These days, you don’t need to go to the movies to find drama. The most action-packed scenes are happening every day in our industry, and we are holding our breath in anticipation of what’s coming next – from federal versus state regulation, to the source-of-funds question, to whether we are giving insurance or securities advice, the drama never stops. Since the April 2010 Suitability in Annuity Transactions Model Regulation of the National Association of Insurance Commissioners (NAIC), the line between what constitutes insurance advice and what constitutes investment advice has become increasingly critical to the business of today’s producer, broker, and advisor. The question is whether today’s insurance professionals are prepared for what’s happening and what’s coming – and more importantly, if everybody is preparing themselves for the right reasons. The issue continues to impact suitability laws at both the state and federal level and has evolved to a point where any consumer recommendation on an insurance product or a securities product requires comprehensive financial analysis of the consumer’s financial matters, in addition to a discussion on broader financial and economic trends. Do annuity salespeople know when a sale is an insurance transaction or a securities transaction? Are they clearly aware of and able to comply with the differing requirements of insurance and securities laws? Someone who offers an in-depth understanding of this controversial issue is Kim O’Brien, President and CEO of the National Association for Fixed Annuities (NAFA) and one of the industry’s leading advocates. From the federal level to the state level, Kim reveals a behind-the-scenes look at the regulatory issues that affect our industry.

Behind SCENE 1:TAX REFORM    Kim: “Tax reform and fiduciary standards are two big issues at the federal level. The tax reform issue is very troubling to NAFA, to anybody who is involved in fixed annuity distribution, and to consumers. The big issue with tax reform is whether fixed annuities will retain tax-deferral on nonqualified products. We’re seeing very strong signals that qualified products (for example IRAs) will retain their tax deferral status, but we’re seeing more indication that Congress is open to conversations which question tax-deferral in the nonqualified space. We are working hard and will continue to work hard to ensure that tax deferral for all annuities will be retained. “But even if we are successful and annuities retain their tax-deferred status, we are seeing tweaks and tinkering with our product on the margins. There are a number of people in Congress, including Senator Baucus’ (D – Montana) staff, who believe that tax policies for annuities should be only driven toward full annuitization and distribution of income to the annuity owner and/or spouse – not for legacy transfer, withdrawals for special circumstances/needs or income for the next generation that is directed and controlled by the parent. They would like to ‘address the expenditures’ of tax policies that allow for anything other than full distribution at a preset age and that’s very concerning to NAFA. And it isn’t just general or oblique references, they’re specifically citing ‘generational transfer,’ the generational stretch IRA and the generational stretch product, allowing you to skip a generation, etc. “Also being discussed is the level of income you are allowed to pass on, suggesting a prohibitive tax at a certain AGI level. They have mentioned $250,000 for joint filers, which would require an additional tax on funds received by that beneficiary, and would absolutely kill the competitiveness of the tax deferral and all the gains you made on the tax deferrals. The power of the tax deferral would be severely curtailed or lost if there is additional and punitive taxes on the transfer to the heir. Don’t forget, we already have an additional 3.8% on joint filers with $250,000 in AGI on the income from an annuity placed in the Affordable Care Act – which was strongly opposed by NAFA – and while this is not the typical annuity buyer today, it may very well be the typical annuity buyer tomorrow.”

SCENE #1, TAKE #2 – FEDERAL: According to Cliff Andrews of CapCity Advocates (NAFA’s lobbyist), “We are anxiously waiting for the release of the insurance modernization report from the Federal Insurance Office that will address a wide range of policy topics about state insurance laws and the guaranty fund system along with suggested reforms. Additionally, regarding suitability issues at the federal level, we are closely watching the SEC request for information about standards of care for retail customer transactions – the SEC is reviewing comments to potentially craft a uniform fiduciary standards rule for broker-dealers and advisors. While the SEC has said it may not create a rule, all indications point toward the likelihood that the SEC will propose a rule next year.”

Behind SCENE 2: FIDUCIARY STANDARDS

Kim: “On the fiduciary level of course we’re dealing with the Department of Labor (DOL) and the SEC. The SEC is very slow producing their study and their requirements for a proposal of a uniform standard on fiduciary care. On the other hand, the DOL is much more aggressive. The Assistant Secretary rejects the argument that the rule will limit consumers’ access to advisors because, as she states, “anyone who has less than $15,000 to invest doesn’t really need a financial services or insurance professional.” We totally disagree. We think those are the folks that desperately need it. We also do not agree with the uninformed or blind assumption that either a uniform standard or a fiduciary standard is always best for the consumer – more on that later.

Behind SCENE 3: THE PLOT REVEALED: LICENSING Kim: “As a result, annuity professionals are wondering what licenses they should be getting. Asking: How should I be licensed to anticipate the future? Of course you cannot just operate in the here-and-now. As a businessperson, and everyone who sells annuities is a businessperson, you need to be forward-looking and ask yourself: ‘What do I need to do today to prepare myself for the future?’

“What licenses should I get. What licenses am I required to get? Should I partner up if I’m an insurance-only agent with an investment advisor? On the investment advisor fiduciary standard, should I start implementing fiduciary-like responsibilities and compliance measures in my insurance practice to protect me for any outcome and perhaps any backward-looking litigation, legislative or regulatory action? Those questions are all valid and good to address. Our answer to those questions is: you should only get the licenses for the services you want and intend to provide to your customers.

“If that’s investment advising activities and services, then you need to be an investment advisor or an Investment Advisory Representative (IAR). If all you want to do is provide insurance and insured retirement products then you need an insurance license and you need to understand what the insurance-only permitted activities are for insurance-only licensed individuals. “If you want to be a broker-dealer and are worried about the fiduciary standard applying to you, our answer is: don’t do anything today. We will fight for you and we believe we will be successful in getting a strong seller’s exclusion. It’s been there since the 1930 Uniform Security Act and every revision since. But don’t get licenses unless you intend to change your business model. If that’s how you want to run your business that is great, but don’t do anything in anticipation of a regulation or rule because unless you will be providing the services the license permits, you’re not setting your business up to succeed, you’re setting it up to protect yourself and instead of success it’s more likely the opposite will be true.”

Behind SCENE 4: STATE-LEVEL ISSUES Kim: “State-level impact is occurring in two areas. One is the NAIC activity which influences state regulation because any model law proposed, or any NAIC bulletin that’s adopted, will impact individuals as well as specific state regulations. States security departments are getting much more aggressive in their desire to control the entire marketplace of retirement products, including fixed annuities, sold through the insurance regulatory system. “This aggression was evident at a recent North American Securities Association (NASAA) meeting in California. They had a private regulator-only session where they actually went through a talking point on how your state can use the source of the funds; the distribution of funds from a security into a fixed non-security product and how your state can get jurisdiction over that transaction. It was a tutorial, if you will, on how to take oversight of the transaction by going to the source of the funding. “Meanwhile, the state insurance departments are not seeking the same type of oversight, from a non-security insurance product to a security product. We had a strong conversation at the National Conference of Insurance Legislators (NCOIL) with the head of their state insurance regulation committee and they have no desire to control the transactions that move from an insurance product to a security. And without the equal interest from the state insurance departments regarding the funding source of the security we have an uneven playing field. On the one hand you have a security division (all but seven states have separate security and insurance divisions) claiming jurisdiction over transactions from securities to insurance and you don’t have the same jurisdictional claim from insurance divisions over transactions from insurance products to securities. This source of funds issue is going to be a big issue moving forward and not just at the state level but with the SEC and FINRA as well.” But do not worry, NAFA is all over it and we will continue to ensure that fixed annuity transactions are protected insurance activity.

SCENE #4, TAKE #2 – STATE SUITABILITY:

According to NAFA Legal Counsel, Pam Heinrich, “Although the Harkin Amendment June 16, 2013 ‘deadline’ has officially or technically passed, we are still seeing state legislatures or state departments of insurance working on the adoption of the 2010 NAIC Suitability in Annuity Transactions Model Regulation.  In fact, the states that have yet to adopt the Model may still do so in order to fall under the Harkin safe harbor.  In addition, most insurance carriers that operate on a national basis have adopted national standards that adhere to the Model.  To date, 32 states and the District of Columbia have adopted the Model regulation, and the Wyoming Department of Insurance has just provided notice of its intent to adopt the Model.”

SCENE #4, TAKE #3: NAFA encourages other state insurance departments to adopt the Permitted Activities Bulletin, as Iowa and Tennessee have already done.  Additionally, NAFA is developing a point-of-sale or point-of-delivery Permitted Activities Disclosure template form, based on the IA/TN bulletin and the NAIC Suitability Model, that members could use in their annuity transactions which would both buttress suitability coverage and provide the consumer with clear information of what their annuity professional is licensed to do and what information they may cover with the consumer and asking the consumer to acknowledge that the transaction did not involve investment advice.”

Behind SCENE 5: PLOT REVEALED – FUTURE IMPACT Kim: “So, annuity salespeople need to make sure they understand the permitted activities of conversation they can have with clients without crossing over into investment advice. To assist, NAFA provides as a resource the Permitted and Not-Permitted Activities guidance memo, which are guiding principles of what services insurance-only and security-only licensed professionals can and cannot provide to their clients. If you notice the language is exactly the same as the Iowa and Tennessee bulletin that is because the states used the language that NAFA and its members developed over a period of almost 18 months with the Iowa Insurance Division. “So we have two states that have adopted these guidelines but even without state adoption it’s a good roadmap for annuity professionals, especially insurance-only agents. NAFA also stresses that you need to be aware of the chronology of your conversation with your customer. NAFA recommends you begin your sales or fact-finding conversation with the discussion about annuities and their benefits for helping to save for retirement, transfer savings to loved ones, etc. Next you conduct the suitability review process and it is during this process of obtaining the information when you can discuss risk diversification, stock market volatility, etc. Do not begin with the investment-related topics or your client’s specific information as you are more likely to cross-over into providing investment advice. And you will note that the Iowa and Tennessee bulletin clearly state that covering the financial objectives, risk tolerance and investment holdings of the consumer, as well as completing forms required by the suitability review process and sales transaction are permitted activities for the insurance-only salesperson. “Remember: the Permitted Activities Bulletin not only assists insurance folks selling annuities, but also makes securities-licensed individuals aware of their obligations and restrictions without holding an insurance license.”

Behind SCENE 6: THE DOL FIDUCIARY RULE Kim: “Our goal is to stop the DOL from restricting lower and modest income Americans access to annuities and to prevent a fee-based only compensation model. We believe their Rule is discrimination against anyone with modest income and, in particular, minorities. Our ultimate goal is to have the DOL Fiduciary Rule wait for the SEC to complete its requirements from the Dodd-Frank Act. The DOL should not put out a rule in advance that could conflict with or duplicate any SEC proposal and create havoc in the annuity marketplace.

“Now back to the axiom that proponents and many in Congress seem to believe without challenge – that uniformity is inherently good, and the fiduciary standard is the ‘best’ standard in all the multitude of services, transactions, and education provided by the financial services and insurance industries.  In this case uniformity will eliminate choice, product innovation, and access to qualified insurance professionals and brokers. NAFA also believes that the suitability standard for fixed annuities is the GOLD standard of care for consumer protection and is the only standard that ensures that if a sale is deemed unsuitability the consumer will have a full refund of their premium paid. “There is no doubt that the fiduciary standard is a strong standard, but it only makes sense for the type of services it’s meant for – investment advisory services. There is much hand wringing and consternation in Washington D.C. over the concerns that consumers are confused by what standard of care they are provided. I don’t think that’s their concern, consumers care that they have a safe and regulated (i.e., protected) marketplace to buy financial products and that they have licensed professionals available who can help them access products and their features. They also care about the quality of the information and the trustworthiness of their advisor, broker, or insurance professional. NAFA is asking for and will not quit until we achieve a meaningful seller’s exemption in the rule, to allow fixed annuities to be sold by any insurance licensed professional under the singular, effective, and consumer-focused suitability standard.”

Behind SCENE 7: POLITICAL SUPPORT Kim: “Senator Orrin Hatch (R – Utah), has played an important part in helping us to gain respect for the views we hold defending state insurance regulation. He unveiled a new bill, the Secure Annuities for Employee (SAFE) Retirement Act of 2013 (S. 1270), representing legislation to strengthen and reform much of the nation’s public and private pension benefit system. We had a thrilling role in how his support came about. We were asked to be a part of a working group, along with the American Council of Life Insurers (ACLI) and Insurance Retirement Institute (IRI) and gave a presentation for the NAIC back in February regarding the problems with the DOL fiduciary rule and its overreach to extend the rule to IRAs. “The IRI’s and ACLI’s justifiable concern is that the DOL rule would also impose a fiduciary standard on the plan sponsor – meaning the employer and their fiduciary role in selecting a provider and all of the difficulties and liability that would cause. NAFA’s concern is always for the fixed annuity product and how this or any rule is going to impact positively or negatively the ability to sell it or the ability to buy it. We were approached right away, as soon as we got off the podium, by Senator Hatch’s office and the conversation started there. We addressed the guaranty fund disclosure as backup protection for consumers, and how the insurance regulatory system works, including solvency requirements and the four steps to insolvency. “There is a very strong history of the strength and solvency of the insurance industry and the protection to ensure customers do not lose any of their annuity value in a troubled economy or due to the rare insolvency. So we met with Senator Hatch’s staff five or six different times on Capitol Hill and provided background on insurance regulation, the state guaranty funds, and the guaranteed and insured elements of fixed annuities. At one meeting a group of NAFA members who are actuaries helped the Senator’s staff with assumptions and projections they were developing as the backbone of their proposed Bill, S. 1270. The outcome would allow for retail fixed annuities through the state insurance regulatory system, insured by the guaranty fund of each state, to be used by employers on a non-mandatory basis – optional – by state and local government agencies. There’s also a private reform section to the bill, but primarily it is to allow for the state and local governments that either have underfunded or zero-funded pension plans to seek an alternative mechanism to provide lifetime pension income to its employees that is fully funded and issued by insurance companies licensed in the state. “The bill allows for employers to set up a bidding process for carriers and a selection process for the carriers and the products that will be provided for employee selection each year. The bill provides that each year individual employees may purchase a “qualified” (as defined in the bill) fixed annuity with guaranteed income payout and the employee aggregates their own annuities over their career with their employer. And they’re also transportable. The bill provides each employee with their own personal pension plan and it really demonstrates the power of fixed annuities – that they can be used to save the pensions of so many Americans.” “What’s important here is that federal oversight is being removed from state and local government agencies and the states are being handed the responsibility for regulation and the insurance company with insuring the pension income guarantees. That’s an important public relations story No. 1 that this Senator and with the bill’s enactment, Congress, sees the state insurance regulatory oversight as a strong and consumer-centric regulator. And No. 2, it brings attention to our track record of solvency. And No. 3, it acknowledges the power and protection of fixed annuities. NAFA sees this bill also as a way to remove the gag order on the guaranty fund. Consumers need to understand they’re protected and they need to understand the extent to which they’re protected and the level to which they are protected. I had a call from a woman in Florida who found out about her state guaranty fund through a series of information and serendipity, and she said, “I’m in Florida, I have one annuity and it’s all with one company, it’s $525,000. I’m exposed.” And I said, yes, you are. “She is four years into a seven-year surrender product; for her to make any change to protect herself she may have a surrender charge depending on the product. She should have had that information upfront so she didn’t have to incur any charges and she could have made sure she could sleep at night knowing, okay, I’ve got some protection, I’m covered by the guaranty fund and I’ve got my money in two different companies. Should one go south I’m covered to that limit. Should another go south I’m covered up to that limit. I am protected. She should have had that protection.”

For more, including Kim’s revealing insights into Elder Abuse, visit www.AnnuityOutlookMagazine.com.