On April 27, New York's Department of Financial Services (NY DFS) issued its updated proposed First Amendment (Updated First Amendment) to New York's Suitability in Annuity Transactions, 11 NYCR 224 (the Annuity Suitability Rule). The issuance of the Updated First Amendment follows the NY DFS' "careful" consideration of all comments submitted on the December 27, 2017 version of the proposed First Amendment. While some of the changes reflected in the Updated First Amendment will smell sweet, it is unclear whether the cloud of uncertainty that formed pending the Updated First Amendment will result in May flowers or June bugs as the industry tries to implement the changes necessary to comply with the requirements in the renamed Suitability in Life Insurance and Annuity Transactions (the Life & Annuity Suitability Rule).
To address the different types of recommendations, the NY DFS, like a gardener, propagated the requirements of the Life & Annuity Suitability Rule by:
- Creating two different standards for the suitability information to be obtained from consumers based on whether the recommendation is for a term life insurance product with no cash value or for any other policy type; and
- Creating two different standards for the duties of insurers and producers based on whether the recommendation is for a sales transaction or an in-force transaction.
In addition, the NY DFS pruned the prior First Amendment by:
- Snipping a number of duties to "transactions" to cut down the potential expansiveness of the prior First Amendment;
- Trimming the definition of recommendation;
- Clipping how the financial interest of the producer, insurer, or any other party should be considered in the recommendation; and
- Cutting back the products that must be considered in the suitability analysis to those "available to the producer" so long as the consumer receives disclosure on the limited range of policies considered in making the recommendation.
The NY DFS also fertilized the Life & Annuity Suitability Rule by:
- Adding new requirements if fee-based and commission-based versions of a policy are available; and
- Clarifying the nature and extent of supervisory controls that an insurer must maintain—but in so doing the NY DFS appeared to hack away at the Annuity Suitability Rule by removing insurers' ability to contract with third parties to supervise producers.
A brief discussion of the Life & Annuity Suitability Rule and some of the questions buzzing around it follows.
Recognizing the variety of genres among policies, the Updated First Amendment requires suitability information based on the "materiality of the transaction," the "complexity of the transaction recommended," and whether the transaction is for a policy "solely providing term life insurance with no cash value" or "any other policy." The Life & Annuity Suitability Rule includes a general condition that the required suitability information is the:
information that is reasonably appropriate to determine the suitability of a recommendation commensurate with the materiality of the transaction to a consumer's financial situation at the time of the recommendation and the complexity of the transaction recommended,including the following, as relevant to the consumer.
The specified lists for a policy solely providing term life insurance with no cash value and for any other policy set forth the following same eight items:
- Annual income;
- Financial situation and needs, including financial resources used for the funding of the policy;
- Financial objectives;
- Intended use of the policy, including duration of existing liability and obligations;
- Existing assets, including investments and insurance holdings;
- Tolerance of non-guaranteed elements in the policy, including variability in premiums, death benefit, or fees; and
- Any other information provided by the consumer which in the reasonable judgement . . . is relevant to the suitability of the transaction.
The specified list for any other policy also sets forth the following five items:
- Financial experience;
- Liquidity needs;
- Liquid net worth;
- Risk tolerance; and
- Tax Status.
The Updated First Amendment's language suggests it may be necessary to develop multiple suitability information forms based on the complexity of the various products. Moreover, each suitability form must provide a means to gather information in addition to the information specified based on the "including" and "commensurate with the materiality of the transaction to a consumer's financial situation" language. Insurers are also tasked with "ensuring that every producer recommending any transaction with respect to the insurer's policies is adequately trained to make the recommendation in accordance with the provisions of [the Life & Annuity Suitability Rule]." This means that insurers would need to ensure that producers are adequately trained in assessing the situations where additional information would be required to make the suitability determination.
Duties for a Sales Transaction or an In-Force Transaction
The prior First Amendment expanded the scope of the Life & Annuity Suitability Rule to apply to "any transaction or recommendation with respect to a proposed or in-force policy." The Updated First Amendment bifurcates transactions into "sales transactions" and "in-force transactions" and implements differing best interest duties for each.
A sales transaction is:
the purchase or issuance of a policy, any replacement . . . conversion, or any modification or election of a contractual provision with respect to an in-force policy that generates new sales compensation.
Under this new definition of sales transaction, if a producer would receive compensation in connection with a recommendation to "renew" a multi-year guarantee annuity contract or to annuitize a contract, the producer must comply with the best interest duties and other duties for a sales transaction.
The best interest duties of producers and insurers with respect to a sales transaction under the Updated First Amendment are nearly identical to those under the prior First Amendment, except for a new requirement when fee-based and commission-based versions of a policy are available, as further discussed below. In addition, the other duties under the Updated First Amendment are substantially similar, except for a new disclosure duty in the event that the producer's range of policies recommended is limited, as further discussed below.
An in-force transaction is:
any modification or election of a contractual provision with respect to an in-force policy that does not generate new sales compensation.
The best interest duties and other duties of producers and insurers with respect to an in-force transaction are a subset of those required for sales transactions. Interestingly, for an in-force transaction, no suitability information is required to be obtained. Yet, there still is an obligation to:
- Act with the care, skill, prudence, and diligence that a prudent person acting in a like capacity and familiar with such matters would use under the circumstances; and
- Not make a recommendation to a consumer to enter into an in-force transaction about which the producer has inadequate knowledge.
Seemingly, to satisfy these in-force transaction duties, some amount of knowledge of a customer's current situation would be needed to make the in-force transaction recommendation. It is not clear whether determining what information to gather would be left to the producer or insurer.
Many of the Duties are Limited to Transactions
While the term "recommendation" includes advice that results in a consumer entering into or refraining from entering into a transaction, as noted above, the best interest duties are limited to sales transactions and in-force transactions. And, the definitions of transactions appear to encompass only actions – purchase of a policy and making a modification or election under a policy. Moreover, as further discussed below, many of the insurers' responsibilities are limited to sales transactions. However, insurers are nonetheless required to have standards and procedures that are tied solely to "recommendations" as follows:
- Review of complaints regarding recommendations inconsistent with the best interest of the consumer;
- The prevention of incentives that are intended or would reasonably be expected to cause producers to make recommendations that are not in the best interest of the consumer; and
- The auditing and/or contemporaneous review of recommendations to monitor producers' compliance.
It is unclear whether insurers are required to implement standards and procedures for recommendations to refrain from entering into a transaction. For example, the best interest requirements are limited to sales transactions and in-force transactions and not to recommendations to refrain from entering into a transaction. Similarly, the requirement to obtain suitability information is limited to sales transactions, meaning there would be no means for insurers to audit recommendations to refrain from entering a transaction.
Definition of Recommendation
To limit the communications that are considered recommendations under the Life & Annuity Suitability Rule, the Updated First Amendment splices the following new language into the definition of recommendation:
A recommendation does not include general factual information to the public, such as advertisements, marketing materials, general education information regarding insurance or other financial products and general administrative services to the consumer.
While this new language will allow for a greater variety of consumer communications, the highlighted language reflects that any consumer communication that is tailored toward the consumer will likely fall within the meaning of a recommendation. Thus, it is unclear whether responding to consumer questions about the potential consequences of a proposed in-force transaction would be viewed as "factual information," "general education information," or "general administrative services." Unless the NY DFS provides some additional clarity, insurers and producers would need to exercise care in engaging in any tailored discussions unless they comply with the various duties of the Life & Annuity Suitability Rule.
Under the prior First Amendment, producers' and insurers' recommendations were required to be "without regard to" their own financial interest. The Updated First Amendment changed the language to state:
The financial or other interests of the producer, insurer, or any other party other than the consumer, shall not be considered in any respect in making the recommendation.
This language seems to merely require that the financial interest of producers and insurers in a sales transaction not be a factor in their decision-making for their recommendations. This also seems to suggest that in documenting "the basis for any recommendations made . . . and the factors and analysis to support the recommendation" there would need to be a statement that the financial or other interests of the producer or insurer were not a factor in the recommendation.
Suitability Based on Products Available to the Producer
Under the prior First Amendment, suitability required a consideration of "all available products, services, and transactions." The Updated First Amendment recognized that the producers' may not have access to all products, services, and transactions, and changed the language to state:
Suitable means in furtherance of a consumer's needs and objectives under the circumstances then prevailing, based upon the suitability information provided by the consumer and all products, services, and transactions available to the producer.
However, to the extent that the products, services, and transactions available to the producer are limited, it appears that the Updated First Amendment also adds a new disclosure requirement, as follows:
A producer may limit the range of policies recommended to consumers based on a captive or affiliation agreement with a particular insurer, where the producer prominently discloses to each consumer in writing prior to a recommendation, in a form acceptable to the superintendent, the nature of the agreement and the circumstances under which the producer will and will not limit the recommendations.
This language raises a number of questions, including:
- Does the disclosure obligation really apply to all situations as it is unlikely that any producer is appointed and authorized to recommend the wide range of policies available through all insurers?
- Is the NY DFS going to create a form that can be used by producers, or will producers have to file their own forms with the NY DFS?
- What obligation do insurers have with respect to this disclosure – does the required system of supervision mean that insurers have to establish, maintain, and audit producers with respect to this disclosure obligation?
It is important to note that the Life & Annuity Suitability Rule specifically states that the required "disclosure is insufficient if it merely states that the producer may limit recommendations without specific disclosure of the extent to which recommendations are, in fact, limited."
New Requirements if Fee-Based and Commission-Based Versions are Available
The NY DFS took notice that traditional commission-based polices are being hybridized into fee-based versions, and the Updated First Amendment includes new requirements when fee-based and commission-based versions of a policy are available as follows:
- An obligation on the person making the recommendation to a consumer to ensure a consumer has been reasonably informed of any differences in features among fee-based and commission-based versions of the policy; and
- An obligation on the insurer when it offers a fee-based version and a commission-based version of a policy, to provide to the consumer a comparison, in a form acceptable to the superintendent, showing the differences between the products.
These new requirements raise a number of questions, including:
- What happens if only the fee-based version of a policy or only the commission-based version of a policy is available for sale by a producer because the producer's employer has restricted the version that the producer may sell? For example, if an employer has decided that all customer accounts will be fee-based only, is the producer nonetheless required to provide information on the commission-based version of the product that is not available through the producer and about which the producer may not have information?
- Is the insurer required to provide the comparison form when the producer working with the consumer is only permitted to sell one version?
- Is the NY DFS going to create a form that can be used by insurers, or will insurers have to file their own forms with the NY DFS?
- With respect to a fee-based version, will an insurer be required to show the asset-based fee the consumer is being charged? If so, how will the insurer know this information? Absent information on the asset-based fee, could consumers misinterpret the comparison as showing the commission-based version as "more expensive"?
Required Insurer Supervisory Controls
A purpose added by the Updated First Amendment is to "clarify the nature and extent of supervisory controls that an insurer must maintain" to comply with the Life & Annuity Suitability Rule. The Updated First Amendment does so by consolidating all of the supervision requirements into Section 224.6. The Updated First Amendment clarifies that for an in-force transaction, an insurer is not required to have a basis that the in-force transaction is suitable because that requirement only applies to sales transactions. As discussed above, it is unclear what type of supervisory controls would be required for in-force transactions.
The Updated First Amendment also added as part of the required supervisory controls, the requirement to establish standards and procedures for the prevention of incentives that are intended or would reasonably be expected to cause producers to make recommendations that are not in the best interest of the consumer. Because an insurer has no way of knowing the compensation practices of other insurers, it seems this requirement would necessarily cause insurers to limit the amount and types of compensation paid and to limit other benefits and perquisites provided to producers to avoid any appearance of having incentives that would cause producers to make recommendations that are not in the best interest of consumers.
It is important to note that in consolidating the insurers' supervisory requirements into Section 224.6, the NY DFS appears to have removed prior language in the Annuity Suitability Rule allowing an insurer "to contract with a third party to establish and maintain a system of supervision with respect to producers." It is unclear whether this language was inadvertently dropped when the requirement to establish a supervision system was moved from Section 224.4(f), or whether the omission is intentional. The absence of the authorizing language is significant for the industry as insurers typically rely on third parties, such as registered broker-dealers, to supervise the sales of their registered representatives.
If finally issued the Life & Annuity Suitability Rule would take effect March 1, 2019. According to the Updated First Amendment, any transaction with respect to an annuity must comply with the Life & Annuity Suitability Rule on March 1, 2019. Any transaction with respect to a life insurance policy, must comply with the Life & Annuity Suitability Rule six months from the March 1, 2019 effective date.
Before its final issuance, the Updated First Amendment is subject to a 30-day notice and public comment period following its anticipated May 16, 2018 publication in the New York State Register. Hopefully following the comment period, the NY DFS will be willing to fix the bugs in the Life & Annuity Suitability Rule, and give a longer period for the industry to implement the new requirements.
We will continue to monitor and report on the activities of the NY DFS and the NAIC's Annuity Suitability Working Group.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.