Annuity Illustrations Under Fire

[Regulators Target Wild Assumptions’ with New Rules]

S TATE REGULATORS are close to adopting rules that would clamp down on illustrations that companies and producers offer with fixed annuities—illustrations that critics have called unrealistic and inconsistent.

The regulation would require that all fixed annuity illustrations meet certain standards to represent all costs and product information accurately and prevent what a National Association of Insurance Commissioners official calls “wild assumptions” that are being used by some sellers. It would also place compliance squarely on companies, meaning producers would likely need approval for any illustration that producers use.

The regulations would apply only to companies and producers that choose to offer illustrations with their fixed annuities. But that doesn’t rule out the possibility that, in the future, illustrations could be required with all fixed annuities, says Jim Mumford, chair of the regulatory group that developed the proposed regulations for the NAIC.

“Currently half, or maybe less, of annuity companies use fixed annuity illustrations,” says Mumford, who is also first deputy insurance commissioner and securities administrator in the Iowa Insurance Division. “But if it later turns out that most companies offer them, we (NAIC) might then look at whether to make it (illustration use) mandatory.”

Some annuity experts like the overall requirements in the proposed regulation but are unhappy that the use of illustrations would remain voluntary.

As Sheryl Moore, president and CEO of, an indexed product 22 InsuranceNewsNet Magazine September 2011 resource in Des Moines, puts it, “if the proposed regulations are to have an impact and be effective, the illustrations need to be mandatory.”

Michael Prestwich, president of ImageSOFT, Inc., Albuquerque agrees: “If the model is totally voluntary, I am not sure what it will accomplish. It’s like what happened with state seatbelt laws. The states made seatbelt use voluntary at first, but many people did not use their seatbelts, so the states made seat-belt use mandatory.”

Both executives have been watching the growth in use of annuity illustrations in recent years. Moore says that over half of the indexed annuity companies in her firm’s database provide illustrations with indexed annuities. She noticed the growth starting seven years ago. Prestwich says that one carrier that uses his company’s annuity illustration software has quadrupled its usage in just the last year.

Moore and Prestwich both have seen a lot of the annuity illustrations that have been coming out and also the software used to create them. Both have concluded, separately, that many of the documents produced by the software are, or can be, misleading. They’ve also concluded that, without mandatory regulations, consumers will not be getting the information they need to make a good decision about the products they are considering.

The NAIC Annuity Disclosure Working Group, which developed the regulations, is aware of these concerns, says Mumford. In fact, the group weighed the merits of making fixed annuity illustrations mandatory, optional or prohibited, he says.

In the end, the group decided to start with the optional route. In part, that’s because annuity illustration use is not yet industry-wide. Also, Mumford says, the companies that do not provide fixed annuity illustrations “don’t want to have to start offering them. They think the disclosure documents they already provide have all the necessary information and explain how the product works.”

So, for now, the plan is to start by requesting adoption of the proposed regulations with illustration use being voluntary and then “see how the market reacts” before reconsidering the mandatory route.

The Regulations

The illustration regulations are among proposed revisions to NAIC’s Annuity Disclosure Model Regulation, which was first adopted in 1999 and has not been changed since. The NAIC Life Insurance and Annuities (A) Committee, which oversaw development of the revisions, approved the changes in a conference call early last month. At press time, the regulations were slated for consideration at NAIC’s summer meeting in Philadelphia.

If adopted by the NAIC Executive Committee, the revised model will go to the Plenary, where Mumford predicts it will pass with a two-thirds majority. The revised model would then go onto the states for adoption.

Only 16 or 17 states adopted the original disclosure model, says Mumford. But he believes that many if not most states will adopt the new version—expressly because it includes, in a new Section 6, the illustration regulations. He says regulators have told him that they want to implement fixed annuity illustrations, because they have received reports that many illustrations are unrealistic and inconsistent, leave out important details or misconstrue product and company information.

The regulations seek to address the problem by setting standards for illustration of guaranteed and non-guaranteed elements for traditional fixed annuities as well as fixed indexed annuities. The proposed rules do not address variable annuity illustrations because the Financial Industry Regulatory Authority (FINRA) is in charge of regulating these illustrations.

Section 6 says the illustration shall not “describe non-guaranteed elements in a manner that is misleading or has the capacity or tendency to mislead; state or imply that the payment or amount of non-guaranteed elements is guaranteed; or be incomplete.”

It says costs and fees “of any type” shall be individually noted and explained, and that the illustration shall recognize in the annuity value any charges for riders or other contract features assessed against the account value or the crediting rate. Where fixed indexed annuities are concerned, it lays out three different “scenarios” for determining the non-guaranteed illustrated values.

Impact on Producers

In states that adopt the regulations, producers would have to present the annuity buyer’s guide and disclosure documents at the same time that they present the product illustration, even if the client never decides to buy. “It’s a package deal,” says Mumford. If the producer is offering a variable annuity, the producer would have to give the customer a buyer’s guide for annuities, in addition to the prospectus required by the Securities and Exchange Commission (SEC) and the illustration required by FINRA. “Again, it’s a pack-age deal,” he says. All three documents must be given to the client even if a customer is just participating in an informational or educational session during which an illustration is presented, Mumford points out. The Annuity Disclosure Working Group was “pretty adamant (on this). The group didn’t want to let that illustration (go) out there all alone, without all the other information.” Also, “producers should know that the illustrations won’t necessarily show how the product values will end up,” says Mumford. “Not even close. In the case of fixed indexed annuities, they will show how the product works in different scenarios, such as good markets and bad markets.” For traditional fixed annuities, the illustrations would have to show current interest rates. That means producers “can’t illustrate interest rates other than what the insurance company is currently offering for the product,” Mumford says. “You can’t go higher and you can’t use wild assumptions.”

Other Consequences

The proposed regulations would make the companies responsible for complying with the illustration requirements, Mumford continues. The rules would also level the playing field between illustrations for traditional fixed annuities and fixed indexed annuities, he says. Prestwich of ImageSOFT believes the initiative is a “good thing,” even though it is not mandatory, because it is calling for standards in an area that is currently unregulated. There are so many moving parts to fixed indexed annuities, that it’s easy for consumers to misunderstand what they are buying, he explains. The standards, if adopted, will help ensure that consumers who receive illustrations will get all the information they need—about the guar-anteed and non-guaranteed elements, fees, loads, etc.—to make an informed decision. It’s better for the customer to see the values, projected out over all the policy years, that to see just a formula in the product materials that tells how the values are calculated, he contends. “A product note could indicate that a guaranteed income rider costs 1 percent, and that this cost will be deducted from the policy values every year. But it’s hard for a customer to see the actual impact of that on policy values without seeing an illustration that shows the cost in dollars on a year-by-year basis—for instance, that a particular rider might end up costing $25,000 over several years.” Seeing that dollar amount in an illustration would be helpful in the decision-making, he says. The problem with many fixed annuity illustrations is that many have been produced with software obtained from third-party vendors that have no background in insurance or credentials in annuities or in software development, says Moore of “As a result, their illustrations often contain inaccurate calculations and inflated values.”

Some illustrations are developed by agents themselves, in some cases using calculations done in spreadsheet soft-ware, she adds. The agents’ intentions may be good, but the illustrations some-times lack key information, or use incorrect information, about things such as the issuing company and its products, she says.

Not all illustrations are that way, Moore concedes. But with so much inconsistency out there right now, the agents and distributors who use illustrations are in a bind. “They can’t be sure that the illustrations they show are in compliance,” she explains.

Moore says she has noticed that large insurance companies tend to have the financial capital and the compliance awareness to develop illustration soft-ware on their own or to endorse soft-ware from reputable vendors that meet compliance standards. But not so for smaller companies, who may find illus-trations to be too costly and time-consuming to offer.

A number of companies flat-out object to fixed annuity illustrations, points out Prestwich. “I’ve talked with CEOs of two carriers who even got angry about it. They say, ‘no, we don’t offer them and we never will.’ Some carriers even forbid their agents from doing any software calculations at all, and they say that if their agents do that, their contracts will be terminated.”

Some carriers don’t like illustrations on grounds that their disclosure documents already show the guaranteed values. And Prestwich believes others don’t like them because illustrations show actual costs for riders and other policy features—and “that’s something they prefer to hide,” he says. As a result, he predicts that the companies that don’t currently offer illustrations will continue to not offer them, even if their state adopts the new voluntary regulations.

Regulations might even lessen the use of fixed annuity illustrations, especially if companies find that providing them takes more time, work and paper, Prestwich adds.

Wondering Why

Moore says companies who oppose illustrations are overlooking an important consideration.

With illustration regulations in force, preferably in a mandatory illustration environment, “companies will be more aware of what the client is seeing than they are now,” Moore says. “That will help ensure compliance. That in turn will help deter class action lawsuits” brought by people who might otherwise (i.e., in a non-regulated environment) claim that the illustration materials they received were misleading or misrepresented certain factors.

Jack Marrion, president of Advantage Compendium Ltd., St. Louis, is predicting that the new regulations, if adopted by NAIC and then implemented by the states, will affect those agents that sell by illustration.

The percentage of agents in that category may be growing, he adds, citing two reasons:

1)      Some fixed annuity producers want to have regulations so they can compete with producers on the variable annuity side of the industry who have been selling by illustration for years. “They complain about the variable annuity illustrations, that they don’t have any-thing to combat them with,” Marrion says.

2)      Universal life insurance agents who go over to the annuity side of the business want to offer illustrations and are frustrated if their annuity carriers do not offer them. “They are accustomed to offering Illustrations with universal life policies, because the regulations for those policies say the customer has to have an illustration, so they want one with annuities, too,” he says.

The thing that puzzles Marrion is that the annuity illustration regulations have drawn so much attention. He says he has heard reports that some illustrations are “very unrealistic.” But from a complaints point of view, “this is not an issue,” he maintains.

Marrion bases his view on research he has conducted into complaints about annuities that have been filed with state insurance regulators—statistics held by the NAIC and also the individual states. “I have found no complaints involving fixed annuity illustrations in any of those records,” he says.

Marrion says he doesn’t have a problem with the proposed illustration regulations, “but from what I see, fixed annuity illustrations were never a problem in the first place.”

Linda Koco, MBA, is a contributing editor to InsuranceNewsNet, specializing in life insurance, annuities and income planning


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