August 22, 2008
Many people have weighed in on this issue and many have said that the state departments of insurance should be the ones to regulate fixed index annuities since they are fixed products. Many have also have said that because fixed index annuities aren't securities, they shouldnt be regulated as such by the SEC or FINRA. I agree with both of these positions.
However, I also think that the current FINRA rules are clear about the responsibilities that broker-dealers have for fixed index annuity recommendations made by their registered representatives. Current FINRA rules are well-established on this question: if a broker-dealer's registered representative recommends a fixed index annuity to a client, then the broker-dealer is responsible for supervising that sale. However, that responsibility on the part of the broker-dealer does not make a fixed index annuity a security. Understandably, if a broker-dealer is required to supervise fixed index annuity sales, they can and should set the rules for which carriers and types of fixed index annuities can be sold by their registered representatives. So, in the current debate, it is important to draw a distinction between supervision, and fixed index annuity security status. If fixed index annuities were securities (which they are not), then broker-dealer affiliation would be required to sell them just like variable annuities. If an agent is a registered representative of a broker-dealer, any fixed index annuities the representative sells still arent securities, even though those sales are subject to broker-dealer supervision.
From what I read, hear, and see, it would seem to me that the SEC's primary concerns about the fixed index annuities are as follows: 1: surrender charges 2. complexity 3. sales practices of agents recommending them and 4. suitability for "older" clients. Let me address each one because I believe none of the SEC's concerns about these four items has anything to do with fixed index annuities being securities.
Surrender charges. Most fixed annuities (whether their interest is guaranteed or it is based on the appreciation of a stock market index) have surrender charges. If a client puts money into a fixed annuity and then withdraws a large chunk of that money during the surrender period, the annuity owner will incur a charge. Fixed annuities have been this way for decades. Incurring such a charge has absolutely nothing to do with whether the annuity is a security or not. Yes, it would be much better if annuity owners never incurred surrender charges, if all agents clearly explained annuity charges to prospective buyers, and if insurance companies built products with lower surrender charges and shorter surrender periods. Whether these things are done or not, has nothing to do with whether fixed index annuities, or fixed interest annuities, should be considered securities. Surrender charges do not make a fixed index annuity a security.
Complexity. Just because a financial product is complex doesn't make it a security. Some long-term care insurance products have cash value and are complicated. Are they now to be considered securities as well? Complexity does not make a fixed index annuity a security.
Sales Practices. Does the annuity industry need to do a better job of training its agents on when annuities are appropriate? Yes. Do agents need to do a better job explaining products? Yes. Do product brochures need to be easier to understand and more straight-forward about charges, fees, and moving parts? Yes. If the annuity industry does a poor job in these areasdoes that make a fixed index annuity a security? No. If there is a problem with agents making bad variable annuity recommendations, then let broker-dealers address those sales with their registered representatives. If there is bad conduct by agents selling fixed interest rate annuities, fixed index annuities, and immediate annuities, then let the state departments of insurance, where the sales are made, address that conduct.
Suitability for the Older Client. Should a 90-year-old invest most of her funds in any type of annuity? Probably not. For that 90-year-old, does it matter what type of annuity? No, probably not. A fixed interest rate annuity, and fixed index annuity, and a variable annuity would probably each be inappropriate. Do fixed interest annuities and fixed index annuities need to be made securities to keep the sale of them to a 90-year-old from occurring? No. Insurance companies and state departments of insurance can handle that. On the question of whether fixed index annuities are appropriate for people 65 and olderthats precisely for whom these products are built. They are ideal for those 65 and older because of their principal protection features and the fact that they provide the opportunity for growth to fight inflation. For those 65 and older, fixed index annuities are often superior to most variable annuities because they provide better protection of principal and profits. For those 65 and older, fixed index annuities are often superior to most fixed rate annuities because they provide better upside potential and inflation-fighting ability. According to a recent insurance company statistic, 52 out of 100 65-year-old married couples living today will have one spouse still alive at 90. Thats 35 years of inflation for half of all 65 year olds. A fixed interest rate annuity may provide too little growth to offset 35 years of inflation.
None of these four concerns have anything to do with regulating fixed index annuities as securities. If the SEC truly has concerns like the ones Ive addressed, then I would strongly encourage the SEC to share some of its funding with the state departments of insurance to help them do their job in regulating the sale of non-security annuity products in their respective states. It is the states job. Let them do it.