Model Regulation #275

The Annuity Suitability (A) Working Group of the NAIC Life Insurance and Annuities (A) Committee held an open meeting on Saturday, March 24, 2018 during the NAIC 2018 Spring National Meeting in Milwaukee, Wisconsin. The meeting centered on proposed revisions to the Suitability in Annuity Transactions Model Regulation #275 ("Model #275") which had been introduced at the NAIC 2017 Fall National Meeting and included a "best interests" standard designed to comport with U.S. Department of Labor's ("DOL") fiduciary rule. Model #275 was adopted to "set standards and procedures for suitable annuity recommendations, and to require insurers to establish a system to supervise recommendations so that the insurance needs and financial objectives of consumers are appropriately addressed." A recent federal circuit court decision has undermined the DOL fiduciary rule raising questions in the Working Group regarding the viability of its proposed revisions to Model #275.

Federal Circuit Court Decisions Affecting DOL Fiduciary Rule

The meeting commenced with a legal analysis provided by Jennifer McAdam of the NAIC of two United States Courts of Appeal decisions impacting the DOL's fiduciary rule (the "Federal Court Decisions"). McAdams explained that the first decision, Chamber of Commerce of the United States of America, et al. v. United States Department of Labor, issued by the Fifth Circuit Court of Appeals struck the DOL fiduciary rule in its entirety. According to McAdam, the Fifth Circuit ruled that, (1) the DOL did not possess authority to adopt the new definition of "fiduciary advice" as it was inconsistent with the text of the Employee Retirement Income Security Act of 1974 ("ERISA"); and (2) the DOL had acted arbitrarily and capriciously when enacting the fiduciary rule in violation of the federal Administrative Procedures Act ("APA").

McAdams next discussed the second decision, Market Synergy Group v. U.S. Dept. of Labor, issued by the Tenth Circuit Court of Appeals two days before the Fifth Circuit decision. In Market Synergy, McAdams explained, the plaintiffs contended that the DOL fiduciary rule violated the APA by: (1) failing to provide sufficient notice of its intention to exclude transactions involving fixed indexed annuities (FIA) from the Prohibited Transaction Exemption (PTE); (2) arbitrarily and capriciously handling FIAs disparately than other fixed annuities by eliminating them from PTE; and (3) failing to sufficiently consider the negative economic effect of its exclusions of FIAs from the PTE. McAdams stated that the Tenth Circuit disagreed with Plaintiffs and upheld part of the DOL fiduciary rule.

McAdams has advised that the DOL was currently considering its options in light of these decisions and was not enforcing the fiduciary rule pending further review.

Stakeholder Comments on the Federal Court Decisions' Effect on Model Regulation #275

The American Council of Life Insurers ("ACLI") has remained committed to developing appropriately tailored rules for annuity sellers to protect consumers. The group is interested in moving forward through a coordinated effort among the NAIC, regulators, state legislators, the DOL and the U.S. Securities and Exchange Commission ("SEC") and the Financial Industry Regulatory Authority ("FINRA"). ACLI seeks a "common sense best interests standard" for annuities, which it believes should be achieved by improving Model Regulation #275 in the following key areas: (1) establishing a process-oriented approach to determining what is in the best interests of the consumers; and (2) identifying and disclosing conflicts of interest regarding cash and non-cash compensation. ACLI has also advised that its president has reached out to the SEC to emphasize the importance of working with state regulators to create a best interests standard of care for annuities. ACLI believes that the NAIC should work with the SEC in connection with the SEC's proposed rule.

The Insured Retirement Institute ("IRI") has expressed its agreement with ACLI's comments and its belief that producers already operate in their clients' best interests. The DOL rule did not recognize this according to the IRI. IRI has suggested that, as the Working Group revises Model #275, it target areas that need enhancement and ensure that there are a wide variety of consumer choices/products. The IRI has implored that the Federal Court Decisions free the Working Group to decide where appropriate changes need to be made.

The American Banks Association ("ABA") has expressed its concerns that the proposed revisions to Model Regulation #275 will unsettle the current annuity marketplace and likely remove banks from offering annuity products, which will negatively affect consumers. According to the ABA, the Model currently incorporates standards that are applied to security sellers, which are too onerous on banks. The ABA has contended that, if the revisions are adopted, Model #275 will create increased litigation and inconsistent compliance requirements for banks across jurisdictions.

The National Association of Insurance and Financial Advisors ("NAIFA") has advised that its representatives have met with the SEC regarding the SEC's proposed rule. NAIFA believes that the NAIC should wait for the SEC so that its model rule can conform to the SEC rule. NAIFA has stated that it supports a best interests standard and has reiterated that NAIFA members have relationships with consumers; thus, annuity sales are driven by that relationship and not by the producer compensation structure. NAIFA has stressed that any approach taken by the NAIC cannot impair the low and middle market consumers' capacity to obtain these products.

Independent Insurance Agents and Brokers of America ("IIABA") has welcomed the Fifth Circuit Decision striking down the DOL fiduciary rule - which the IIABA deems "very troubling" - and has expressed that the Fifth Circuit Decision allows the Working Group to pause and reset. Before the Decision, the Working Group's goal, according to IIABA, was to create a Model that was uniform with the DOL rule. The IIABA has contended that now, the Working Group can reassess this goal. The IIABA believes that the best interests standard is too vague and does not provide sufficient direction to brokers and agents. NAIC has an opportunity to provide more defined guidance.

Reinsurance Provisions of the Covered Agreement Between EU and U.S.

The NAIC Reinsurance (E) Task Force ("RTF") held an open meeting on Sunday, March 25, 2018 during the NAIC 2018 Spring National Meeting in Milwaukee, Wisconsin. During the meeting, the RTF focused on the reinsurance provisions of the Agreement Between the European Union and the United States of America on Prudential Measures Regarding Insurance and Reinsurance ("Covered Agreement"), which was executed by the United States and the European Union on September 22, 2017. The Covered Agreement will "eliminate reinsurance requirements for EU reinsurers that maintain a minimum amount of own funds equivalent to $250 million and a solvency capital ratio (SCR) of 100% under Solvency II," and allow U.S. reinsurers to do business in the EU without local presence so long as they "maintain capital and surplus equivalent to €226 million with an RBC of 300% of Authorized Control Level." The Covered Agreement requires U.S. states to implement rules that comport with the Covered Agreement within 60 months or risk pre-emption by the federal government.

NAIC To Revise Models To Extend Covered Agreement's Reinsurance Collateral Requirements to Non-EU Qualified Jurisdictions

On February 20, 2018, the NAIC held a public hearing in New York to address the reinsurance collateral provisions of the Covered Agreement. Commissioners McPeak and Altmaier and Superintendent Vullo presided over the meeting, which was attended by approximately 160 people and by another 181 participating by conference call. During the public hearing, 18 speakers - including a representative from the U.S. Department of Treasury, several U.S. domestic insurers and U.S. trade associations, international reinsurers and international trade associations - provided testimony regarding the collateral requirements. The NAIC also received twenty (20) comment letters from various stakeholders and interested parties.

As a result of the hearing, the NAIC has determined that industry consensus favors extending the benefits of the reinsurance collateral requirements of the Covered Agreement to reinsurers in non-EU qualified jurisdictions (Bermuda, Japan, Switzerland and, after Brexit, the UK). However, industry representatives have made it clear that they support this initiative only if the non-EU reinsurers are required to treat the states in the same manner and with the same recognition as do the EU states. This specifically includes a mandate that the non-EU reinsurers recognize the states' approach to group supervision, including group capital.

As such, the commissioner group presiding over the February meeting has drafted a memorandum to the NAIC Financial Condition (E) Committee recommending that it adopt a request for NAIC Model Law Development to amend the Credit for Reinsurance Model Law (#785) and the Credit for Reinsurance Model Regulation (#786) so that those Models both conform to the Covered Agreement's collateral requirements and bestow reinsurers domiciled in non-EU qualified jurisdictions the same or similar reinsurance collateral requirements. In so doing, the commissioners have recommended that the Committee direct NAIC staff to draft the proposed amendments for the RTF's review.

The commissioner group has also advised the Committee to adopt charges to the RTF to (1) revise Model #785 and Model #786 to conform to the Covered Agreement; and (2) design amendments to those Models that authorize non-EU reinsurers domiciled in Qualified Jurisdictions to follow the same or similar reinsurance collateral requirements as set forth in the Covered Agreement. Based on comments and testimony received during the public hearing, the commissioners have asked that the charge mandate that any changes to Model #785 and Model #786 require these reinsurers to be bound by all other constraints imposed upon the EU in the Covered Agreement, including the mandate that the Qualified Jurisdiction agree to recognize the state's approach to group supervision, including group capital. The RTF will be directed to convene with international regulators, as well as other interested parties, to ensure they will abide by this approach.

The commissioner group has also recommended that Financial Condition (E) Committee adopt charges to the Qualified Jurisdiction (E) Working Group to require qualified jurisdictions to recognize fundamental NAIC solvency enterprises, including group supervision, group capital standards as well as mandate increased information sharing between the states and Qualified Jurisdictions so that reinsurers domiciled in those jurisdictions are treated no differently than EU reinsurers under the Covered Agreement.

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