September 10, 2008
We respectfully submit this response to address the SECs position on fixed index annuities (FIAs) and its proposed rule to regulate most fixed index annuities as securities. We are limiting our response to the impact on the end consumer and why these products are an integral part of retirement planning but not a security. While we agree with the multitude of responses that address the legal and adverse economic issues of this proposal, we believe the SEC is somehow misguided in its understanding of the nature product design and, ultimately, the benefits of fixed index annuities to consumers, and we are concerned that these issues may have been underemphasized.
Fixed Annuities Today
The fixed annuity products offered today provide a multitude of benefits to consumers and are vastly superior to those offered five to 10 years ago. Todays products provide consumers with the opportunity to tie interest earnings to an outside index, which adds integrity to the crediting rate process. The indices give clients the opportunity for upside potential and growth without exposing them to investment risk and erosion of principal or requiring them to sacrifice liquidity features and many other traditional insurance features such as competitive minimum guarantees. These products are structured and positioned to help consumers move to and live through retirement. They are first and foremost insurance products, offering guarantees that serve as a minimum or floor for the owner. The typical security or variable annuity does not offer such an advantage. So, we take great exception to the SECs comments that individuals who purchase index annuities are exposed to significant investment risk i.e., the volatility of the underlying securities index.
Importance of a Floor—Fixed index annuities are designed to give consumers a reasonable range of returns that, under no circumstances, can be less than the floor (i.e., contractual minimum guaranteed rate).Consumers purchase FIAs for many of the same reasons people purchase savings instruments such as CDs or traditional fixed annuities. The ability of FIAs to provide returns that help consumers plan for retirement while protecting their assets from market risk and potential loss of principal is what makes fixed index annuities such a valuable and unique non-security product. The floor is contractual, the surrender charges are guaranteed, the limits on upside potential are clearly highlighted, and liquidity features are guaranteed. All of this makes a fixed index annuity a non-security product that is an essential part of a consumers overall retirement plan.
Access to Annuity Values—In addition to misunderstanding that FIA purchasers are not exposed to significant investment risk, the SEC appears to misunderstand several other features of FIAs. This misunderstanding, once clarified, illustrates why FIAs are suitable for many consumers and why they are clearly not securities. Several of these features, or attributes, are misinterpreted quite often by so-called financial experts whose work is printed or distributed nationally.
Most FIAs provide consumers who experience life-changing events, such as confinement to a long-term care facility, diagnosis of a terminal illness, or hospitalization, with access to most or all of their retirement assets without the assessment of surrender charges. Consumers may not be able to rely on access to their assets or effectively plan for such events with a security product (e.g., stock, bond, mutual fund, or many variable annuities). Further, the investment risk inherent in security products can change the availability and value of consumers retirement assets. Imagine a consumer (in this case an investor) who planned in 2007 to access his retirement assets from his mutual fund in 2008. As of September 8, 2008, the SP 500 was down 13.6% from January 1, 2008, and the Dow Jones was down 13.2%. That consumer would have had over 10% fewer retirement assets available to respond to a life-changing event or to merely enjoy retirement (assuming the underlying mutual fund or variable annuity tracked the SP or Dow).
Maturity Age Confusion—A criticism of FIAs is that a consumer has locked his or her retirement assets, subject to surrender charges, for up to 20 or 30 years. The example given was a 65-year-old locked into his annuity until he reaches age 95 or 100, when the product matures. This is totally a misunderstood concept and shows a lack of understanding of FIAs. Of great concern is that several attorneys general and securities regulators have cited this as an issue. If the SEC is basing any of its decisions on these misunderstandings, we offer the following clarification: A 65-year-old who buys an FIA with a 10-year surrender charge schedule can get out of the product (full surrender) after 10 years (age 75), with no surrender charges. While the maturity age of the annuity may have been 95 or 100, it is only the age, according to tax law, when an annuity owner must take a full surrender or convert to an income stream and can no longer continue to defer taxes on the contracts gain. An owner has access to the annuity values up and until such a date. The maturity date aspect of a FIA is often cited as a reason consumers age 60 to 65 or older should not purchase an FIA. This is a gross inaccuracy and causes FIAs to be viewed in a bad light and cited as unsuitable. Unlike securities, almost all FIA products give consumers access to a percentage, often 10%, of their annuitys value immediately and each and every year thereafter until the annuity is surrendered or is converted to an income stream through the election of a settlement option.
Surrender Charges—Surrender charges are cited as a reason why someone should not purchase an FIA or another reason for the SEC to monitor sales practices. The surrender charges enable carriers to develop investment strategies that correlate to the benefits, features, and guarantees offered in FIA products (just like those available in traditional annuities). Consequently, surrender charges vary in percentage and duration. Surrender charges should be evaluated in light of the products full features and benefits and the consumers needs.
We acknowledge that surrender charges have been a major source of complaints in the past. These complaints resulted primarily from placing a disproportionate share of a customers assets in a FIA. Today, this issue has been addressed by state insurance regulatory reforms, including suitability guidelines, sales practice requirements, and annuity disclosure regulations. Surrender charges are clearly disclosed to consumers in the annuity contract, annuity disclosure forms, and buyers guide. Further, during the suitability review, the insurance agent is required to ask consumers if they intend to keep the annuity through the surrender charge period to ensure the product provides long-term benefits.
Safety and Security—The recent downturn in the stock market highlights the strength and value of FIAs. While millions of Americans with equity securities, stock mutual funds, or variable annuities suffered financial losses as a result of a 20% plunge in the stock market, FIA holders did not lose a penny in retirement savings. Given the recent market turmoil, who is better protected against significant investment risk? Someone who bought a security, e.g., a stock, mutual fund, or indexed fund, or someone who purchased a fixed index annuity? Clearly, the client who purchased a fixed index annuity is better protected. We strongly believe in the consumer value of the fixed index annuity, especially in a bear market status. Fixed index annuities offer the guarantee of minimum interest and the opportunity for additional interest, while promising owners that their principal is protected. Again, we emphasize that we disagree with the SECs position that those who purchase fixed index annuities are exposed to investment risk, as the account value for these products is either stable or increases. While people may purchase fixed index annuities for the upside potential of earnings that are tied to securities index, the inherent reasons for purchase are the insurance and guarantees provided in the product. The insurer bears the majority of any investment risk, not the consumer, who has a strong minimum guarantee over the life of the product. Insurers guarantee repayment of principal through their general funds, which are overseen by state insurance regulators. Most securities, including basic variable annuities do not have insurance features and do not have underlying guarantees of principal and interest.
Impact of an SEC Rule on FIAs
The unique benefits that a fixed index annuity offers consumers are compelling, and we firmly believe these benefits will be eroded over time if FIAs were considered securities.
Product Development—Pressure would be exerted on providers and distributors to develop products that emphasize performance rather than guarantees. It is a consumers nature to chase or focus on performance, and the data is overwhelming that a consumer who takes such an approach does not benefit in the long term. The professional insurance agent is educated and trained to help conduct a thorough needs analysis to ensure that all product recommendations meet consumers short- and long-term financial needs and goals. They also help customers to understand the importance of balancing performance with safety and security. If FIAs were considered securities, the product would be restructured over time to emphasize performance (not necessary the best choice for the client) and the discipline of building guarantees and other safety, security, and traditional insurance features would be deemphasized. In the long run, the consumer would miss out on the traditional insurance features and guarantees and other attributes of the current FIA product structure.
The benefits that the current distribution provides to consumers would be marginalized if FIAs were regulated as securities. We find that most insurance agents are focused and concerned about consumers and making product recommendations that meet the financial needs of consumers. They are well versed in, and experienced at, explaining the benefits and limitations of fixed index annuity products. They are also well trained, educated, and equipped to select from a broad range of insurance products, including FIAs, to meet their clients needs. The average age of agents is over 48, and the majority of agents have more than 10 years of insurance experience. They are qualified and provide a valuable service to consumers, and we are concerned that their professionalism is being swept aside by the actions of a few rogue agents, which every industry has.
Sales Practices—FIA sales practices continue to be refined by state insurance regulators and insurance professionals and is quite far from being broken, as implied by the SECs comments. Going above and beyond what most states require, state regulators and insurance companies have made great strides in providing consumers with important information regarding fixed index annuities, including information on interest crediting mechanics, surrender charges, access to annuity values, and other available options. The information is easy to understand and not buried in a prospectus that most consumers cant understand or choose not to read or that doesnt fit a FIA. Most recently, the ACLIs board took steps to improve annuity disclosure and suitability requirements that go beyond current state insurance laws, in an effort to assist consumers in making annuity purchases, including the purchase of an FIA. Such efforts include improving disclosure in the annuity transaction, promoting uniform suitability standards, and ensuring proper credentials for annuity producers. Further, the majority of states have existing and newly enacted state laws that protect consumers from unsuitable sales and fraudulent and misleading sales practices, require full disclosure and free return of policies, and provide nonforfeiture protection and more. We are confident that the current state regulation and oversight of these products by insurance commissioners is not only appropriate but also effective in ensuring consumers understand the insurance elements of what they are buying and where to satisfy any concern, question, or complaint.
No one benefits from an unsuitable annuity sale. The insurance industry, state regulators, insurance agents, and independent marketing organizations are committed to assisting and ensuring all sales are suitable for the client based on the information the client provides. The majority of states have adopted the Suitability in Annuity Transactions Model Regulation, which requires heightened supervision of all annuity sales for consumers of all ages. In addition, many of the large fixed index annuity insurers require the suitability review for sales made in all states and all ages, even if the state has not adopted the model regulation, to ensure that all sales are suitable and designed to meet clients short- and long-term financial goals and objectives.
We believe that state insurance sales disclosure and sales practice protection laws and regulations applicable to fixed index annuities adequately protect consumers. While we recognize that, with any industry, there may be some bad apples, we do not believe that the sales practices highlighted on the recent Dateline episode are reflective of the industry as a whole. Moreover, a sting operation of comparable size and duration would certainly net similar perpetrators misselling variable annuities, mutual funds, or other securities that are currently regulated by the SEC.
Consumer Confusion—We do not believe that it is in best interest of consumers to move product design, sales and marketing jurisdiction, and regulation of fixed index annuities to the SEC and FINRA. Should securities rules and regulations be applied to non-securities product, consumers would likely be confused and overloaded with too much irrelevant and non-productive information. Trying to apply securities regulation to a fixed index annuity would be confusing, costly, and redundant and could potentially limit a consumers access to certain products. For example, trying to describe an FIA in a prospectus, rather than a product-specific buyers guide, would not serve a customer well. When you evaluate the outcome, you realize that regulating FIAs as securities doesnt fit or, to use an old adage, it would be like trying to fit a round peg in a square hole, which further supports the position that FIAs are not securities.
To further clarify these points, we offer the following:
The SEC and FINRA have regulated the sales of securities for many years however, there continues to be much investor confusion relating to those products, as evident by the volume of complaints, recently revised suitability standards for variable annuities, and current volume of FINRA arbitrations and client-initiated litigation. According to the Advantage Compendium, the complaint rate on FIAs is one complaint for every $109 million in sales. Further, the current suitability standards in most states meet or exceed SEC requirements. Complaint resolution through a state department of insurance is much more effective than that provided by securities law. Rather than having to hire an attorney and wait months to go to an arbitration hearing or trial, a consumer working with the local department of insurance receives direct representation at no cost within a few weeks.
The SEC alleges that the growth of fixed index annuities has been accompanied by a growth in complaints of abusive sales practices. In fact, fixed index annuities account for just one-tenth of one percent of all insurance complaints filed with the NAIC.
The statements made in the SECs executive summary gave us great concern that the SEC does not clearly understand fixed index annuities, which could result in start-and-stop regulation, regulation that needlessly stifles innovation, and regulation that doesnt address the heart of the matter, which is protecting consumers while providing them with access to affordable products to meet their financial and retirement goals. We believe the SEC has not given the industry and particularly the NAIC due credit for their actions to ensure that fixed index annuities sales are suitable.
The problems created and the data both support our position that consumers would be better served if the SEC and FINRA focused on securities regulation and insurance regulators focused on insurance (non-security) products, which clearly includes fixed index annuities. To do otherwise would create confusion, redundancy, and increased costs, all of which would negatively impact the end consumer. Each group should focus on its respective area of expertise.
In Summary
We believe the arguments and comments made by other parties support the legal conclusion that FIAs are not securities and that the proposed change would cause a negative economic impact well in excess of $100 million to small annuity providers and insurance agents/agencies and other small businesses operating within the insurance industry. As such, the rule would violate the Small Business Regulatory Enforcement Fairness Act of 1996. The proposed rule would reduce competition and harm consumers by limiting access to FIAs.
Most importantly, the fixed index annuitys unique range of returns supported by a floor and many other contractual guarantees provide consumers with significant benefits. The strength of the FIA is in its structure and design—which is centered on features that are beneficial and meaningful to consumers—and not in being a security. Just because the returns of a FIA are linked to an index should not negate the basic insurance product structure and guarantees that cause it to be an insurance product and not a security. Further, the proposed movement of this product to the SECs and FINRAs jurisdiction would not benefit consumers. The proposed rule fails to recognize the nature of the FIA and that consumers are well served by insurance professionals and state regulators. It also fails to recognize the changes in sales and marketing regulation fostered by the NAIC and state regulators, and in fact, it would undermine many state initiatives in place concerning sales practices. Fitting these products into a securities environment would be costly and confusing to consumers, as the FIA doesnt fit security guidelines.
The FIA market has grown rapidly due to strong demand for products that provide a combination of guarantees and upside potential, and generally consumers have been pleased with the results.
Respectfully yours,
R. Preston Pitts
President
Legacy