Iowa and Arizona Adopt Best-Interest Standard for Annuity Sales Effective January 1, 2021

Iowa (Iowa Code section 507B.4A) and Arizona (Arizona Code SB 1557) passed the revised Suitability in Annuity Transactions Model Regulation effective January 1, 2021.   The National Association of Insurance Commissioners, (“NAIC”) successfully modeled the SEC Regulation BI (Section 240.151-1, eff. 6/5/19) https://www.sec.gov/rules/final/2019 and https://www.naic.org/store/free/MDL-275. to harmonize federal and state best interest standards.  The “Best Interest” obligation applies to both Insurers and Producers when making a recommendation of an annuity. 

There has been dissent by both New York and California which insisted on creating a fiduciary standard in the Model.  The revised Model however explicitly states that the Care Obligation DOES NOT create a fiduciary obligation or relationship, (see Sec. 6.A.(1)(d)).  The NAIC convened a Working Group, Chaired by Commissioner Ommen of Iowa to create Frequently Asked Questions and Answers (“FAQs”).  The Group plans to discuss them during their meeting on July 29^th. 

Below highlights practical considerations for both producers and insurers as they implement the revised Model.

Overview of the Revised Model:

Both insurers and producers are required to act in the best interest of the consumer, based on the circumstances known at the time of the recommendation, “without placing the producer’s or the insurer’s financial interest ahead of the consumer’s interest.” (Emphasis added, (section 6.A.)).

• The regulation applies to all recommendations, even where there isn’t a sale which will be a tough area to contemplate compliance and for insurers to design adequate supervision procedures
• Formal prepaid funeral contracts are excluded
• Cash compensation is broadly defined fees, commissions, sales charge etc. and specifically calls out Intermediary which is a new definition (although the independent marketing group override is outside the disclosure)
• Non-Cash compensation is also a new definition meant to eliminate sales contests directly tied to specific annuities during a limited period of time
• Consumer Profile Information, (“CPI”) replaces suitability information and is much broader-the suitability form will need to be updated to include:
  • Debts and other obligations
  • Financial resources use to fund the annuity
  • Insurance needs is a new element
  • Risk tolerance including “non-guaranteed elements” -a new definition
• A material conflict of Interest is a new definition-meaning a financial interest of the producer in the sale of an annuity that a reasonable person would expect to influence the impartiality of a recommendation but DOES NOT include cash or non-cash compensation
• Non-guaranteed elements definition was added for consumers to call out changes to the product negatively impacting rates subject to company discretion
• Producer definition includes both insurers, agents and intermediaries/marketing organizations if they are required to be licensed

Best Interest Obligation:

• Requires producers to not place financial interest ahead of the consumer’s interest (not “without regard to” producer’s financial interest
• Best Interest applies to whomever exercised material control and influence regardless if there was not direct contact with the consumer.
• Four Obligations under section 6.A.1 (in whole):
  • Care-four prongs:
    • Reasonable efforts to obtain and understand Consumer Profile Information, (“CPI”)
    • Understand the available recommendation options/types of products the producer is licensed to sell NOT to analyze or consider products outside their available portfolio; it should be noted however that there may be compliance traps associated with this requirement for producers that only have access to one or two insurers’ products or for captive agents whose insurer has inferior rates
    • Have a reasonable basis to believe the recommendation effectively addresses the consumer’s financial situation, insurance needs, and financial objectives over the life of the product (as outlined in the CPI)
      • Producers should disclose relevant factors to the consumer, including the product, and the insurer when making the recommendation & that they will benefit from certain features of the annuity (such as income rider)
    • Communicate the basis of the recommendation
  • Explicitly states that the Care Obligation DOES NOT create a fiduciary obligation or relationship
  • Replacements: the replacement must substantially benefit v. replaced annuity over the life of the product
    • Look back time frame from three to six years.
    • Explicitly disclaims any requirement for a producer to obtain any license other than an insurance license – which addresses the position that the replacement of a security is per se subject to securities laws, note however that there is a risk that the State Securities regulators may determine the replacement of a security does constitute investment advice as Illinois did so. See Van Dyke v. White, 2019 IL 121452.
    • Disclosure-the NAIC provided a template for producers to meet the first part of this obligation; including the consumer’s right to request additional information, i.e. Cash compensation.
    • The second part of this obligation focuses on the disclosure of product features that can negatively impact values prior to or at the time of the sale.
  • Conflict of Interest-producers must identify and avoid or reasonably manage and disclose material conflicts of interest. It is best to avoid these.  The final version of #275 was vague about what was covered by a “material conflict”-hopefully, the Working Group on the FAQs will address
  • Documentation-as a best practice, producers should make and keep a written record of the recommendation and basis for it
    • If the consumer refuses to provide data for the CPI, a form included in the Model should be signed
    • If the consumer wants to buy the annuity NOT based on a recommendation, the consumer must sign this statement; both of which should be rare/non-existent.
  • Carrier/Insurer supervision requirements: Equivalent to producers
    • Establish and maintain a supervision system that is reasonably designed to achieve compliance
      • Update all forms, suitability and producers guides reflecting revisions
      • Procedures to detect non-compliance and delivery of disclosures
      • Eliminate non-cash compensation based on individual products and limited time period
      • Annual report to senior management must be specific and in writing
      • Delegation allowed but with oversight, reporting and supervision
    • Producer training update: Supplements the current Model requirements to include “standard of conduct” implying that the new best interest standard and all its accompanying requirements would need to be part of the training.  For producers who have already done training, either a new 4-credit training course or an additional one-time 1-credit training course pertaining to the new standards and requirements of the amended regulation. 

Insurers Focus Area(s) to Revise or Build:

• New standard of care and how carriers will monitor if agents are meeting it
• Detecting if agent recommendations are NOT in compliance with subsections 6A, B, D, E
• Sampling attestations, interviews, other means to test compliance
• Ensuring agents are delivering the required info; query if carriers can or should require new disclosure forms
• New procedures to assess suspicious consumer refusals
• Limiting or eliminating specific sales contests, quotas, bonuses, etc. for specific annuities during a limited time; query what impact on IMOs who run similar campaigns
• Carriers to compare the suitability info on the client and ensuring that there wasn’t a product offered by the same carrier that was objectively better for the client
• Examining safe harbors provided and if workable- meeting “financial professional” and “comparable standard” tests
• How to adequately roll out new compliance training for agents, IMOs, BDs, RIAs
• Changes in forms, such as replacement forms

Despite the adoption of the new Model and Iowa and Arizona taking the lead in implementing by the first of 2021, the Department of Labor has reared its head by proposing a new exemption from the prohibited transaction provisions of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”) and the Internal Revenue Code in connection with the provision of investment advice. 

This proposal flies in the face of the revised Model by making producers/financial institutions fiduciaries in the sale of qualified products, including rollovers from an ERISA plan to a non-ERISA Individual Retirement Account (“IRA”).  It is unclear whether the NAIC or the new Working Group will take on the Department of Labor given the revised Model’s explicit language to the contrary. 

Notwithstanding the clear dispute, producers and insurers should proceed with applying the revised Model.