November 13, 2008
First I want to clearly state that I support SEC regulation and supervision of “indexed” insurance products.
I have been an insurance agent and broker/dealer registered representative and registered principal for over 25 years and have been a member of organizations associated with those designations for most of that period. In my extensive experience with many insurance products I have never seen any product as poorly understood by the public, and in many cases by the insurance agent selling the product as are indexed annuities.
I recently had an owner of a “bonus indexed annuity” come in to seek our advice who had purchased the annuity at the bottom of the stock market decline in 2002. She sought our advice because while the stock market was substantially higher at that point than when she had purchased the annuity, her account had not risen and, after the very substantial surrender charges, she would have less than she did at the bottom of the market five years earlier. The agent who sold it to her was also a registered representative of a broker dealer who had sold her a variable annuity at the top of the market in 2000. As she liquidated the variable annuity to purchase the indexed bonus indexed annuity she was told that the “bonus” function of the indexed annuity would offset the surrender charges from the variable annuity. I contacted the compliance department of the broker/dealer and was told that they did not supervise the representative’s non-securities insurance activities and that they did not monitor the sale of variable annuities unless the proceeds were transferred to a security.
While I was a branch office manager of a broker dealer with which I am no longer associated I asked two representatives to find a different broker/dealer after discovering they were conducting a wholesale transfer of variable and mutual fund products to indexed annuities. I initially wrote the practice up as a deficiency in an audit of their off-site office but their appeal was upheld as the indexed annuities were not securities. To the best of my knowledge, they continued the practice of replacing recently commissioned securities with bonus indexed annuities.
My experience has been that members of the public quite sincerely believe that they are “investing in the market” when purchasing an indexed annuity and do not have an understanding of the risks, surrender charges, and possible illiquidity of the product and irrecoverable losses in the event of an insurance company failure. The terms “indexed” and “S&P 500 Stock Index” are commonly used in conjunction with the sale of the indexed annuities and my experience indicates that members of the public come away believing that they are invested in an S&P 500 Index fund with a guarantee against loss.
I have heard many insurance agents brag about the high level of commissions they have earned selling indexed insurance products to members of the public who were in a loss position in the market. In some of those cases the insurance agent had also sold the customer a commissioned securities product only a few years before. In other cases the insurance agent was not securities licensed but was working in conjunction with a registered representative who had made the earlier sale, thereby circumventing FINRA supervision.
A major radio station out of Dallas broadcasts lengthy live infomercial each Saturday in which a non-securities licensed insurance agent touts the virtues of “investing in the market with no risk” via indexed annuities. I called the agent who basically told me to “buzz-off” claiming that as he was not securities licensed he was not subject to securities laws.
From the issues above I have concluded that a rather large loop-hole exists in the securities supervision system in that a so-called investment in an indexed annuity with funds being moved from securities is generally considered to not be a supervised activity under SEC or FINRA rules but is also generally considered to be a securities investment by members of the public.
Sincerely yours,
Jeffrey W. McClure, CFP®