Secondary market for annuities comes under pressure

Interstate group's decision to allow insurers to terminate guaranteed benefits strikes nerve

Feb 28, 2010 @ 12:01 am

By Darla Mercado

The nascent secondary market for annuities and their guaranteed benefits could be stunted as the result of a vote last week by state insurance regulators to allow carriers to terminate the annuity benefits if a client sells the contract.

Last Monday, the Interstate Insurance Product Regulation Commission, composed of the insurance regulators from 35 states and Puerto Rico, voted in favor of a uniform provision that would allow insurance carriers to terminate at their discretion guaranteed living and death benefits in the event of a change in ownership or assignment.

Indiana was the sole dissenter among the represented jurisdictions.

The vote could make it harder for clients to sell annuities to others, which could limit the attractiveness of the market.

The commission will officially announce the provision this week, and it will likely become effective by the end of May, according to executive director Karen Schutter.

The commission applies uniform structural standards to life insurance policies and annuities sold in the member jurisdictions.

The reasoning behind the commission's decision, members have said, was concern over the price of the products and the potential for controversial stranger-originated transactions.

The approval of the provision has already struck a nerve with the National Conference of Insurance Legislators. That group's president, Robert R. Damron, a member of the Kentucky House of Representatives, has since proposed legislation in the state's General Assembly to exclude the Bluegrass State from having to comply with the commission's decision.

Although life settlements, which are a secondary market for insurance, and the secondary market for annuities aren't the same, they share some commonalities. The Life Insurance Settlement Association was in communication with the commission on the proposed provisions, opposing their passage.

Experts in the life settlements field have a hard time determining the exact size of the secondary market for annuities but estimate that it is much smaller than the life settlements market. Last year, life insurance policies with some $8 billion in death benefits were settled, according to estimates from Aite Group LLC.

“We want to preserve consumers' ability to [sell their products in the secondary market] if their products don't perform,” said Brian Staples, president of Right LLC, a regulatory-compliance consulting firm that specializes in life settlements.

“We know that there are annuity products that aren't performing as they were sold,” he said. “We know that there are consumers whose circumstances have changed because of the crisis.”

Some of the better-known players in the small annuity-purchasing business are J.G. Wentworth Inc.and Peach-tree Financial Solutions.

Other companies think that there is a potential for growth when it comes to buying underwater variable annuities from clients who don't want them.

“Consumers own valuable variable annuity contracts now, and their death benefits are very high,” said an executive at a firm that has been aggregating variable annuities. The executive asked that neither he nor his firm be identified because the company is approaching broker-dealers in the hope of giving firms an option when clients want to sell an annuity. Advisers and consumer advocates assert that annuity holders could benefit from the existence and growth of such a market. “I've had clients who could have benefited from the legitimate sale of their variable annuity in the secondary market,” said Joy Slabaugh, partner at EST Financial Group. She declined to disclose the amount of assets the firm has under management. In one situation, a client wanted to surrender his variable annuity because he had a large purchase in mind — a helicopter. Despite Ms. Slabaugh's attempt to dissuade the client from cashing in the annuity, the client surrendered the product and got his cash. “There are times like this when a person's objective changes and the investment that was suitable a few years ago is no longer suitable,” she said. “The way I see it, there were some riders on this annuity that could've been attractive to an institutional investor. Having a secondary market provides more liquidity options,” Ms. Slabaugh said. Although she has never conducted such a transaction, she noted that her broker-dealer, H. Beck Inc., would call for extensive scrutiny on the sale and questions on the suitability. The firm would most likely have to supervise the business, per the Financial Industry Regulatory Authority Inc.'s rules on how broker-dealers are supposed to approach life settlements with variable insurance products.

ADDITIONAL OPTIONS

The option of turning to the secondary market gives the consumer a chance to bail out if the product was sold inappropriately in the first place, said Birny Birnbaum, executive director of the Center for Economic Justice. He criticized the commission's decision to push forward with the provision to allow insurers to terminate guaranteed living and death benefits.

“We don't have effective suitability requirements, so when customers are sold inappropriate annuities, insurers have a monopoly on what you can do,” Mr. Birnbaum said. “This is the life insurance industry getting the government to shield them from competition, so the customer suffers as a result.”

In light of recent news reports on the controversial third-party sales of annuities on sick people so that investors can reap the death benefit and make aggressive investment plays, insurers have raised concerns that a secondary market could encourage stranger-originated-annuity sales.

“Without the ability to terminate riders, there's a market for [stranger-originated life insurance] with guarantees, which would be detrimental to the genuine consumer's interest,” Michael Lovendusky, vice president and associate general counsel of the American Council of Life Insurers, said during the conference call.

Mr. Staples argued that it is inaccurate to equate improperly written insurance products with the nature of the overall secondary market.

“The secondary market has been supportive of enforcing insurable interest; we don't want improper annuities, because they taint the marketplace,” he said.

“Of course there's concern about stranger-originated annuities, but the response to those types of abuses isn't to eliminate the market,” Mr. Birnbaum said.

“That's like saying that there are problems in the secondary-mortgage market, so we should eliminate the market altogether,” he added. “That's insane.”

E-mail Darla Mercado at dmercado@investmentnews.com.

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