- Revisions to NAIC Model #275 strengthen the suitability standard for recommendations of annuity products to a best interest standard; the revisions align producer and insurer oversight of annuities with heightened standards established by the SEC’s Regulation Best Interest.
- The stronger standard demonstrates an ongoing focus on financial services conduct and sales practices as well as consumer protection standards related to unfair, deceptive, or abusive acts or practices.
- NAIC is working to finalize FAQs to provide additional guidance to states seeking to adopt the revised regulation.
- So far, nine states have taken up the revised Model #275 while another eight are in process of doing so. Some states are considering their own best interest standards.
The NAIC Annuity Suitability Working Group has conducted multiple public meetings, most recently on March 25, 2021, to discuss proposed revisions to NAIC’s draft Frequently Asked Questions (FAQs) document intended as guidance for states adopting the revisions approved last year to NAIC’s Model #275, known as the Suitability in Annuity Transactions Model Regulation. The FAQs were initially released for comment in September 2020 (FAQs as originally proposed) and are expected to be adopted, with revisions, at a meeting later this spring.
NAIC Model #275 and Best Interest
The Model #275 revisions, approved in February 2020, were intended to clarify that all recommendations of an annuity purchase by producers (as defined in the rule – see Note 1 below) and insurers must be in the best interest of the consumer under circumstances known at the time the recommendation is made, without placing the producer’s or the insurer’s financial interest ahead of the consumer’s interest. The revisions also incorporate a best interest standard; the best interest standard does not reach the level of a fiduciary duty.
Best interest standard. Producers and insurers will be deemed to have acted in the best interest of the consumer if they have satisfied obligations outlined in the regulation regarding care, disclosure, conflict of interest, and documentation. Key highlights of these obligations follow.
- Care. In making the recommendation of an annuity, a producer must exercise reasonable diligence, care, and skill to know the customer’s financial situation, needs, and objectives; understand available options; have a basis to believe the recommended option effectively addresses the consumer’s situation over the life of the product; and communicate the basis of the recommendation. This includes making a reasonable effort to obtain consumer profile information, as defined in the regulation (see Note 2), from the consumer prior to the recommendation.
- Disclosure. Prior to a recommendation or sale of an annuity, a producer must prominently disclose to the consumer the scope and terms of the relationship with the consumer and the role of the producer; an affirmative statement of the products the producer is licensed and authorized to sell; an affirmatives statement of the insurers the producer is authorized to sell products for; the sources and types of compensation to be received by the producer; and a notice of the consumer’s rights to request additional information.
- Conflict of interest. A producer shall identify and avoid or reasonably manage and disclose material conflicts of interest, including material conflicts of interest related to an ownership interest.
- “Material conflict of interest” is defined to mean a financial interest of the producer in the sale of an annuity that a reasonable person would expect to influence the impartiality of a recommendation. “Material conflict of interest” does not include cash compensation or non-cash compensation.
- Documentation. At the time of a recommendation or sale of an annuity, the producer must make a written record of the recommendation and the basis for it; obtain, if appropriate, a consumer signed statement documenting the customer’s refusal to provide the consumer profile information and understanding of the ramifications of not providing the information; and obtaining, if appropriate, a consumer signed statement acknowledging the annuity is not recommended by the producer.
The best interest obligations apply to all producers that have exercised material control or influence in the making of a recommendation and have received direct compensation as a result of the recommendation or sale, regardless of whether the producer has had any direct contact with the consumer.
Supervisory system. An insurer must establish and maintain a supervision system that is reasonably designed to achieve the insurer’s and its producers’ compliance with the regulation including product training and licensing requirements, recommendation reviews and the basis for recommendation, procedures for the detection of noncompliance, identification of suspicious consumer refusals to provide consumer profile information, and limitations on sales incentives.
Safe harbor. A safe harbor is provided for recommendations and sales of annuities made by financial professionals in compliance with business rules, controls, and procedures that satisfy a comparable standard, such as the SEC’s Regulation Best Interest.
SEC Regulation Best Interest. SEC Regulation Best Interest became effective in June 2020. At a high level, the regulation requires broker-dealers to act in the best interest of retail customers at the time a recommendation is made, without placing financial or other interests ahead of the interests of the customer (the “General Obligation”). It also requires conflicts of interest to be disclosed. The General Obligation is satisfied by meeting obligations for disclosure, care, conflicts of interest, and compliance. Regulation Best Interest does not impose a fiduciary standard on broker-dealers. NAIC states that it sought to harmonize Model #275 with the SEC’s Regulation Best Interest. (Refer to KPMG Regulatory Insights Regulatory Alert here)
Adoption. As of April 1, 2021, nine states have adopted the NAIC’s revised Model #275, including Alabama, Arizona, Arkansas, Delaware, Idaho, Iowa, Michigan, Ohio, and Rhode Island. Eight other states are currently considering legislation or regulations that would implement the NAIC annuity sales model regulation including Kentucky, Maine, Montana, Nebraska, Nevada, North Dakota, Texas, and Virginia.
The New York Department of Financial Services separately adopted its own best interest standard for agents and brokers licensed to sell life insurance and annuity products in the state. NY DFS Regulation 187 requires insurers to establish standards and procedures to supervise recommendations with respect to life insurance policies and annuity contracts, so that any transaction with respect to those policies is in the best interest of the consumer and appropriately addresses the insurance needs and financial objectives of the consumer, and the amount of compensation or incentive received is not influenced by the recommendation.
Note 1: “Producer” is defined as a person or entity required to be licensed under the laws of the state to sell, solicit or negotiate insurance, including annuities. Producer includers an insurer where no producer is involved.
Note 2: “Consumer profile information” means information that is reasonably appropriate to determine whether a recommendation addresses the consumer’s financial situation, insurance needs, and financial objectives, including, at a minimum, the consumer’s age, income, assets and liabilities, financial expertise, objectives, time horizon, plans for use, liquidity needs, risk tolerance, and tax status.