On December 27, 2017, the New York Department of Financial Services (NYS-DFS), the regulatory authority for the insurance industry in New York, published a proposal (New York Proposal) to add a “best interest” standard to Insurance Regulation 187 (the New York Regulation), a regulation that imposes suitability requirements on annuity recommendations by producers and insurers in New York. The New York Proposal was issued a few weeks after the National Association of Insurance Commissioners (NAIC) suitability working group exposed a proposal (NAIC Proposal) to add a “best interest” standard to the NAIC Model Suitability Regulation (NAIC Model), putting the New York Proposal on a path for potential adoption before the NAIC completes its process.

State Suitability Regulations

A majority of states, including New York, have adopted laws or regulations requiring insurance producers to make “suitable” annuity purchase and replacement recommendations to consumers and requiring insurers to maintain a supervision system designed to achieve compliance with their laws and regulations governing suitability. To a considerable extent, these laws and regulations draw upon the NAIC Model, which was most recently updated in 2010.

Suitability under a Cloud

The “suitability” touchstone at the heart of the NAIC Model and the New York Regulation has been under a cloud since 2015, when the Department of Labor (DOL) published a rulemaking proposal (fiduciary rulemaking) to expand the investment advice fiduciary definition and standards for ERISA plans and IRA accounts. This proposal, which was adopted by DOL in 2016 and partially implemented in June 2017, applies to insurance producers recommending annuities for ERISA plans and IRA accounts. The fiduciary rulemaking also encompassed new and updated prohibited transaction exemptions (DOL exemptions) that articulated a “best interest” standard for advice to ERISA plans and IRA accounts, requiring fiduciaries to provide advice in the “best interest” of the retirement investor “without regard to” the fiduciaries’ financial interests. In finalizing the DOL exemptions, the DOL emphasized that its “best interest” standard is not the same as a “suitability” standard and in its view is a higher standard.

While the public record suggests that DOL conferred with state insurance regulators in developing the “best interest” standard, state insurance regulators did not come together to focus on the implications of DOL’s best interest standard for state annuity suitability regulations until last year. As discussed below, state insurance regulators, acting primarily through the NAIC, are considering enhancements to existing suitability standards to encompass a “best interest” standard similar to the DOL standard.

NAIC Proposal’s Key Elements

The NAIC Proposal would make the following key changes to the NAIC Model that state insurance regulators could then consider incorporating into their existing suitability regulations:

  • Best Interest Standard. The NAIC Proposal requires that an annuity purchase and replacement recommendation not only be suitable as is currently the case, but also be in the “best interest” of the consumer at the time the recommendation is made. Notably, the NAIC Proposal does not substitute “best interest” for suitability; rather, the NAIC Proposal requires that a recommendation be both “suitable” and in the “best interest” of the consumer.
  • Best Interest Defined. The NAIC Proposal defines “best interest” to mean “acting with reasonable diligence, care, skill and prudence in a manner that puts the interest of the consumer first and foremost.” This definition is similar to the DOL best interest standard, but differs in using the “first and foremost” qualifier instead of the “without regard to” qualifier in the DOL standard.
  • But Not “Best Available” or “Least Expensive.” The NAIC Proposal clarifies that “best interest” does not mean that a recommendation must be for the least expensive annuity product, or the annuity product with the highest stated interest rate or income payout rate available at the time, or the single “best” annuity product available in the marketplace at the time of the transaction.
  • Not Limited to IRA Annuities. The NAIC Proposal applies to recommended sales and replacements of all annuities for consumers, regardless of whether the annuity is purchased for an IRA account subject to the DOL’s best interest standard.
  • Scope Expanded to Solicitation, Negotiation and Sales. The NAIC Proposal expands the “scope” of the NAIC Model to apply to solicitation, negotiation and sales of annuities, in addition to recommendations, but most of the operative provisions continue to focus on “recommendations.”
  • More Suitability Information. The NAIC Proposal expands the “suitability information” that a producer must make reasonable efforts to obtain from a consumer before making a recommendation to include information about the consumer’s risk tolerance for changes in nonguaranteed elements in an annuity and a consumer’s financial resources to fund the annuity.
  • Producer Evaluation Responsibility. The NAIC Proposal requires a producer to evaluate the types of financial products that correspond to the consumer’s disclosed suitability information and address the consumer’s financial objectives.
  • Substantial Financial Benefit Standard. The NAIC Proposal requires that any replacement recommendation be based on a determination that the replacement would provide a substantial financial benefit to the consumer over the life of the product.
  • New Disclosures. The NAIC Proposal requires consumer disclosures of any limitations the producer or the insurer has in regard to the type of financial products that can be provided, whether only specific insurance company products or a limited range of annuity products can be offered, the scope of the services provided, and the scope of the producer’s licenses. The NAIC Proposal also requires consumer disclosures of any and all material conflicts of interest, the percentage or amount of cash compensation above 3% that the producer would receive, whether the producer would receive non-cash compensation from an insurer or intermediary (such as an insurance marketing organization (IMO)), and the basis or bases for the annuity recommendation.
  • Senior Exploitation Training Required. The NAIC Proposal requires that producer training include training on financial exploitation of seniors and other vulnerable adults.
  • Reasonable Cash Compensation Limitation. The NAIC Proposal prohibits a producer from receiving more than reasonable cash compensation in making a recommendation, from making any materially misleading statements about the annuity transaction, or basing a recommendation on the producer’s own financial interest. In this regard, the NAIC Proposal defines “reasonable cash compensation” as cash compensation that reflects the time and complexity of the product and the transaction involved and is not connected to the volume of production.
  • Prohibited Practices. The NAIC Proposal adds a new section on “prohibited practices,” that prohibits receiving more than reasonable compensation, and prohibits making material misstatements or basing a recommendation on the producer’s or insurer’s own financial interest.

The proposal to require that cash compensation be “reasonable,” and to define “reasonable compensation” as compensation reflecting time and complexity of the advice, are clearly taken from the “impartial conduct standards” included in the DOL exemptions, and do not appear to have a historical basis in insurance regulation. In this respect, the NAIC Proposal is likely to be viewed as introducing new standards into the insurance industry for producer compensation.

New York Proposal’s Key Elements

The New York Proposal contains a number of the elements of the NAIC Proposal, such as the requirement that a recommendation be both suitable and in the best interest of a consumer, additional suitability information requirements, and senior exploitation training requirements. But the New York Proposal moves significantly beyond the NAIC Proposal in the following respects:

  • Applies to Life Insurance. The New York Proposal applies to life insurance recommendations, as well as annuity recommendations.
  • Applies to Modification and Election Recommendations. The New York Proposal applies not only to recommendations for purchase and replacement transactions, but also to recommendations relating to modifications or an election of a contractual provision.
  • Applies to Hold or No-Action Recommendations. The New York Proposal applies to recommendations to a consumer that the consumer refrain from entering into a transaction.
  • Applies to All Producers in Chain. The New York Proposal applies to “every producer in the transaction” (e.g., presumably including wholesalers) regardless of whether the producer had direct contact with the consumer.
  • Uses “Without Regard To” Standard. The New York Proposal uses a definition of “best interest” that is more in line with the DOL description (i.e., that a recommendation is made “without regard to” the financial or other interests of the producer, insurer or other party) rather than the “first and foremost” standard in the NAIC Proposal. The New York Proposal does not include the qualifying text in the NAIC Proposal that “best interest” does not mean the “single best” product.
  • Defines “Suitable.” The New York Proposal introduces a definition of “suitable” as meaning “in furtherance of a consumer’s needs and objectives under the circumstances then prevailing, based upon the suitability information provided by the consumer and all available products, services and transactions.”
  • Requires Assessment of Consumer Financial Ability to Pay. The New York Proposal requires a producer to have a reasonable basis to believe that the consumer has the financial ability to meet the financial commitment under the policy. (This particular provision is likely to be more relevant in the case of a policy contemplating ongoing payments.)
  • Consumer Disclosures. Like the NAIC Proposal, the New York Proposal requires consumer disclosure of the basis for a recommendation, but the New York Proposal elaborates that this disclosure address all “relevant suitability considerations and product information, whether favorable or unfavorable.”
  • Required Product and Comparison Disclosure. The New York Proposal requires an insurer to provide to a consumer “all relevant policy information with respect to evaluating any transaction or proposed transaction, including a comparison, in a form acceptable to the superintendent, of all available policies of the same product type offered by the insurer.”

While the New York Proposal does not include the compensation disclosure elements of the NAIC Proposal, it appears likely this is a result of such disclosure obligations already existing under New York Regulation 194.

Of final note, the New York Proposal prohibits a producer from stating or implying that a recommendation is part of financial planning, financial advice, investment management or related services unless the producer has a specific certification or professional designation in that area. This prohibition arguably may be inconsistent with the NAIC Proposal’s requirement (discussed above) that a producer evaluate the types of financial products which correspond to the consumer’s disclosed suitability information and address the consumer’s financial objectives.

Next Steps. Comment periods are in effect for both the NAIC Proposal and the New York Proposal. The comment period for the NAIC Proposal is scheduled to end on January 22, 2018, after which the NAIC is likely to expose a revised draft. The 60-day comment period for the New York Proposal is scheduled to end on February 25, 2018. It is yet unclear whether NYS-DFS will publish a revised draft after considering comments submitted during the current comment period, or proceed directly to adopting the Proposal. Under New York law, NYS-DFS can proceed with adopting a rule proposal without an additional review-and-comment period, if it deems the final changes made to the proposal are immaterial.