The NAIC’s New Model Regulation Governing Suitability in Annuity Transactions Misleads and Fails to Protect Consumers

August 28, 2020

In the Spring of 2020, the National Association of Insurance Commissioners (“NAIC”) adopted a new “model regulation” that purports to protect consumers by toughening the standards that must be followed by agents and insurers selling annuities to consumers.[1]  The new model regulation, called the Suitability in Annuity Transactions Model Regulation (No. 275), was met with much applause by the insurer and agent communities.  That is not surprising because the new model regulation is profoundly anti-consumer, as it not only fails to protect consumers but affirmatively misleads them into thinking that the agent selling the annuity is obligated to act in the consumer’s best interest. 

States including California had urged the NAIC to adopt a true best interest standard, which requires that the agent act in the best interest of the consumer and consider only the consumer’s interest in recommending an annuity.  California’s position was rejected by the NAIC.  California also recommended that a best interest standard be applied to investment-oriented life insurance policies in addition to annuities.  That recommendation was also rejected by the NAIC. 

LICAC has urged the California Insurance Commissioner, Ricardo Lara, to press ahead with the pro-consumer standard that he had advocated to the NAIC and to co-sponsor legislation requiring agents and insurers selling annuities and investment-oriented life insurance policies (aka life insurance investment schemes or “LIIS” policies) to act in the best interests of their customers.  LIIS policies are at least as difficult for consumers to understand as annuities and should be governed by a true “best interest” standard as well.  There is no plausible argument for imposing “best interest” obligations on agents selling annuities but not on agents selling LIIS policies.

New York has recently adopted a regulation (Department of Financial Services Regulation 187  (11 NYCRR 224 – Insurance Regulation 187) that imposes a true “best interest” standard on sales of both annuities and life insurance policies.  Several states have already enacted their own form of fiduciary duty standards applicable to the sale of securities, but these do not extend to sales of indexed universal life policies because these are not securities.  In its discussions with California regulators, LICAC has recommended a “best interest” standard similar to New York’s, although the New York regulation extends to term policies, and LICAC is not convinced that consumers are well served by extending the “best interest” standard for term policies, which are far easier for consumers to understand.    

Below we highlight some of the key flaws in the NAIC model regulation:

  1. The Model Regulation misleads consumers by calling itself a “best interest” standard and allowing agents to tell consumers that they are obligated by law to act in the consumer’s best interest. 
    • While New York’s recently adopted Regulation 187 requires the agent to consider only the interests of the consumer in making a recommendation, the Model Regulation permits the agent to give its own interest equal weight to the consumer’s.  Exactly how an agent can balance its own interest with those of its customer is not clear, but one can be sure the consumer will not be protected by such a standard.
    • The New York regulation requires that an agent’s recommendation reflect “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 then prevailing,” while the NAIC Model Regulation adopts a convoluted negligence test, requiring that the agent “exercise reasonable diligence, care and skill” to “have a reasonable basis to believe the recommendation effectively addresses the consumer’s financial situation, insurance needs and financial objectives . . . .”  The Model Regulation should, but does not, require the agent to consider whether not purchasing an annuity may better suit the consumer’s interests.
    • The Model Regulation misleads consumers, who will understand a “best interest” standard to be essentially a fiduciary standard, but the duties imposed by the Model Regulation fall far short of a fiduciary standard; indeed, the Model Regulation explicitly states that it does not impose a fiduciary duty or relationship.  Section 6.A(1)(d).
  2. The Model Regulation defines “material conflict of interest” to exclude all cash and non-cash compensation and does not require disclosure of commissions to consumers unless the consumer asks for it.  Section 5.I.  California had recommended more rigorous regulation of conflicts of interest and that commissions and non-cash compensation be disclosed to consumers.  DOI Letter of July 15, 2019.
  3. The Model Regulation does not go far enough in limiting the abuses of sales contests or quotas or similar programs.  The Model Regulation prohibits “sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sales of specific annuities within a limited period of time.”  Section 6.C.(2)(h).  This is too narrow.  Any compensation system that provides higher marginal compensation as sales increase invites abuse.  Thus, a bonus or higher commission rate that kicks in above a certain level of sales will increase the incentive for the agent to recommend a transaction that is not in the consumer’s interest.  California had proposed that the Model Regulation prohibit such programs.   DOI Letter of July 15, 2019.
  4. The Model Regulation requires only that the agent make a note in its file as to the basis of the recommendation, while California had proposed that consumers be provided the recommendation in writing.   DOI Letter of July 15, 2019  New York’s Regulation 187 requires that the agent disclose to the consumer “in a reasonable summary format all relevant suitability considerations and product information, both favorable and unfavorable, that provide the basis for any recommendations.” Regulation 187, Section 224.4(f)(1).
  5. Those disclosures that agents are required to make to consumers (e.g., that the agent can only sell annuities from a particular insurer or that the agent is not licensed to sell competing products such as mutual funds or stocks) occur too late in the sales process, at the point when the agent decides that a recommendation is made; such disclosures should be provided early in the sales process, at the same time the consumer provides consumer profile information.  
  6. The Model Regulation allows agents to state that they sell the products of multiple companies even if the companies are all part of the same insurer group.  Such disclosures imply that the agent has considered competing insurers in deciding what annuity or policy to recommend to the consumer, but that is not the case if all the insurers considered are part of the same insurer group. 
  7. The Model Regulation imposes no duties on the agent where the sale is not based on a recommendation of the agent or if the consumer does not provide relevant consumer profile information and permits such sales so long as the consumer signs an acknowledgment of the transaction that warns that the consumer may lose rights under the state insurance code.   See NAIC forms included in model regulation. Such forms cannot protect consumers from bad sales and bad sales practices.  Agents and insurers should be prohibited from making sales in such circumstances because the benefits to consumers from preventing bad sales and bad sales practices far outweigh any benefit to consumers from being able to buy annuities or LIIS policies that are not based on any recommendation or that are based on incomplete – potentially significantly incomplete– consumer profile information.
  8. The Model Regulation is inconsistent with existing California law in that its definition of “Consumer profile information” fails to include two factors that California Insurance Code subsections 10509.913(i)(13) and (14) require to be considered:
    • Whether or not the consumer has a reverse mortgage; and
    • Whether or not the consumer intends to apply for means-tested government benefits, including, but not limited to, Medicaid or the Veterans’ Aid and Attendance Program. 

An annuity is not likely to be suitable for a consumer who has a reverse mortgage or who qualifies for Medicaid or the Veterans’ Aid and Attendance Program, as these consumers generally need ready access to their funds and should not lock them up by buying an annuity.

These are only some of the many flaws in the NAIC Model Regulation, which does not protect consumers and should not be adopted.  To the contrary, a true best interest standard is needed.


[1] Model regulations are adopted by the NAIC for states to use as a model or template for their own legislation.  Model regulations become law only after they are adopted by individual states; frequently, they are adopted (in whole or with alterations) by many states.