The New Best Interest Standard for Annuity Sales: An Overview of Revisions to the NAIC’s Model Regulation #275

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In February 2020, the National Association of Insurance Commissioners (NAIC) approved revisions to its Suitability in Annuity Transactions Model Regulation (#275). The revised regulation requires that all annuity recommendations by producers and insurers meet a “best interest” standard.

Under the new model regulation, insurance producers and carriers may not place their financial interests ahead of the consumer’s interest when recommending an annuity product. Furthermore, insurers are required to establish and maintain a system to supervise producer recommendations, so the insurance needs and financial objectives of consumers are addressed effectively. The new model also prohibits an insurer from issuing an annuity product to a consumer unless the insurer has a reasonable basis to believe the annuity would address the consumer’s insurance needs and financial objectives effectively.

The NAIC’s new best interest standard uses the Securities and Exchange Commission’s recent Regulation Best Interest as a model. For the past 10 years, insurance regulators have used a “suitability” standard, similar to the Financial Industry Regulatory Authority’s (FINRA), to regulate annuities sales. The best-interest standard on sales and recommendations of annuity products by insurance producers is a higher standard than the 2010 model regulation’s suitability requirements, but it does not reach the level of a fiduciary duty.

A producer would be deemed to have acted in the consumer’s best interest if the producer meets the obligations of care, disclosure, conflict of interest, and documentation that are detailed in the model regulation. Insurance companies are required to supervise producer compliance with this rule and to maintain compensation systems that will not undermine the best interest of clients.

Like the 2010 model regulation, the new model regulation requires that producers be trained in its requirements. For producers new to selling annuities, the new model calls for a four-hour training course. For veteran producers who were trained under the old model regulation, the new model regulation allows for a one-hour update course, although the regulation makes this option available only for the first six months after their state adopts the new rule (states may vary this time period).

The new model regulation applies only to the recommendation or sale of an annuity. It also provides for various exemptions from its requirements, such as exemptions for certain group annuities. The model also provides a safe harbor for sales and recommendations made in compliance with “comparable standards,” for example, those that comply with applicable SEC or FINRA securities requirements for broker-dealers and registered investment advisers.

The NAIC recommends that states amend their annuity sales regulations in response to the new model regulation. The NAIC’s 2010 Model Regulation was adopted by 45 states and the District of Colombia in the wake of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. Previous projections suggested that half the states could adopt the model regulation in some form by the end of 2020,  but may be delayed due to the COVID-19 pandemic.

An Important Note

This following content summarizes and highlights key revisions made to the NAIC’s model regulation #275—it is not the complete version of the model regulation itself. Please see the full text of the revised and complete model regulation here. Additional information on Model Regulation #275 is available here.

Best Interest Obligation: Reasonable Diligence, Care, and Skill

Under the NAIC’s revised Suitability in Annuity Transactions Model Regulation (#275), producers must now “exercise reasonable diligence, care, and skill” when recommending an annuity and shall act in the best interest of the consumer, under the circumstances known at the time the recommendation is made, without placing the producer’s or the insurer’s financial interest ahead of the consumer’s interest.

A producer’s obligations regarding care, disclosure, conflict of interest, and documentation include making appropriate recommendations that consider the consumer’s financial situation, insurance needs, and financial objectives, and reasonable efforts must be made to obtain consumer profile information from the consumer before making a recommendation.

Thus, a producer must be familiar with the annuity options available. Of those annuities the producer is authorized and licensed to sell, the producer must have a reasonable basis to believe the consumer would benefit from certain features of the annuity, such as annuitization, death or living benefit, or other insurance-related features. The producer must also be able to communicate the basis of the recommendation.

Consumer profile information; characteristics of the insurer; and product costs, rates, benefits, and features are generally relevant factors in determining whether an annuity addresses a consumer’s financial situation, insurance needs, and financial objectives. While each factor’s importance may vary depending on a consumer’s circumstances, each factor may not be considered in isolation.

Producers must make an effort to gather customer profile information to determine whether a recommendation addresses the consumer’s financial situation, insurance needs, and financial objectives, including age, income, assets and liabilities, financial experience, objectives, time horizon, use of the annuity, liquidity needs, risk tolerance, and tax status.

When exchanging or replacing an annuity, a producer must consider the whole transaction, factoring in surrender charges, commencement of a new surrender period, loss of existing benefits, increased fees, and other exchanges or replacements made within the previous five years. The new product must substantially benefit the consumer in comparison to the replaced product for its duration.

Disclosures

The model regulation requires specific disclosures of the customer relationship between the producer and consumer, the products the producer is authorized or licensed to sell, and the producer’s compensation. The model regulation requires the use of a disclosure form (“Insurance Agent [Producer] Disclosure for Annuities”)signed by both the producer and customer; an example is provided as an appendix.

Customer relationship: Before making a recommendation or selling an annuity, a producer must disclose in writing the scope and terms of the relationship with the consumer and the producer’s role in the transaction.

Products: The producer must state which products the producer is licensed and authorized to sell (fixed, fixed-indexed, and variable annuities; life insurance; mutual funds; stocks and bonds; and certificates of deposit).

Insurers: The producer must provide a statement describing the insurers for which the producer is authorized, contracted, appointed, or otherwise able to sell insurance products by indicating one insurer, from two or more insurers, or from two or more insurers although primarily contracted with one insurer.

Compensation: The producer must also describe the sources and types of cash and non-cash compensation received, including whether the producer is to be compensated for the sale of a recommended annuity by commission as part of a premium or other remuneration received from the insurer, intermediary or other producer or by a fee as a result of a contract for advice or consulting services; and a notice of the consumer’s right to request additional information regarding cash compensation. Upon request, the producer must disclose a reasonable estimate of the amount of cash compensation to be received, which may be stated as a range of amounts or percentages; and whether it’s a one-time or multiple occurrence amount, and if a multiple occurrence amount, the frequency and amount, which may be stated as a range of amounts or percentages.

Conflicts of Interest: A producer shall identify and avoid or reasonably manage and disclose material conflicts of interest, including material conflicts of interest related to an ownership interest.

Documentation: At the time of recommendation or sale, a producer must document any recommendation and its basis in writing. Should a customer refuse to provide consumer profile information, the producer must obtain a statement signed by the consumer that documents the customer’s refusal and the customer’s understanding of the implications of not providing consumer profile information. The model regulation provides a sample form (“Consumer Refusal to Provide Information”) as an appendix. Furthermore, a producer must obtain a statement signed by the consumer acknowledging that the annuity transaction is not recommended if a customer decides to buy an annuity that is not recommended by the producer.

Application of best interest: Any requirement that applies to one producer must apply to each producer who was involved in the recommendation and has received direct compensation as a result, regardless of consumer contact. Providing marketing or educational materials, product wholesaling or other back office product support, and general supervision of a producer do not, in and of themselves, constitute material control or influence.

Transactions not based on a recommendation: A producer shall have no obligation to a consumer if no recommendation is made, if a recommendation was made and was later found to have been based on materially inaccurate information provided by the consumer, if a consumer refuses to provide relevant consumer profile information and the annuity transaction is not recommended. If a consumer decides to purchase an annuity transaction that is not based on a recommendation, a disclosure must be made in writing and signed by both the producer and consumer. The model regulation provides a sample form (“Consumer Decision to Purchase an Annuity NOT Based on a Recommendation”) as an appendix.

Reasonable basis: Except as described under transactions not based on a recommendation, an insurer may not issue a recommended annuity unless there is a reasonable basis to believe it would effectively address a consumer’s financial situation, insurance needs, and financial objectives, based on the consumer’s consumer profile information.

Supervision System

An insurer must establish and maintain a supervision system that is reasonably designed to achieve the insurer’s and its producers’ compliance with model regulation #275, including:

Review

The insurer shall establish and maintain procedures for the review of each annuity recommendation prior to issuance that are designed to ensure that there is a reasonable basis to determine that the recommended annuity would effectively address the particular consumer’s financial situation, insurance needs and financial objectives.

Non-compliance detection

The insurer shall establish and maintain reasonable procedures to detect recommendations that are not in compliance, including confirmation of the consumer’s profile information, systematic customer surveys, producer and consumer interviews, confirmation letters, producer statements or attestations, and internal monitoring. The insurer shall establish and maintain reasonable procedures to identify and address suspicious consumer refusals to provide consumer profile information.

Verification

The insurer shall establish and maintain reasonable procedures to assess, prior to or upon issuance or delivery of an annuity, whether a producer has provided to the consumer the required information.

Sales incentives

The insurer shall establish and maintain reasonable procedures to identify and eliminate any sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sales of specific annuities within limited periods of time. The insurer is not required to make its compensation system incentive-neutral with those of other carriers that may have different system. (But differences between carriers are still subject to the rule that prohibits placing the producer’s or insurer’s interests ahead of the consumer’s.)

Effectiveness of supervision program

The insurer shall annually provide a written report to senior management, including to the senior manager responsible for audit functions, which details a review, with appropriate testing, reasonably designed to determine the effectiveness of the supervision system, exceptions found, and any corrective action recommended or taken.

Safe Harbor

Recommendations and sales of annuities made by registered broker-dealers, investment advisers, or a plan fiduciary in compliance with business rules, controls, and procedures that conform to a comparable standard, such as the SEC’s Regulation Best Interest, shall satisfy the requirements under this regulation as long as the insurer monitors the relevant conduct of the financial professional or the entity responsible for supervising the financial professional.

Compliance Mitigation, Penalties, Enforcement

Insurers are responsible for compliance with this regulation. If a violation occurs, the commissioner may order an insurer or agency to take reasonably appropriate corrective action for any consumer harmed by an insurer’s failure to comply or that of a producer or contracted agent for the insurer. Appropriate penalties and sanctions may apply as well. Applicable penalties for a violation may be reduced or eliminated if corrective action is taken for the consumer is taken promptly and if the violation is not part of a pattern or practice.

Recordkeeping

Insurers, general agents, independent agencies, and producers must maintain records of information collected from the consumer; disclosures made to the consumer, including summaries of oral disclosures; and other information used in making the recommendations that were the basis for insurance transactions. Each state will specify the required number of years after the annuity transaction is completed that records are to be kept.

Producer Training

A producer who has completed an annuity training course approved by the department of insurance prior to the effective date of the amended regulation must complete either a new four-credit training course approved by the department of insurance or an additional one-time, one-credit training course approved by the department of insurance and offered by an approved education provider. The training must focus on appropriate sales practices, replacement transactions, and disclosure requirements in the amended regulation. An insurer must verify that a producer has completed the required annuity training course before allowing the producer to sell an annuity product.

RegEd offers the two courses that meet the requirements of the NAIC’s revised model regulation #275, which will be submitted for approval and continuing education (CE) credit in each state as their versions of this regulation become effective:

Recommending Annuities Under the NAIC Best Interest Standard (490)

This is the standard four-hour training course required of insurance agents before they may sell annuities. It details the standard of care agents must adhere to when recommending annuities to clients. It discusses the fact finding and analysis required to make a recommendation that is in the best interest of the client. It discusses conflicts of interests, disclosures to clients, and documentation. In addition, the course reviews the operations of different types of annuities and how they are used to meet different client needs.

Recommending Annuities Under the New NAIC Best Interest Standard—One-Hour Update Course (491)

Veteran insurance agents who previously qualified to sell annuities under their state’s version of the NAIC annuity suitability regulation may take this one-hour update course to qualify to sell annuities under the new NAIC best-interest standard. This course details the standard of care agents must adhere to when recommending annuities to clients. It discusses the fact finding and analysis required to make a recommendation that is in the best interest of the client. It discusses conflicts of interests, disclosures to clients, and documentation.

RegEd is ready to assist insurance companies manage the process of revising the standards of the Suitability in Annuity Transactions Model Regulation (#275), including tracking recommendations, managing disclosures, documentation, and other compliance obligations, supported by efficient and enabling technology and people with deep experience in the process. For more information: sales@reged.com, www.reged.com, or 800-334-8322.

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