Security Regulators Step Up Review Of Annuities

January 23, 2013

By Linda Koco

Security regulators in the U.S and internationally are sending out signals that they intend to step up review of distribution of complex financial products, such as variable annuities and equity-linked instruments. This could impact advisors who handle such products in the future. 

For example, the Financial Industry Regulatory Authority, Inc. (FINRA) has sent out a  January 11 letter to broker-dealers  indicating that variable annuities are among its regulatory and examination priorities in 2013.

The same letter also says it will examine B-D firms and registered representatives to ensure they have a full understanding of complex or high-yield products, particularly in regard to market risk, credit risk and liquidity risk exposures. This reinforces points FINRA raised last year in its Regulatory Notice 12-03 onHeightened Supervision of Complex Products.

Meanwhile, an international securities organization has just released its “final report” on suitability requirements in the distribution of complex financial products. The report does not name life insurance or annuity products in the long list of examples that it gives of complex products, but it does include the term “equity-linked instruments and instruments whose potential pay-off is linked to market parameters.”

That equity-linked phrasing will be of interest to U.S. financial professionals for two key reasons.

First, that term has a variable/indexed product-like ring to it, and so may be viewed as “catching” certain insurance products that have equity-linking features. The final understanding will likely depend on how international regulators, and country-specific regulators, interpret “equity-linked instruments.” For now, it’s sufficient to note that the language may be encompassing enough to sweep in certain insurance product types.

Second, the organization that published the report is the International Organization of Securities Commissions (IOSCO). This organization is no stranger to variable products. In fact, in announcing its new report, IOSCO points out that the report is intended to “complement” work done by the Joint Forum on the topic of complex products which include, among many others, “variable insurance products.”

[Note: The Joint Forum is an international group of regulators from banking, securities and insurance. IOSCO is a parent committee of this group as is the Basel Committee on Banking Supervision (BCBS) and the International Association of Insurance Supervisors (IAIS)].

A convergence

The above would suggest that regulatory thinking may be converging around suitability standards and complex products. It may also be that some regulators will consider treating certain insurance and annuity product as complex products within this context. This is not certain at this time, but one thing is certain:  There is definite linkage between U.S. regulators and the international regulatory community.

For instance, the U.S. Securities and Exchange Commission (SEC), FINRA, and the National Association of Insurance Commissioners (NAIC) all have relationships of some kind with IOSCO.

The SEC: The SEC website says that SEC is an IOSCO member. As such, it says, the SEC “actively participates” in the organization’s policy committees, its standing committee on risk and research, and certain IOSCO task forces.  “The standards developed by the policy committees or task forces, and then publicly issued by IOSCO, become the benchmark against which an IOSCO member's regulatory practices are assessed,” the website adds.

FINRA: This self-regulatory organization says, on its website, that its international activities include deepening involvement and developing FINRA viewpoints in policy dialogues with global regulatory organizations. And one of those organizations is IOSCO.

NAIC: This organization of U.S. state insurance regulators is a member of The Joint Forum, the international organization mentioned above. The Joint Forum addresses “cross-sectoral issues” common to insurance, banking and securities, NAIC says on its website.

The Joint Forum does not have the power to pass regulations, according to the NAIC. That may be an important point for U.S. financial advisors and insurance professionals who may be wondering what impact the Forum, IOSCO and related bodies could actually have on everyday business.

However, NAIC also says that the Joint Forum can “make strong recommendations and these are often adopted by member nations, as well as other countries.” In addition, the Joint Forum develops guidance, principles and identifies best practices “of mutual interest” to the three supervisory standard setters, NAIC says.

Impact for advisors

It would appear that U.S. advisors won’t need to start looking for an IOSCO regulator or members of the Joint Forum to come knocking on their doors. But advisors may want to stay tuned to increased FINRA supervision and examination of variable annuity sales and to “influences” from abroad, especially concerning complex products, however these may be construed down the road.

The IOSCO report on complex products will probably function more like a set of guidelines for securities regulators in the countries that participate in the organization, says James J. Eccleston, a Chicago attorney who has been following regulatory interest in complex financial products and who often represents financial advisors.

“But individual advisors don’t need to pay close attention to the provisions,” adds the chief strategist and lead attorney at Eccleston Law Offices in a telephone interview.

“These are international guidelines, and they could impact what regulators do in the U.S. regarding complex financial products,” he allows. “But nothing definitive would happen here without formal rulemaking.”

It’s much more important to heed the regulations from the state insurance regulators, the SEC and FINRA, he says.

Of course, Eccleston adds, it might be good for advisors to check out the IOSCO report, “so they can see what the world of securities regulators are contemplating. Just remember that, at most, they are looking at only a potential impact on the U.S. market.”

The FINRA letter

As for the FINRA letter to B-Ds and its earlier Notice 12-03, that’s another matter. Eccleston says FINRA’s actions regarding complex products have been the subject of discussion among securities lawyers and their clients in recent times. 

Of most significance for annuity professionals are FINRA statements about variable annuities in the January letter to B-Ds, he says.

On the one hand, the letter concedes that variable annuities “can offer valuable benefits to investors seeking predictable income streams, tax deferral for investment gains and flexible investment choices.”

On the other hand, the FINRA letter warns that “long holding periods in conjunction with significant surrender charges can make them unsuitable for investors who have near-term liquidity needs.”

In addition, the letter warns against the negative impact on variable annuity performance of “high fees and expenses” and cautions that high commissions can invite switching.

Even more surprising, Eccleston says, is the letter’s admonition that variable annuity company consolidation “may provide an inappropriate incentive for brokers to recommend exchanges” through buy-back offers, spurs to swap out product guarantees, etc.

The letter includes a list of several variable annuity areas where FINRA examiners plan to focus in 2013.

These areas include “suitability of recommendations, the brokers’ level of product-specific knowledge, the level of due diligence in assessing the risk tolerance and liquidity needs of the customer when making investment recommendations, the manner in which material risk exposures are disclosed to customers and the impact on broker compensation associated with competing investment alternatives.”

To Eccleston’s way of thinking, “That is a big deal. They are saying they are going to focus on suitability, product-specific knowledge, due diligence, disclosure and broker compensation impact.”

That is in addition to the letter’s comments about focusing on complex products. Given current market conditions, the letter says, FINRA is “particularly concerned” about B-Ds and reps having “full understanding of complex or high-yield products, potential failures to adequately explain the risk-versus-return profile of certain products, as well as a disconnect between customer expectations and risk tolerances.”

The letter also states that, “Certain, sometimes complex, products have recently surfaced as potentially unsuitable and otherwise problematic for retail investors based on their underlying market, credit and liquidity risk characteristics.”

Eccleston’s take is that, “in 2013, there will be more enforcement action through FINRA” in these areas.


Linda Koco, MBA, is a contributing editor to AnnuityNews, specializing in life insurance, annuities and income planning. Linda can be reached at [email protected].


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1/23/2013 2:58:11 PM - chicago

I don't think 3% plus .50 trail is big commission---mutual fund commission are much the same.

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