On December 21, 2009, the Life Insurance and Annuities (A) Committee (the "A Committee") unanimously adopted the revisions to the Suitability in Annuity Transactions Model Regulation (the "Suitability Regulation") developed in substance by the Suitability in Annuity Sales Working Group (the "Working Group"). The Working Group proposed a December 1, 2009 draft of the revisions at the December 6, 2009 meeting of the A Committee in San Francisco. The A Committee asked Iowa to coordinate efforts to make certain clarifying and technical amendments to the December 1, 2009 draft and Iowa proposed a December 17, 2009 draft with such amendments (the "December 17th Draft").

At the December 21st meeting, Jim Mumford, First Deputy Insurance Commissioner of Iowa, explained that in drafting the revisions to the Suitability Regulation, the Working Group sought to incorporate three key features into the Suitability Regulation: (i) imposing responsibility for compliance with the Suitability Regulation on insurers; (ii) requiring a review of every recommended annuity sale; and (iii) requiring producer training with respect to annuities in general and with respect to the specific recommended annuity product. While the December 17th Draft does not include all the various provisions requested by regulators and interested parties and there are certain provisions that may benefit from further clarification, various regulators asserted that the December 17th Draft substantially improved consumer protection. Several regulators and interested parties recommended that the A Committee consider forming a group that would develop guidelines or "frequently asked questions" to clarify certain provisions of the December 17th Draft. To become final, the December 17th Draft must be approved by the NAIC Executive Committee and Plenary. Each state must then adopt the Suitability Regulation before it would apply in the state, with the December 17th Draft providing an effective date six months from adoption.

Discussed below are the key revisions made by the December 17th Draft to the existing Suitability Regulation, along with some considerations for insurers and producers as they reflect on the impact of the revisions to their practices. The December 17th Draft:

  • Specifies additional "suitability information" that must be collected to determine the suitability of a recommendation. The December 17th Draft incorporates most of the information required by FINRA Rule 2821. Unlike FINRA Rule 2821, it also requires information on the "financial resources used for the funding of the annuity."

As a result of the additional required suitability information, an insurer may need to change its application or other forms to ensure that all the suitability information is collected from a consumer. In addition, if the financial resource for the funding of the annuity is a security, producers and insurers may wish to consider whether this requires the producer to also be securities licensed.

  • Expands the standard for making a recommendation by requiring the producer, or if no producer is involved, the insurer, to have reasonable grounds for believing all four of the following are true:

(1) The consumer has been reasonably informed of the various features of the annuity;

(2) The consumer would benefit from certain features of the annuity;

(3) The particular annuity as a whole is suitable; and

(4) In the case of an exchange of an annuity, the exchange is suitable, including taking into consideration whether:

(a) The consumer will incur a surrender charge, be subject to the commencement of a new surrender period, lose existing benefits (such as death, living or other contractual benefits), or be subject to increased fees, investment advisory fees or charges for riders and similar product enhancements;

(b) The consumer would benefit from product enhancements and improvements; and

(c) The consumer has had another annuity exchange and, in particular, within the preceding 36 months.

These impose on producers (i) a new disclosure requirement and (ii) three specific considerations in making the suitability determination. In light of positions taken by some regulators in market conduct examinations, for the purposes of subsequent examination by state insurance regulatory authorities, insurers should consider what documentation would reflect the producers' compliance with the disclosure requirement and their assessment of the specific considerations underlying each recommendation.

  • Generally prohibits "an insurer [from issuing] an annuity recommended to a consumer unless the annuity is suitable based on the consumer's suitability information."

This provision, along with the revisions regarding penalties, clarifies that insurers are responsible for the outcome of each recommended annuity sale. Thus, to the extent that a recommended annuity sale is not suitable, insurance regulatory authorities will most likely assert that the insurer must take corrective action. In determining whether any penalty or sanction should be imposed, the insurance regulatory authority may consider whether the insurer previously took voluntarily corrective action.

Some state insurance regulatory authorities have asserted that insurers should have an independent duty to assess suitability, not just review their producers' suitability determinations. Thus, it is possible that some states will further modify (or interpret) this language to impose an independent obligation on insurers to determine suitability.

  • Continues to allow the sale of an annuity if a consumer chooses to "optout" of providing the consumer's suitability information, but imposes the following additional requirements:

(1) The customer must sign a statement documenting the customer's refusal to provide suitability information;

(2) The customer must sign a statement that the annuity transaction is not recommended; and

(3) The issuance of the annuity must be reasonable under all the circumstances actually known to the insurer at the time the annuity is issued.

To the extent that an insurer allows a consumer to opt-out of providing suitability information, the producer will be required to obtain the requisite consumer statements. In light of positions taken by some regulators in market conduct examinations, insurers should consider what documentation would reflect the producers' compliance. In addition, insurers should consider how they will assess the information received to determine whether the sale of the annuity to such consumers is reasonable, and to consider how they will document such assessment for purposes of subsequent examination by state insurance regulatory authorities.

  • Revises the supervision requirements imposed on insurers by specifying procedures that must be included in a supervision system that is reasonably designed to achieve the insurer's and its producers' compliance with the Suitability Regulation. These minimum procedures must include:

(1) A means to inform producers of the requirements of the Suitability Regulation and incorporating the requirements into producer training manuals;

(2) A means to assure that producers comply with specified producer training;

(3) Providing product specific training and training materials which explain all material features of the annuity products;

(4) A review of each recommendation of an annuity prior to issuance to determine that the recommendation is suitable, which may be accomplished through a screening process designed to identify recommendations that are subject to additional review;

(5) A means to detect recommendations that are not suitable, which may be accomplished by confirming consumer suitability information, systematic customer surveys, interviews, confirmation letters and programs of internal monitoring that may take place after the issuance or delivery of the annuity; and

(6) An annual report to senior management that details a review and testing of the effectiveness of the supervision system, including any exceptions found and corrective action taken or recommended.

Insurers should review their existing training requirements and supervision and suitability review procedures and consider whether additional training, supervision and suitability review procedures are needed to comply with these requirements. This includes procedures for annual testing of the insurers' supervision system. Insurers may wish to document their procedures for training, supervision and suitability review for purposes of subsequent examination by state insurance authorities.

  • Continues to allow an insurer to contract with third parties to perform the insurer's supervision system, but clarifies that the insurer is responsible for taking appropriate corrective action and may be subject to sanctions and penalties. Accordingly, it requires insurers to monitor and, as appropriate, conduct audits to ensure that the contracted function is properly performed and obtain an annual certification from a senior manager of the contracted party that the function is being properly performed.

Insurers contracting with third parties will need to develop a procedure for monitoring and auditing the functions contracted to the third parties. In addition, consistent with one of the three key principles, regulators will seek to ensure that insurers are ultimately responsible for suitable sales. As result, to the extent that a recommended annuity sale is not suitable, it is likely that insurance regulatory authorities will assert that the insurer must take corrective action.

  • Clarifies that if fixed annuity sales (in addition to variable annuity sales) are made in compliance with FINRA suitability and supervision requirements, the transaction satisfies the Suitability Regulation (the "FINRA Safeharbor"). In addition, the December 17th Draft imposes two new conditions in order to rely on the FINRA Safeharbor.

(1) The insurer must monitor the FINRA member's transactions "using information collected in the normal course of the insurer's business"; and

(2) The insurer must provide reports to the FINRA members that are "reasonably appropriate to assist in the FINRA member's maintenance of its supervision system."

Insurers should consider what information it is currently collecting with respect to monitoring annuity sales practices for non-FINRA sales and whether this type of information could be used to monitor FINRA members' transactions or would be reasonably appropriate to assist the FINRA members' maintenance of its supervision system. This may be an area for which additional guidance should be sought from any working group formed by the A Committee.

  • Imposes new producer training requirements, as follows:

(1) Product specific training so the producer has adequate knowledge in order to recommend the product; and

(2) A minimum four hour training course on annuities and appropriate sales practices, replacement and disclosure requirements.

Insurers should review their procedures to require its producers to comply with these new training requirements and revise or adopt appropriate procedures. In addition, insurers should review their product materials provided to producers to ensure that they explain all material features of the annuity so the producer has adequate knowledge.

  • Specifies that in the event of a violation of the Suitability Regulation, the applicable insurance regulatory authority may order corrective action as well as penalties and sanctions. It also permits the insurance regulatory authority to reduce the penalty if corrective action was taken after a violation was discovered or the violation was not part of a pattern or practice.

Consistent with one of the three key principles, regulators will seek to ensure that insurers are ultimately responsible for suitable sales and will likely require corrective action for any unsuitable sales. While the interested parties raised concerns that the revised language could be used to impose sanctions and penalties for a single violation instead of requiring a "pattern or practice," regulators noted that states have different legal standards required to prove violations. Accordingly, a "pattern or practice" is not required in all states, and insurers should be sensitive to any unique legal standards used to determine a violation of the Suitability Regulation by the individual state insurance regulatory authorities. The definition of "pattern or practice" may be an area for which additional guidance should be sought from any working group formed by the A Committee.