Securities Regulator Proposes to Improve The Accuracy of Communications Regarding Variable Insurance Products

By James Eccleston

INRA (the Financial Industry Regulatory Authority) has filed Regulatory Notice 08-39 for public comment. Among other things, FINRA proposes to improve the manner in which variable insurance products are advertised, particularly with regard to guarantees and riders, performance illustrations and investment analysis tools. The proposal, if approved, will better protect the public when considering whether or not to purchase these often-confusing products. Let's examine the more important parts of FINRA's proposal.

First, FINRA proposes helpful changes to the manner in which firms can identify a variable insurance product and describe its liquidity. For example, firms will not be able to imply that a variable insurance product is a mutual fund. Second, firms will be prohibited from "falsely implying that variable insurance products are short-term, liquid investments." Likewise, FINRA wants discussions regarding access to account values to be "balanced by a description of the potential effect of all charges, penalties or tax consequences resulting from a redemption or surrender." Finally, "any discussion of loans and withdrawals would have to explain their impact on account values and death benefits."

Second, the proposal contains several important changes regarding guarantee claims and riders. As FINRA states it, "Communications concerning variable insurance products frequently emphasize guarantees or riders, particularly to the extent that they protect an investor in a down market." The goal of the proposal is to insure that such communications be fair and balanced. Accordingly, FINRA proposes, first, that firms not exaggerate the benefits of a guarantee or an insurance company's financial strength or credit rating. All communications must disclose "all material applicable limitations or qualifications". Moreover, communications regarding guarantees will have to disclose "that the investment return and principal value of an investment option are not guaranteed and will fluctuate." Similarly, with both guarantees and riders, FINRA proposes that communications will have to consider "the circumstances under which the guarantee or rider will not benefit the customer." In all cases, firms will have to "explain the nature of the rider, its costs and limitations and the fact that it is an optional feature of the contract."

Third, in the regulatory notice FINRA expresses its continued concerns that the purchase of a variable annuity through a tax-qualified account (such as an IRA) may be unsuitable, because the variable annuity "does not provide any additional tax-deferred treatment of earnings beyond the treatment provided by the tax-qualified retirement plan itself." As a result, FINRA reminds firms that they must determine whether any other, non-tax, benefits exist. Additionally, the proposal would require firms to disclose that the variable annuity contract provides no additional tax benefits.

Fourth, FINRA proposes many changes to the manner in which firms can communicate with the public about the performance of variable life insurance policies. Among the most notable, FINRA proposes, first, that all performance communications "must reflect the deduction of all fees and charges applicable at the investment option level." Second, firms will have to "prominently disclose": (1) "whether the performance reflects the deduction of additional fees and charges disclosed in the prospectus other than at the investment option level"; (2) "the fees and charges disclosed in the prospectus not deducted from the performance (e.g., life insurance premiums)"; and (3) "that if all fees and charges disclosed in the prospectus had been deducted, the performance quoted would have been lower." Moreover, FINRA also proposes that firms be required to "urge" investors to obtain a personalized hypothetical illustration of the performance of the variable life insurance policy being considered. Among other things, such an illustration would "reflect all applicable fees and charges disclosed in the prospectus, including the cost of insurance."

Fifth, FINRA proposes that firms be allowed to utilize investment analysis tools, such as Monte Carlo simulations that project a range of possible outcomes for certain investments. If utilized, firms would have to comply with a number of requirements, and would have to "employ a tool that either: produces results that reflect the deduction of maximum guaranteed charges; or provides the user with a personalized hypothetical illustration that reflects these charges."

In conclusion, FINRA's proposal is a good one to protect investors! Let's hope that it ultimately is approved.

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James Eccleston, an attorney specializing in adviser and broker-dealer issues, is a partner with Shaheen, Novoselsky, Staat, Filipowski & Eccleston in Chicago.