In a surprising and stunning decision, the New York Supreme Court Appellate Division struck down Regulation 187, which established tough rules governing the sale of life insurance and annuities.
The late-April ruling left the industry both delighted and wondering, “What’s next?”
Regulation 187 stood as an outlier regulation ever since it took effect in 2019. First, it closely resembles the fiduciary rule put forth by the Obama administration. Producers recommending higher-priced, complex annuity and life insurance products face a high compliance barrier.
Second, the regulation was extended to life insurance sales on Feb. 1, 2020. By contrast, the Suitability in Annuity Transactions regulation update completed in 2020 by a National Association of Insurance Commissioners’ working group is a lower barrier that applies only to annuity sales.
Insurers and producers agreed they could live with the new NAIC standard, which has been adopted by nine states as this issue went to press. Seven more states are considering the NAIC update.
Some insurers and producers decided the New York regulations were too onerous and avoided selling products in the state. For them, the court decision overturning Regulation 187 was especially satisfying.
But it raised an obvious legal question: If a New York court determined that the state’s best interest standard is “unconstitutionally vague” and uses “subjective terms,” what does that mean for the NAIC model?
New York regulators had no interest in the NAIC plans when it came to writing new rules for annuity sales. While NAIC regulators worked to update their suitability model, their New York counterparts quickly passed Regulation 187.
It mandates enhanced disclosure and documentation, required of the producer and insurance carrier, as well as training programs. Only the interests of the consumer are to be considered in any recommendation, and producers must act with the care, skill, prudence and diligence that a prudent person acting in a like capacity and familiar with such matters would use.
The Independent Insurance Agents and Brokers of New York and the Professional Insurance Agents of New York State filed suit in 2018 to stop the regulation. The National Association of Insurance and Financial Advisors-NY filed a separate suit that was later joined with the Big I-NY/PIA-NY lawsuit.
The lawsuits made several arguments, including that Regulation 187 conflicts with governing statutory scheme and is beyond the respondent’s authority to impose; it is unreasonable, arbitrary and capricious and lacks a rational basis; and it is unconstitutionally vague.
The Supreme Court Appellate Division agreed, reversing a lower-court ruling.
The court noted that the regulation uses “subjective terms,” “fails to provide sufficient concrete, practical guidance for producers,” and “provide[s] insufficient guidance with respect to how producers must conduct themselves in order to comply.”
Industry observers were thrilled by the decision.
“Our members have tried mightily to comply with the regulation, but, as the court found, it has been extremely difficult to meet the vague and subjective standards of the rule,” said Finseca CEO Marc Cadin.
The court’s decision acknowledged that Regulation 187 provides examples of what a producer’s “recommendation” triggering the “best interest” analysis did not include, (marketing materials, general advertisements and educational information).
However, the definition of “recommendation” was so broad that it provided to the producer no clear guidance as to what information or advice would not fall within the scope of the regulation, the law firm Bressler, Amery & Ross noted in a blog post.
About That NAIC Model
That brings us to the NAIC model that so many states are rushing to adopt. It, too, tends to rely on similar broad language. The model states that “to satisfy the best interest obligation,” a producer or an insurer must satisfy four obligations: care, disclosure, conflict of interest and documentation.
To satisfy the four obligations, when making a recommendation, producers must:
» Know the consumer’s financial situation, insurance needs and financial objectives;
» Understand the available recommendation options;
» Have a reasonable basis to believe the recommended option effectively addresses the consumer’s financial situation, insurance needs and financial objectives;
» Communicate the basis of the recommendation to the consumer;
» Disclose their role in the transaction, their compensation, and any material conflicts of interest; and
» Document, in writing, any recommendation and the justification for such recommendation.
It’s fair to question whether other state best-interest rules could be successfully challenged in court. And would anyone want to? Many industry executives and their legal teams have come to accept best interest as an acceptable standard, one that at least avoids the dreaded fiduciary label.
Or it might be a moot point. The New York State Department of Financial Services seems likely to appeal the appellate court decision, although that had not been decided by press deadline.
“DFS continues to believe in the consumer protective notion that insurance agents and brokers must not put their own profits above the needs of the consumers who turn to them for advice; this is the heart of the regulation. We are reviewing the decision and will consider our appellate rights,” a DFS spokeswoman said in a statement.
Otherwise, it is not unusual for rules to be vague, noted Fred Reish, fiduciary expert and a partner at Faegre Drinker in Los Angeles.
“Many rules, including the fiduciary prudent man rule, are principles-based and necessarily vague, at least as compared to rules that define specific acts,” he said. “In a principles-based environment, as opposed to a rules-based world, the issue is usually whether the advisor or agent has followed a thoughtful, professional process to reach a decision or recommendation. Those concepts are embedded in many of our laws and are not going away.”