Late last week, Senator Elizabeth Warren, Ranking Member of the U.S. Senate Subcommittee on Economic Policy, sent a letter to 15 of the top writers of annuity products
, including AIG Companies, Allianz Life Insurance Company of North America, AXA, Lincoln Financial Group, New York Life Insurance Company, and MetLife, seeking information about the manner in which these companies compensate their insurance agents for the sale of these products. Warren emphasized that sales made to those close to retirement were of paramount interest and expressed concern over agents that were “more interested in earning perks than in acting in their client’s best interest.” The use of this “best interest” language is particularly important given the recent publication of a Department of Labor (DOL) proposed rule, which would impose a new definition of “fiduciary” for purposes of the rendering of investment advice, but would permit that fiduciary to receive certain otherwise prohibited forms of compensation where such fiduciary agrees to act in the “best interest” of their client.
The letter describes various types of incentive compensation received by insurance agents based upon annuity sales volume, including cruises, other types of vacations, iPads, and more, and states that sales based upon receipt of these rewards present conflict of interest issues between the agent and the consumer. Moreover, the letter points out that this type of non–cash-based compensation has been prohibited for the sale of securities since 2003, but that the forms of compensation paid for the sale of annuities has not been so restricted. Note, however, that New York Insurance Law Section 4228 does limit the amount of prizes and rewards that can be received based upon the sale of individual life insurance and annuity products by New York- licensed insurance companies. Specifically, this statute provides that no single prize can exceed $250 and the total value of all such prizes in a calendar year may not exceed $1,000.
The implications of the Warren inquiry are potentially extensive and highlight the regulatory friction that already exists between federal and state regulation of insurance and, specifically, the sale of variable and fixed annuity products. Variable annuities are securities under federal securities laws, but they are also insurance products under state insurance laws. Broker-dealers that sell these types of annuities must be registered representatives under federal securities laws and licensed insurance agents under state insurance laws. As such, they are subject to federal and state regulation governing the sale and marketing of these products and rules governing compensation. Fixed annuities are not considered securities and are governed only by state insurance laws. The sale of these products requires only an insurance license, but many state regulators have imposed new suitability regulations and rules specifically addressing the sale of annuities to seniors. Also implicated are frequently overlooked state insurance laws in many states prohibiting or restricting rebates in the sale of insurance products of all kinds, including annuities and the classification in many state insurance laws of rebates and sales inducements of insurance products including annuities as “unfair trade practices.” (See, for example, OCGA 33-64 (b) (8) (B) (Georgia); 215 ILCS 5/151 (Illinois); RS 22:1964 (7) and (8) (Louisiana); and NYIL 4224 (c) (New York). While some states, such as California and Florida, have in recent years diluted their prohibitions on rebating, the issues raised by Senator Warren also have the potential to ignite a thorough re-examination by the National Association of Insurance Commissioners of the loosening of state anti-rebating standards, with the possible result that more states may reclassify inducements in the sale of annuities as an “unfair insurance trade practice.” As a result, overlapping federal and state regulations and confusion over what regulatory regime applies may be a continuing, and possibly more prominent, issue for distributors in the near future.
Interestingly, since the information that Warren is seeking involves the type of compensation that is not permitted in the sale of securities, her inquiry will mostly target the sale of fixed annuity products, which are governed by state, not federal, regulation. Federal oversight in the sale of fixed annuities was the subject of much controversy in 2008 through 2010 when the Securities and Exchange Commission (SEC) tried unsuccessfully to classify equity-indexed annuities as securities. The Warren letter may very well resurrect this initiative and will no doubt raise new challenges.
Additionally, the Warren letter appears to dovetail with the DOL proposed rule, which would amend the definition of “fiduciary” for persons who render what is considered “investment advice.” The proposed definition would include, for example, advice given to 401(k) plan participants who roll their contributions into individual retirement accounts. This includes the population of “individuals on the verge of retirement,” with which Warren is primarily concerned. Once a distributor is classified as an investment advice fiduciary, unless subject to an exception, that distributor must adhere to the standards for fiduciary conduct and prohibited transaction rules under the Employee Retirement Income and Security Act. Additionally, the proposed rule includes an exemption for a fiduciary giving investment advice and permits the receipt of otherwise prohibited compensation where the fiduciary agrees in writing to be subject to a “best interest” standard. The imposition of such a standard would presumably add another layer to the point-of-sale protocols surrounding the sale of annuities, including but not limited to, federal and/or state suitability regulations, and, where the annuity is replacing one already in existence, state replacement rules.