U.S. may soon regulate Indexed Annuities as insurance products

It will take an act of Congress but insurers could be very close to getting what they’ve been seeking for the last two years — a declaration that equity indexed annuities will be regulated as insurance products, and not as securities.

A House-Senate conference committee working on the nearly 2,000-page financial services reform legislation, approved an amendment proposed by Sen. Tom Harkin, D-Iowa, on separate votes. Senators on the committee approved the measure 8-4, and House conferees also gave it a thumbs-up.

H.R. 4173 now moves to each chamber for a final yes-or-no vote. Supporters are hoping to have it ready to be signed by President Obama by the first week in July, but the death of Sen. Robert Byrd, D-W.Va., and concerns from other senators about changes that have been made to the bill could delay a vote (see related article elsewhere in this edition).

“We are pleased that Senator Harkin’s amendment passed the Senate and was accepted by the House and will clarify the status of these products,” said Nick Gerhart, vice president of compliance communications at American Equity Investment Life Insurance Company. “The amendment encourages the adoption of the NAIC model suitability rule and further enhances the consumer protections the industry has in place. We support final passage.”

The Harkin Amendment is a response to the SEC’s vote in December 2008 to adopt Rule 151a and regulate indexed annuities as securities starting in 2011. Indexed annuities provide a base, guaranteed return and could pay more, depending on the performance of a stock-market index. The rule was intended to apply to indexed annuities in which the payout “is more likely than not” to exceed the amount guaranteed under the contract.

The Harkin Amendment would give insurance departments regulatory authority when indexed annuities satisfy standard nonforfeiture laws or one of two NAIC nonforfeiture model laws. They would also have to be issued by a company domiciled in a state that has suitability requirements that meet or exceed the NAIC’s Suitability in Annuity Transactions Model Regulation. Further, the company would have to have nationwide suitability standards that meet or exceed the requirements of the suitability model.

But the amendment almost died several times before it was finally approved. First, it faced significant opposition from the beginning from Sen. Jack Reed, D-R.I., and others who opposed it. Reed said Harkin had misinterpreted a federal appeals court ruling by saying it meant the SEC had no jurisdiction over indexed products. Reed also said “there have been repeated abuses of this product.”

That opposition, though ultimately unsuccessful, was significant because Reed chairs the securities subcommittee of the Senate Banking, Housing and Urban Affairs Committee.

Insurance supporters also had to get over a major hurdle just to have the amendment considered. Typically, amendments can deal only with existing language and Harkin’s Amendment wasn’t part of either the House or Senate versions of the legislation that was being reconciled.

Reed objected once again, saying, “This is a major amendment of securities law without any hearings or debate. I don’t think this is the proper place to make such a change.”

But Senate conferees were given the go-ahead to vote on it after the Senate parliamentarian said it was relevant to the issues before the conference committee.

That in itself was a master stroke, but the amendment almost died again during the all-night negotiations that continued after the Senate conferees had approved it, but before the House members had acted. In those critical hours, the Congressional Budget Office responded to a request from Rep. Barney Frank, D-Mass, who had asked about the cost.

“About $1.0 billion over 10 years,” CBO said in its memo to the chairman of the House Financial Services Committee.

You read that right. The CBO said it would cost a billion dollars for an amendment would prevent the federal government from spending a single dime to regulate an insurance product.

Here’s the logic from Mark Booth, CBO’s unit chief of revenue estimating: “We estimate that the amendment would result to some degree in a shift in economic activity out of immediately taxable investments and into tax-deferred equity annuities, with an estimated revenue [read that to mean “tax”] loss of about $1.0 billion over 10 years.”

“That logic is so backward it’s unbelievable,” said Jim Poolman, a lobbyist for the 151a insurance coalition. Even so, he said he wasn’t surprised to hear that one of Harkin’s staffers told others on the coalition, “You guys are screwed.”

Which left Frank, who hasn’t exactly been on the insurance side of this issue, with all the ammunition he needed to derail it if he chose to do so.

Poolman said discussions continued until 3 or 4 in the morning, when, “in the end, Frank let it go. Under the rules, Congress has to find ways to pay for programs without adding to the budget deficit, and we think Frank was more worried about finding the other $19 billion to pay for the rest of the bill.”

Poolman, a former North Dakota insurance commissioner, said that, in the end, “We’re pleased that Congress saw the value of state insurance regulation and saw the SEC’s action as a pure overreach of its authority. Fixed indexed annuities haven’t lost a dime. That’s because they’re insurance products and are guaranteed.”

That’s not how the Consumer Federation of America saw things. It was generally pleased with a bill that “marks the biggest transformation of financial regulation in this country since the Great Depression.” But it wasn’t pleased at all with the Harkin Amendment, which it said would defer regulation of indexed annuities to “weaker insurance rules” and “open a gaping hole in investor protections without any assurance that the insurance regulation relied on in its place is adequate or effective.”

Said CFA director of investor protection Barbara Roper: “It is dispiriting to see members of the conference committee vote to weaken investor protections and undermine SEC authority in the very bill that is supposed to restore investor confidence and market integrity.

“It sends a sobering message to those who are counting on Congress and regulators to stand up to self-interested industry pleadings and insist on tough enforcement of the reforms it is preparing to adopt,” she added.

That view doesn’t square with insurers and insurance regulators, who have insisted all along that indexed annuities are insurance products because they offer a fixed and guaranteed rate of return first and an additional benefit if a specified index or indices surpassed certain benchmarks.

The NAIC said as much in a June 22 letter to the top leadership of the House Financial Services Committee and the Senate Banking Committee. “Indexed annuities are fundamentally insurance products and should be regulated by state insurance regulators who can approve annuities contracts before they can be introduced to the market, monitor individuals involved with the sales and marketing of the annuities, and regulate the investments and financial strength of the issuing company,” said the letter signed by the NAIC’s officers.

“The language offered by Senator Harkin, combined with the continued activities of the NAIC, will ensure continued strong protection of consumers investing in these products,” the letter concluded.

Pending passage of the legislation and the president’s signature, that insurance-or-securities debate should now be moot. “This is an insurance product,” Harkin said after conferees voted. “It always has been and still is today. The SEC’s got a lot of other things to do than regulate what is now an insurance market.”

He’ll get no argument from Eric Marhoun, general counsel for the Old Mutual Financial Network. “We are pleased the Senate and House conferees have taken an important step in clarifying the status of these guaranteed insurance products and we support final passage of the measure.”

Old Mutual joined with American Equity Investment Life and others in a lawsuit to overturn Rule 151a and a federal appeals court ruled last summer that the SEC had the authority to regulate indexed products, but hadn’t proved its case that it should. The court said the SEC hadn’t considered the impact the rule would have on efficiency, competition and capital formation.

“Our company, with many good allies, has been working steadfastly for two years to overturn Rule 151a and it is our intention to see this through,” Marhoun told ICI. “Given these developments, we hope and anticipate the rule will be either formally vacated by the D.C. Court of Appeals or set aside by the SEC so the SEC can focus on its core jurisdiction.”

Alan Prochoroff is the editor and publisher Insurance Compliance Insight.

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(06/29/10)