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The State of Suitability in a Fiduciary Landscape – NAIC Considers Revising Model Rule

The National Association of Insurance Commissioners (NAIC) has convened a new Annuity Suitability Working Group to consider changes to NAIC Suitability in Annuity Transactions Model Regulation (MDL #275). The NAIC’s Model Rule Review committee had previously declined to consider amending the current (2010) version of the Suitability Model Regulation, but this decision was reconsidered, almost certainly in light of the uncertain regulatory environment created by the Department of Labor’s promulgation of the fiduciary duty rule. The first meeting of the Working Group took place at the NAIC Spring National Meeting on Saturday, April 8th.

The Working Group is chaired by Dean L. Cameron, the Director of the Idaho Department of Insurance; other members of the working group include representatives from insurance departments for the states of Iowa, California, Maryland, Nebraska, New Hampshire, New York, Oklahoma, Rhode Island, and Tennessee. The charge of the working group, which reports to the NAIC Life Insurance and Annuity (A) Committee, is to:

  1. Review and revise, as necessary, the Suitability in Annuity Transactions Model Regulation (#275); and
  2. Consider how to promote greater uniformity across NAIC member jurisdictions.
Brief History of the Suitability Model Rule

In 2003 the NAIC first adopted a model rule to regulate the activities of insurers and producers to ensure that any recommendation they made to a consumer to purchase an annuity product was ‘suitable,’ based on relevant information obtained from the consumer. This first model rule was called the Senior Protection in Annuity Transactions Model Regulation, which, as its name suggests, was limited in scope to the sale of annuities to senior citizens, defined as individuals aged 65 years or older.

This first model rule required insurers and producers to have “reasonable grounds” to believe that the recommendation was suitable, based on the consumer’s financial situation and needs, and to make reasonable efforts to obtain information on the consumer’s financial status, tax status, investment objectives, and other information deemed reasonable by the insurer or producer. Otherwise, there was no definition of suitability information.

In regard to the supervisory duties of insurers to meet the obligations of the new regulation, the 2003 model rule required insurers to have in place a system of supervision that was reasonably designed to ensure suitable sales. Such a system could either be carried out by the insurer or through contract with a third party. If the insurer did contract out for the supervisory obligations, they were required to make a reasonable inquiry to ensure that the third party was performing its contracted functions, either by (1) obtaining a certificate from a third party senior manager tasked with the responsibility of ensuring compliance; or (2) contracting with another third party contractor to review the supervisory functions to determine compliance. As long as the insurer made such a reasonable inquiry of the third party supervisor, the insurer would be considered in compliance with the model rule’s requirements for having a supervisory system in place to ensure suitable sales. In the 2003 version of the suitability model, there were no producer training requirements.

In 2006, the NAIC amended the original model rule to expand the model’s protections to consumers of all ages – not just those aged 65 or older. In making that change in scope, the model rule’s name was changed to the Suitability in Annuity Transactions Model Regulation.

2010 brought major developments to the scope and application of the NAIC suitability model rule: first, the NAIC adopted extensive amendments to the model rule, and, in July 2010, Congress passed the Dodd-Frank bill, which included the Harkin Amendment, a “safe harbor” provision for indexed annuity products, which afforded protection only upon adoption of the 2010 revised model rule.

The 2010 amendments to the 2003/2006 version of the rule largely centered on three core areas:

  • Increased Insurer Oversight and Compliance Obligations
    Here, the 2010 model rule still allows insurers to contract with a third party for performance of a supervisory function; however, now insurers may be subject to sanctions and penalties if the third party’s supervisory function is not properly performed. Insurers are required to monitor the third party’s contracted function and take appropriate corrective action when necessary.

    Insurers are also required to maintain reasonable procedures to detect recommendations that are not suitable; in other words, insurers must have a review process in place that is designed to ensure that there is a reasonable basis to determine that every recommendation to purchase, replace, or exchange an annuity is suitable. In this regard, insurers are required to provide an annual report to senior management regarding the efficacy of the suitability review procedures.

  • New Insurance Producer Training Requirements
    The 2010 model requires insurance producers to complete both product-specific training and general annuity product training prior to soliciting the sale of an annuity product. In the first instance, insurers must provide product-specific training and training materials that explain all material features of the annuity product. The general annuity training course must be at least long enough to qualify for 4 CE credits and must address a variety of informational topics related to annuities.

    For producers who sell in multiple states, the model rule allows for completion of the one-time, four-hour annuity training course in one state to satisfy this general training requirement in a different state, as long as the training requirements are substantially similar. Insurers must verify that an insurance producer has completed the annuity training course before that producer is allowed to sell an annuity product for that insurer.

  • Enhanced Suitability Standards
    The 2010 amended rule is similar to the 2003 version in that insurers or insurance producers must still have “reasonable grounds” to believe that recommendation to purchase (or exchange or replace) an annuity is suitable for the consumer based on the facts disclosed by the consumer. But in the 2010 version of the rule, the suitability determination goes beyond the consumer’s general financial situation and needs. In addition to the consumer’s financial status, tax status, and financial objectives, the 2010 model rule sets forth a list of itemized “suitability information” that insurers or insurance producers must make a reasonable effort to obtain. This 12-point list includes the consumer’s: age, annual income, financial situation and needs, including the financial resources for funding the annuity, financial experience, financial objectives, intended use of the annuity, financial time horizon, existing assets, liquidity needs, liquid net worth, risk tolerance, and tax status.

    In addition, when assessing suitability, insurers or producers must have a reasonable basis to believe that the consumer has been reasonably informed regarding various features of the annuity, including limitations on returns and potential surrender charges; the consumer would benefit from certain features of the annuity; and the particular annuity, as a whole, including the underlying subaccounts, are suitable for the consumer.

Harkin Amendment To Dodd-Frank
Following the adoption of the revised 2010 suitability model, in July 2010 Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, which included an amendment authored by Senator Tom Harkin of Iowa to provide a safe harbor for fixed indexed annuities: Section 989J of the Act provided that fixed indexed annuities would be considered insurance products and exempt from regulation as securities as long as the indexed annuity is either (a) sold by an insurance carrier that is domiciled in a state that has adopted the 2010 model revisions or (b) sold in a state that has adopted the 2010 model revisions.

With leadership from the state insurance commissioners and, especially, with the passage of the Harkin Amendment, state legislatures and state departments of insurance began to take action to adopt the 2010 NAIC Suitability in Annuity Transactions Model Regulation

Status of Adoption of 2010 Suitability Model Rule by the States

The second of the two charges given to the Annuity Suitability Working Group is to “consider how to promote greater uniformity across NAIC member jurisdictions.” As of this writing, 44 states plus the District of Columbia have adopted the 2010 suitability model regulation, in full or in part. (Also, North Carolina has recently introduced legislation directing the NC Dept. of Insurance to adopt rules “substantially similar” to the model rule.) While the majority of the states have adopted regulations that substantively conform to the model, some states, such as Arizona and Indiana, have adopted the producer training requirements only, and other states, such as Montana and New York have adopted the enhanced suitability standards without the producer training requirements. In addition, several states (e.g., California, Florida, and Minnesota) have suitability standards that go beyond the model requirements. Five states – Arkansas, Nevada, New Mexico, Pennsylvania, and Vermont – have not yet taken action to adopt the revised 2010 suitability model rule. So, despite general – and growing – consensus around the model rule, it is clear there is not uniformity across the states.

Where Does the Suitability Model Rule Fit in a (Potential) Fiduciary World?

In terms of the first articulated charge, the working group is grappling with this question: should the NAIC proactively revise the current suitability model rule in light of the current federal regulatory landscape? An ancillary question is whether the NAIC should take action before individual states move to adopt stricter suitability standards.

There is still great uncertainty as to where the Department of Labor’s fiduciary duty rule will end up. As we are all aware, President Trump has ordered the Department to conduct a complete review of the rule in order to determine whether the rule should be revised, rescinded, or left as is. Despite his clear direction to complete this review before moving forward with the implementation of the rule, the Department intends to make applicable certain aspects of the rule – including, most distressingly, the onerous Impartial Conduct Standards – on June 9, 2017, before it has seriously begun, much less completed, the mandated review. The industry and Congress have pushed back hard on the Department’s end-run, and NAFA has launched a concerted grassroots effort to delay the June 9th date.

In the meantime, four different lawsuits are progressing through the court system challenging the rule, including NAFA’s lawsuit, which is in appeal before the U.S. Court of Appeals for the D.C. Circuit; and the SEC could act to implement a uniform fiduciary standard on financial advisors that might also capture sellers of fixed and fixed indexed annuities.

Given all this, the NAIC has taken action to review and revise the model, perhaps along the line of adopting a “best interest” or quasi-fiduciary-type standard – which some have called suitability-plus. Because any change would have great impact on the fixed annuity industry, NAFA will continue to monitor the activities of the Annuity Suitability Working Group and will engage with the working group so that the interests of NAFA members and annuity consumers are advanced and protected.

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