All fixed and variable annuities are governed by a comprehensive state regulatory framework. State laws govern the organization and licensing of insurance companies, and state insurance departments oversee insurance company operations. Generally, annuity contracts and amendments must be filed with, and approved by, each state in which contracts are sold. Insurance agents (often referred to as “producers”) need to be licensed in each state in which they operate. Only licensed insurance agents may sell annuity contracts.
The National Association of Insurance Commissioners (NAIC) is a voluntary organization of the chief insurance regulatory officials of the 50 states, the District of Columbia, and five U.S. territories that promotes best practices and uniformity in state insurance laws. It has developed numerous “model laws” and “model regulations” that are designed to protect consumers and maintain the financial stability of the insurance marketplace. Each state can decide whether to adopt these model laws and model regulations and are free to modify them as they deem appropriate.
Insurance Company Licensing
In order to offer annuity products in a state, an insurance company must be licensed in that state. A company needs to be licensed regardless of whether it is a “domestic” insurance company (i.e., organized in the state) or a “foreign” insurance company (i.e., organized in another state). To be licensed, an insurance company must be organized according to specific state laws. Before it is granted a license, an insurance company must demonstrate compliance with strict capital, surplus, and financial requirements. In addition, the state scrutinizes the experience and character of the company’s management. The state issues a license only if it determines that the company is organized in such a way that it will protect the interests of its contract owners.
Agent Licensing and Appointment
Insurance agents must be licensed by state insurance departments. Applicants must submit a form to the state providing information about their experience, character, and financial responsibility. They also have to pass a written examination. (Agents selling variable annuities are also regulated by the SEC and FINRA.) Insurance agents also must be appointed by each insurance company for which he or she serves as agent.
Contract Requirements and Prior Regulatory Approval
Annuity contracts and related forms generally must be filed and approved in every state where they will be sold. An alternative, more streamlined method of obtaining state approval is to file through the Interstate Insurance Product Commission (IIPRC), of which 41 states are currently members. While there is no standard required form for annuity contracts, states and the IIPRC mandate that certain provisions be included in all contracts, such as a free-look provision that allows a contract owner to examine the contract for a period of time and return it for a refund if dissatisfied for any reason. Generally, contracts need to be readable and cover all of the contract’s basic features before the state will approve the contract for sale. Amendments to contracts also must be filed and approved. If the amendment could adversely affect existing contract owners’ rights, prior approval from the contract owners may be required.
Protection Against Insurance Company Insolvency
State Guaranty Funds
All states, the District of Columbia, and Puerto Rico have guaranty funds to protect contract owners against insurance company insolvency. Insurers doing business in a state must contribute to that state’s guaranty fund. The actual coverage provided for annuity contracts varies from state to state, but cash values and annuity benefits generally are protected for at least $100,000. Coverage generally is not provided for variable annuity contracts other than those portions that are guaranteed by the insurance company, e.g., fixed accounts.
Insulation From Insurance Company’s Creditors
Variable annuity contracts are issued through life insurance company separate accounts. When a contract owner allocates purchase payments to a variable investment option under a variable annuity contract, those assets are held in the separate account. The assets in the separate account are insulated against the creditors of the insurance company in the event of the company’s insolvency (in some states, annuity assets are also shielded from the contract owner’s creditors).
Regulation of Annuity Sales Practices
Most states have adopted advertising rules governing the marketing of annuity contracts. State insurance departments review advertising materials periodically. Advertising rules are designed to prevent misleading, deceptive, or confusing advertisements, based on the overall impression that the advertisement may reasonably be expected to create upon a person of average intelligence within the segment of the public to which the advertisement is directed.
Unfair Trade Practices Rules
All states have adopted unfair trade practices acts with provisions that apply to an insurer’s activities. These laws define and prohibit unfair methods of competition and unfair or deceptive business practices, including those involved with the issuance, sale, and administration of annuity contracts.
NAIC Suitability in Annuity Transactions Model Regulation
The NAIC Suitability in Annuity Transactions Model Regulation (the “Suitability Model”) sets standards for suitable annuity recommendations and requires insurers to establish a system to supervise annuity recommendations. The Suitability Model is patterned after similar FINRA requirements governing the suitability of variable annuity transactions, which are described below. Compliance with the FINRA requirements is deemed to satisfy the requirements of the Suitability Model Regulation. As of the date of publication, 45 states and the District of Columbia have adopted either the current version of the Suitability Model (which was adopted by the NAIC in 2010) or one of the previous versions. Three other states have suitability rules that do not follow the Suitability Model.
Among other things, the Suitability Model requires an insurance producer, when making a recommendation to a consumer to purchase or exchange an annuity, to make reasonable efforts to obtain “suitability information,” such as the consumer’s age, annual income, financial objectives, and risk tolerance, that is “reasonably appropriate” to determine the suitability of the recommendation. It also requires the insurance producer to have “reasonable grounds” for believing that the recommendation is suitable for the consumer based on the suitability information and other facts provided by the consumer. In addition, the insurance producer must have a “reasonable basis” for believing: that the consumer has been “reasonably informed” of the annuity’s features; that the consumer would benefit from certain of those features; that the annuity as a whole, the underlying investment options selected by the consumer, and any riders or similar product enhancements are suitable for the consumer; and in the case of an exchange or replacement of an annuity, the exchange or replacement is suitable. If no insurance producer is involved, these requirements apply to the insurer.
The Suitability Model also requires insurers to establish a supervisory system that is “reasonably designed” to achieve compliance with its requirements, including procedures for reviewing recommendations before issuing an annuity to ensure there is a “reasonable basis” to determine that a recommendation is suitable, as well as “reasonable procedures” for detecting recommendations that are not suitable.
NAIC Annuity Disclosure Model Regulation
The NAIC Annuity Disclosure Model Regulation (the "Disclosure Model") requires that consumers be provided an Annuity Buyer's Guide and a disclosure document. As of the date of publication, one state has adopted the latest version of the Disclosure Model (which was adopted by the NAIC in 2010), while approximately 30 states have adopted either the previous version or annuity disclosure rules that do not follow the Disclosure Model.
The current version of the Disclosure Model applies to fixed, fixed indexed, and variable annuities (except for non-registered variable annuities issued exclusively to accredited investors or qualified purchasers), while the previous version applied only to fixed and fixed indexed annuities. For variable annuities, the disclosure document requirement will apply after January 1, 2014, unless and until the SEC adopts a summary prospectus rule or FINRA approves for use a simplified disclosure form applicable to variable annuities.
The revised Disclosure Model also includes standards for fixed and fixed indexed annuity illustrations that require, among other things: a narrative summary (unless the information is provided at the same time in a disclosure document); a numeric summary; for annuities with market value adjustment features (MVA), a narrative explanation of the MVA, a demonstration of the MVA under at least one positive and one negative scenario, and actual MVA floors and ceilings; and for fixed indexed annuity illustrations, specific requirements on illustrating non-guaranteed values. These illustration standards do not apply to variable annuity illustrations.