SEC Commissioner To VA Sellers: You Must Comply With Reg BI, Too

A warning from the former acting chair of the Securities and Exchange Commission that life insurers may no longer be able to pay commissions on variable annuity sales hasn’t exactly set off an industry firestorm, but nevertheless could mean the elimination of some lucrative incentives and revised compensation plans for issuers of the policies.

Most of all, it created confusion.

Speaking last month at the American Law Institute Continuing Legal Education 2021 Conference, Commissioner Allison Herron Lee told life insurance company lawyers that variable annuity issuers will have to comply with the SEC’s Regulation Best Interest, not just state or industry annuity conflict of interest rules, such as the National Association of Insurance Commissioners annuity sales' model regulation.

“As states continue to adopt and implement the NAIC model,” Lee said, “I encourage those of you in the securities and insurance industries to evaluate your policies and procedures, to ensure they are consistent with both standards.”

Eighteen states so far have adopted the NAIC best-interest model regulation.

Conflict Mitigation

At the center of the issue are rules to prevent insurance agents from recommending products that carry profitable incentives and commissions over ones that might be more suitable for the policyholder but not as lucrative for the agent, a subject of a spate of lawsuits in the last decade.

But the industry has come a long way to rectify problems since then, experts say.

A 2016 Department of Labor fiduciary rule sought to correct conflicts of interest and disclosure requirements for financial services. The rule was struck down by the courts in 2018, but not before many companies instituted polices for compliance; practices that are still in place.

Last February, the NAIC approved best-interest rules clarifying that all recommendations by agents and insurers must be in the best interest of the consumer and that agents and carriers may not place their financial interest ahead of the consumers' interest in making a recommendation. Industry experts believed the NAIC model is a companion to the SEC Regulation Best Interest and there’s not a great divide between the two.

However, some debate has erupted over specifics of the arcane language in both, such as a standard definition of “recommendation,” whether some conflicts are acceptable, what exactly does “mitigation” mean and whether the NAIC model even goes far enough.

“[Commissioner Lee] apparently believes the NAIC model does not have the same requirements regarding conflict management as Reg BI has,” said Issa Hanna, counsel at the law firm of Eversheds Sutherland. “Reg BI has more specific and expansive standards when it comes to managing conflicts that are associated with recommendations. So, I think the reason why she is making this point is because she doesn't want to see individual insurance producers or registered representatives thinking that they can engage in certain conflicted practices that are permissible under the NAIC model.”

Not Much Difference

But those familiar with both rules say there’s not much light between the two.

“We think that it would be very, very difficult to come up with a scenario where a form of compensation or a type of incentive would be discouraged or prohibited under the SEC model, but would somehow be permissible under the NAIC framework,” said Jason Berkowitz, chief legal and regulatory affairs officer of the Insured Retirement Institute, who was among those who helped draft elements of the NAIC rule.

Under both the SEC regulations and NAIC rules, brokers and dealers must make certain they are recommending products that are in the client’s best interest and not selecting a particular product because of the compensation or incentives attached to it, Berkowitz said. Moreover, they must be able to document and disclose how they reached their recommendation.

“This is really to the benefit of everybody, the advisor and the client,” he said. “You really need to be very, very thorough in documenting what processes you follow to gather all the relevant information that you need about the individual policy before deciding what to recommend and what analysis you conducted to determine which product you actually encouraged the consumer to consider purchasing.”

The mitigation standards, he said, would require sales documentation to be reviewed by another agent or supervisor or in some cases, even a panel of colleagues.

Another Fiduciary Rule?

But despite the compatibilities of the two regulations, Berkowitz believes the industry can expect some changes associated with the SEC’s warning about compliance, particularly increased scrutiny and companies revisiting and revising their compensation structures and incentive programs.

“I think a lot of those programs are already being reevaluated and restructured,” he said. “So, I don't know that we would necessarily expect to see a massive shift. But you might see some incremental changes to those sorts of programs as the SEC’s model regulation gets more traction across the country.”

In addition, Berkowitz said the industry expects a rewritten DOL fiduciary rule to be unveiled soon and is girding for yet another level of compensation and incentive requirements.

“I think there was a real recognition by the industry that even though that particular DOL rule was struck down, the direction of the overall regulatory environment was going in the direction of being more thoughtful about what sorts of policies and procedures and practices and compensation structures should be permitted,” he said. “And so rather than saying, ‘Oh, this rule went away, we're gonna just revert back to our old status quo,’ they sort of looked at the new world and said, ‘Well, we're doing better by our clients now,’ with the new policies that were developed.”

Doug Bailey is a journalist and freelance writer who lives outside of Boston. He can be reached at [email protected].