August 27, 2008
To Whom It May Concern at the SEC:
I am a licensed insurance professional. I am writing to you because I do not support the adoption of proposed Rule 151A, which would classify most indexed annuities as securities. In addition, I am concerned that the application of proposed Rule 151A would not be limited to indexed annuities and that other annuity and insurance products that happen to fit the criteria set out in the rule would be brought within the scope of the rule. I urge you to withdraw the proposal.
At the outset, let me clearly state that I firmly believe that people who promote unsuitable sales and engage in misleading sales practices should be aggressively prosecuted and subject to meaningful sanctions. However, concerns about suitability, disclosure and marketing methods, however valid, are not the relevant criteria for determining whether a financial product is or is not a security. Properly structured indexed annuities do not share the same investment risk as investment products such as mutual funds and individual stocks, since with an indexed annuity the risk of a downturn in the related index rests with the issuer of the product and not the consumer.
In my opinion indexed annuities should continue to be treated as insurance products, and the state insurance regulatory structure is the appropriate means for addressing the concerns raised by the SEC. The professional organizations I belong to, the National Association of Insurance and Financial Advisors, and the National Association for Fixed Annuities are committed to working with the NAIC and state insurance commissioners towards the goal of having every state adopt and vigorously enforce the NAIC’s model regulations on annuity suitability and disclosure. I also support NAIFA’s recommendation that a state regulatory body be designated to develop standards for indexed annuity product design so that inappropriate indexed annuity products would be prevented from reaching the marketplace.
NAFA believes the state insurance departments and insurance companies do a better job of ensuring suitable and appropriate sales than any federal entity. The states provide consumers with local access to department employees who can help them with their complaint, more timely and efficient processing of their complaints, and they avoid the often lengthy and costly arbitration process through the SEC.
The SEC has acknowledged that the current arbitration process isn’t working. They even put out a release saying so and that they needed to review the current process as there were many complaints that the process was time consuming, convoluted, and expensive. Also, the state insurance departments are also the final determination of insurance company licensing, product approval and marketing and they hold quite a big stick over the carriers when it comes to market conduct and complaints.
Excess interest has never been the test for defining a security or an insurance product. An annuity that provides a guaranteed interest rate that is promised the first year is a declared-rate annuity, one that is promised for a select number of years is multi-year guarantee annuity or a MYGA, one that is promised to provide a specified income stream is an immediate and one that is promised based in part on the positive changes of an outside index is an index annuities. Also, excess interest is the cash value basis for all universal life and whole life insurance products.
You can’t re-define risk. The law has already defined risk. Risk is assumed by the individual if, because of market fluctuations, some or all of their money could be lost. The fixed insurance product, including the indexed annuity, promises that if the market goes down, you will never lose your principal or your previous interest. That promise means the assumption of risk (risk of the consequences of negative market returns) is born by the insurance company.
In regards to Commissions;
A common misperception is that fixed index annuities pay higher-than-usual commissions. Commissions payable on IAs today are as low as 1% and the average on all IA products is 6.91%. More importantly, the indexed annuity commission received by the agent averaged 7.81% of premium during the same period. With only 90 basis points difference between the commissions available and the commissions paid, the common assumption that “high commissions” are used as inducement to sell very elderly people unsuitable annuities is repudiated. Furthermore, over 98% of all fixed annuity products reduce commissions by 50% or more with some paying 0% at older ages (typically age 75 and above). This is very dissimilar to mutual funds or other market risk products that do not waive surrender charges or guarantee certain minimum positive returns in the event of death, nursing home confinement, terminal illness, RMDs, creation of a lifetime stream of income, etc. I am unaware of any other financial instrument that reduces surrender charges (or contingent deferred sales charges) due to age.
Furthermore, the average commission that was paid to agents is well below asset fees paid out year after year. And, unlike asset fees, annuity commissions are not taken out of the purchaser’s premium, but rather are paid directly to the producer by the carrier. A no-surrender charge product with a typical 1% annual asset fee as opposed to say a 7-year surrender charge product with a 6% commission will actually have a higher cost to the client and will thus reduce the potential return to the client, not increase it. An asset based trail must recover an increasing cost over time from the spreads and since the spreads cannot be increased (in most cases), they start out higher at the outset than spreads on products with traditional stacked front end commissions and contingent deferred sales charges. Just as a typical “A” share mutual fund will actually cost a client less if the asset is held for a longer duration than a “B” share mutual fund will, so will a stacked front end commission on the annuity cost less than the asset based trail over the same duration.
Two Supreme Court rulings and a lower court case confirmed the status of index annuities as non-registered insurance products. A review in 1997 by the SEC resulting in “no-comment” further confirmed their non-registered status.
There have been no substantive changes to either the insurance elements or the interest crediting concept on these products since the decisions or the SEC’s review in 1997. In addition the Internal Revenue Service recognizes the insurance status of these products by taxing interest earnings as income whereas earnings and losses on securities are taxed as capital gains/losses. Index annuities are unambiguously insurance products regulated and supervised by the state insurance departments. Chairman Cox’s statements about the surrender periods and complaints were influenced by his exclusive discussions with FINRA and NASAA both of whom have revenues to gain by wresting control of the approval and distribution of this insurance product from the states. State insurance commissioners have made many attempts to meet with Chairman Cox. NAFA and insurance carriers have had many meetings with SEC staff. They have been informed of the products’ many liquidity features and the lack of substantive complaint numbers relative to the number of index annuity policyholders. The SEC’s recent actions are not consistent with the facts.
I am not sure whether Chairman Cox is uninformed or simply ignoring the many liquidity options in fixed annuities, far and above other financial instruments. These include penalty-free annual withdrawals, penalty-free access at death or illness, and the ability to elect a lifetime income as early as the fifth year. Based on NAIC documentation, index annuities complaints in 2007 represented 248 out of 204, 801. In addition, over half of the 248 were categorized as “claim handling, underwriting and policy service” NOT marketing or agent conduct making the complaint ratio one for every 60,000 to 70,000 new policies sold in a given year. This ratio is similar to those for other insurance products. NAFA and our carrier, marketing and producer members believe that any complaint is one complaint too many, but it appears that Chairman Cox is relying on anecdotal commentary from NASAA and FINRA without the facts. Also, despite many attempts, these two organizations have failed to provide the data to document their claims and do not even track or document similar statistics for securities complaints, leaving one to wonder how they could possibly assert that complaints would improve under their jurisdiction.
Fixed index annuities are excellent products. Fixed index annuities offer many advantages to consumers, including protection against market risk and income tax deferral. The value of fixed index annuities for consumers has been underscored by the recent experiences of the economic downturn when securities have decreased in value significantly. Proposed Rule 151A creates a new unnecessary layer of regulation that will cause consumer confusion and economic disruption. The consequences of the SEC taking on a regulatory role of fixed index annuities over the current system of state regulation and oversight are likely to confuse consumers about what constitutes a market-risk security. The required changes for insurance carriers and producers will dramatically increase costs for those who sell and buy these annuities. Proposed Rule 151A is not legally supported. It does not make sense for annuities that have no market related downside risk to the consumer to be treated as securities. Fixed index annuities are unlike other products where the consumer bears such market risk. Proposed Rule 151A has not been appropriately vetted for comment and is being rushed to adoption. The proposed rule appeared unexpectedly and with a very short comment period. The proposed rule represents a significant potential impact on the financial services industry and consumers and deserves adequate time for examination and analysis to determine the extent of its impact. Criticism of fixed index annuities, while of concern, has been exaggerated, and the few documented instances of fixed index annuity market abuses – similar to abuses which on occasion do occur for all financial products including those regulated by the SEC – have been largely corrected for fixed index annuities. State regulators have worked hard to put in place logical controls, and the products have evolved to further meet consumer needs. States have in place resources to respond to consumer concerns and provide local and thorough investigations of consumer complaints.
I believe that principal protection, guaranteed income and minimum interest provided by fixed annuities are critical features Americans need to meet their savings and income goals during retirement, especially during these turbulent economic times.
For these reasons, I urge the SEC to withdraw the proposed rule. Thank you for your consideration of my views on this matter.
Sincerely and Respectfully Yours,
Simeon T. Fitzmartin
The Fitzmartin Agency, LLC