are based on an index, it could be misleading to represent the product as nonvariable. Furthermore, issuing an indexed contract as nonvariable may deceptively affect the risk purported to be assumed by the insurer, in that the insured assumes a portion of the investment risk. However, these possible violations of state insurance laws are not generally recognized, in part due to the confusion over whether the SEC views such contracts as transferring investment risk to consumers.

7. The typical equity index contract obligates the insurer to credit excess interest at a nonguaranteed rate from the general account, with the crediting rate being determined at the end of each period. The interest crediting method thus employed pays a share of company surplus, i.e., a dividend. Therefore, if no separate account is established, the contract is a participating contract, and any dividend (excess interest) thus paid must comply with applicable statutes, rules and actuarial standards of practice.
It may be difficult for insurers issuing such contracts to comply with participating contract requirements. Most such forms are titled and described as nonparticipating. However, this misrepresents their true nature, makes their provisions misleading, and deceptively affects the risk purported to be assumed in the general coverage of a nonparticipating contract.

http://www.sec.gov/rules/concept/s72297/hippen1.txt

[Take 2]

First I've heard the SEC is interested. http://www.insurancenewsnet.com/arti...lnid=302015301

Equity-Indexed Annuities Scrutinized USA TODAY

The Securities and Exchange Commission may be considering whether EIAs should be treated as securities.... NASD is concerned that marketing is too aggressive and may cause buyers to think EIAs are investments.

"Some of the pitches are appalling," says NASD Vice Chairman Mary Schapiro. The NASD cites marketing claims such as: "Growth potential without market risk!" and "A win/win investment vehicle!"

One reason for the hot pitches: Commissions on EIAs are hefty. ... "I've seen commissions of up to 16%," says ...a vice president at Nationwide Financial, which offers a 5% commission on its EIA.

The NASD told its broker-dealer members Monday that they should treat EIAs similarly to securities, including supervising sales of them. NASD cannot say these products are securities, however.

In July, the SEC sent a letter to some of the largest issuers, asking for sales materials, disclosures and their "legal analysis as to why (securities) registration is not required." The commission has the power to declare that EIAs are securities. ...This is the first time it has formally looked at EIAs since 1997.... If they were considered securities, as are stocks, mutual funds and variable annuities, they also would be supervised by the NASD and SEC.

If the SEC decides these products are securities, then issuers will have to register them....

Carl Wilkerson, a vice president at the American Council of Life Insurers, says the SEC's letter isn't creating alarm in the industry because compliance with the request for information is voluntary. Broker-dealers that sell EIAs probably will follow NASD guidance, he says, although they don't necessarily agree with it.

[kazh]

Equity-indexed annuities don't make sense Take an easy-to-understand, sensible, low-cost investment.
Now add a lumpy layer of costs and complex rules, and what have you got?
A new product called an equity-indexed annuity, an unattractive offering from the insurance industry. The equity index annuity apparently is an attempt to capitalize on the popularity of index mutual funds. ...But an equity index annuity is another animal ....

These annuities remind me of a dish I made .... The recipe started with a simple piece of fish, then added cheese, spinach, breadcrumbs, nutmeg, .... Bake at 350 degrees, and what do you have? An inedible mess.

Both the [SEC] and the [NASD] ... have warned investors about equity-index annuities. NASD called them "anything but easy to understand."... Most equity-indexed annuities offer investors only a portion of the return .... ... And, ... they charge "surrender fees" if you want to take your money out ....

So why would you buy one of these things instead of just sending your money to an index mutual fund ...? The companies ... give guarantees that you'll make at least a minimum return. But the guarantees are pretty thin soup. Typically, they offer minimum 3 percent annual returns on 90 percent of the money you put in - and some offer less. ...
If you want the growth potential of the stock market, along with the security of a fixed-rate investment, ... put part into an index fund .... Put the rest into a bank certificate of deposit or U.S. saving bonds, which offer sure-thing returns.

And if someone wants to sell you an equity-indexed annuity, give them the response you'd give to my cheese-fish-spinach dinner: "No thanks."
KATHLEEN LYNN, North Jersey Media Group

http://www.northjersey.com/page.php?...Y3dnFlZUVFeXk5
so, why does it sell? no securities license, so hype is unrestrained.

[JMO Fan]

The insurance industry should stand up to efforts by the National Association of Securities Dealers to regulate equity-indexed annuities. Joan Boros, a partner at Jorden Burt L.L.P., Washington, delivered that message here at the annual meeting of the National Association of Variable Annuities ....

The NASD, Washington, released a notice in August that discusses supervision of EIA sales, and the U.S. Securities and Exchange Commission has sent out a letter of inquiry to a variety of EIA issuers.

Boros ... declared that EIA issuers need ... to bring regulators up to speed on the EIA market. ... The NASD’s current EIA regulatory effort far exceeds the NASD’s jurisdiction ..., Boros said.

Non-registered EIAs are not regulated by the SEC and NASD, and that means that non-registered EIAs are not subject to the same customer suitability, disclosure, and sales practice requirements imposed on registered securities, Boros said. ...
If the NASD starts looking ... as vigorously as it has looked at variable annuities, then this segment of the industry is “in deep trouble,” Boros warned. Boros added that NASD scrutiny of EIAs is causing the SEC to take a closer look at the products.

The SEC could come up with new rules, expand existing rules to cover EIA products, decide to take no action, or bring a “poster child” enforcement action against one EIA issuer based on specific provisions of a specific EIA contract ..., Boros said.

http://cms.nationalunderwriter.com/c...-nava-boros-jc

What Boros DIDN'T say is critical: the SEC has never said that non-registered EIAs are not securities; they could regulate them any time they choose. The SEC's discussion on release of Rule 151 leaves no doubt that indexed insurance products are outside the safe harbor. The SEC's open letter was never closed, which leaves the SEC in perfect position to pounce if provoked.

[Take 2]

Robert Glauber, chairman of the NASD, Washington, complained ..."equity-indexed annuities ... are subject to utterly ambiguous regulation because it isn't entirely clear to anyone whether they're insurance products or securities. Yet all these products look pretty much the same to investors," he continued. "EIAs are particularly complex. They are often marketed as risk-free, which they most certainly are not. And they are marketed disproportionately to elderly people, often without suitability analyses having been made. And sales commissions are as high as 10%."

The NASD has proposed a set of rules to stop "this sort of irresponsible behavior in sales of variable annuities," Glauber said. The proposal includes requirements for a tailored suitability analysis and approval of any annuity sale by a principal of the selling broker's firm, Glauber said. ..."I think what we need to do here is invite the state insurance regulators to work with us on harmonizing and clarifying the rules for fixed and equity-indexed annuities sales. We've had some preliminary discussions with some of them toward that end, but we have a long way to go."

http://www.insurancenewsnet.com/arti...lnid=330422804
New state rules to come? It doesn't appear the subject is closed.

[JMO Fan]

The Cry Over Indexed Annuities: FACT OR FICTION NAFA Sets the Record Straight Declared rate and indexed annuities are under attack on multiple fronts including: inaccurate, one-sided stories in the consumer and business media, class action lawsuits and last but not least, the National Association of Securities Dealers (NASD). While these outlets are entitled to their own opinion, NAFA, the National Association for Fixed Annuities, would like to set the record straight on fact versus fiction and ask your assistance in making the facts better known.

Fact #1 - Annuities are NOT SECURITIES

The NASD concedes that it is not their role to determine the securities status of an insurance contract or other financial instrument. Still, ... they publicly stated their strong recommendation that indexed annuities be treated as securities by member firms. ... NAFA maintains that indexed annuities are NOT per se securities and that the various positions of the NASD and others fail to consider the core features of Indexed Products that make them eligible for exclusion from registration as a security. ... Furthermore, NAFA contends that the NTM creates an anti-competitive climate because, in the absence of guidance from the SEC, NASD members may fear disciplinary action for all past and future sales ... NAFA's position is clear and substantiated. These are insurance products not per se securities...

http://www.insurancenewsnet.com/arti...op_lh&id=54541 A key phrase is "the absence of guidance from the SEC", which is the only body empowered to legally determine whether a specific contract is a security. The SEC discussion of indexed contracts in the release of Rule 151 put ALL indexed contracts outside the safe harbor. So it seems unwise for NAFA to state their exemption as fact; the NASD advice seems much wiser.

It still appears that the principal reason for failure to register an indexed annuity is to permit unregistered agents to sell them. Else why are only 2% of sales going through broker-dealers? It's not because broker-dealers can't sell them, or because equity index commissions are low; it's because equity index products can't compete with the advantages of variable annuities.

[JMO Fan]

NSAA weighs in.

Equity-Indexed Annuities Sales Take a Hit as Proposed Regulations Seek to Protect Naive Investors February 5, 2007

As we know, EIAs offer both guaranteed principle and a guaranteed minimum interest rate and are tax-deferred. But what makes them different from other fixed annuities is that EIAs’ crediting rates are based on S&P 500 Index (or other stock market indexes selected by the company) performance.

Introduced in 1995, EIAs sales reached $25 billion in 2005. But sales of Equity-Indexed Annuities (EIAs) were down by 5% in the first nine months of 2006 compared to the same period in 2005. According to LIMRA, sales of EIA were down 18% from the second quarter of 2005.

Many industry experts believe NASD Notice 05-50 regarding its position on EIAs released in 2005 triggered the decline. The notice reads:

The sale of an EIA registered under the federal securities laws is subject to the full panoply of regulation applicable to the sale of any security. The principles articulated in this Notice apply to EIAs that are sold by associated persons of a broker-dealer, whether the EIA has been manufactured by an insurance company that is affiliated with the broker-dealer or by an unaffiliated insurance company.

NASD Notice 05-50, created a tricky situation for independent insurance producers with securities license on how or even whether they should push equity-indexed annuities. This caused EIA sales to tumble.

Following the NASD’s lead, the North American Securities Administrators Association (NSAA) said high commissions agents make on EIAs fueled the tremendous sales of EIAs in 2005. But the agency is worried unsuitable investors may be conned into buying EIAs using misleading marketing tactics. NSAA is focusing on protecting senior citizens who are being aggressively targeted via nationwide investment seminars.

Consumer Reports raised its own warning against these investment seminars. The group portrayed problems related to the recently well-publicized senior seminars being held by some today. Held at a hotel or restaurant offering free meals, a “senior specialist” claiming expertise in investments for people above 55 years old leads the seminar. The senior specialist reviews portfolios and usually suggests that participants liquidate their stocks and invest them instead in variable or equity-indexed annuities.

However, EIAs have long holding periods and carry enormous penalties for early-withdrawal. Regulators claim equity-indexed annuity sold by licensed agents or brokers remain unsuitable for many elderly buyers.

In January 2007, Massachusetts brokerage Investors' Capital Corp. was ordered to pay a $500,000 fine to Secretary of State William F. Galvin for selling equity-indexed annuities to investors over age 75 in 2004 and 2005. The company was charged with selling annuities to people who could not enjoy its full benefits because they were too old. As reported, Dorothy Eddy, 73, also found the hard way that EIA was too good to be true.

In 2003, after attending an AmerUs Annuity Group financial planning seminar bundled with a free lunch at a Florida restaurant, Eddy decided to invest almost $156,000 of her retirement nest egg stash. The pitch was she would earn 7% with no practically downside. Eventually, Eddy realized she couldn’t touch her funds for the next 14 years - until she is almost 85 years old - unless she pays hefty surrender charges starting at 18%. Their high administrative fees also bring down the fund’s performance.

Eddy, along with other Florida senior citizens in the same predicament sued AmerUs Annuity Group. The complaint alleges AmerUs Life Insurance Co. manipulated Florida senior citizens into buying EIAs with the maturity dates well beyond the seniors' life expectancies. Gordon Hargrove & James, which is representing Eddy and others in the lawsuit said the many companies are pushing investment products tie up retirees' nest eggs for 10, 15 and 20 years making them useless for most seniors.

NSAA also claims EIAs are not considered securities and are not regulated as strictly as variable annuities and mutual funds. NSAA President Joseph Borg says the agency’s 2007 agenda will include defining equity indexed securities as securities and increasing penalty to deter committing crimes against seniors.

So who should invest in EIAs? As EIAs are categorized as fixed annuities, conservative investors are more likely attracted to them. At the right age, the right financial status and time of their life, investors benefit from tax deferral, the opportunity of better performance and no principal risk.

© Entire contents copyright 2006 by InsuranceNewsNet.com, Inc. All rights reserved.

http://insurancenewsnet.com/article....op_lh&id=75347 NSAA, as well as NASD, wants all equity index annuities treated as securities.

[Take 2]

This would be a deterrent to some sales:

Equity-indexed annuities are only one example of a financial product that a firm might erroneously treat as a non-security. ... NASD considers all of these products to be securities, subject to firm supervision.

http://www.nasd.com/PressRoom/Speech...o/NASDW_014261

[kazh]

Anybody else heard this?

The SEC is getting in on the act and is expected to decide in the first half of 2007 whether equity-indexed annuities should be considered securities. ... Under the Securities Act Rule 151 safe harbor, annuity contracts are exempt from securities regulations if the product is issued by an insurer that is subject to state insurance regulation, the insurer assumes the investment risk and the product is not marketed as an investment.

But in August 2006, the SEC sent letters to a number of insurers requesting equity-indexed annuities sales material and contract information. Industry experts say that based on the contracted payout rates, the SEC is concerned that the equity-indexed annuity buyer may be assuming investment risk instead of the insurer, making them subject to securities regulations.

http://registeredrep.com/mag/finance_fish_fowl/
Whom did they ask?