Dodd-Frank repeal could lead to big changes for indexed annuities

Scrapping or revising the law could lead to the disappearance of the Harkin Amendment, which would pave the way to indexed annuities being classified as securities rather than insurance products

Feb 6, 2017 @ 4:41 pm

By Greg Iacurci

President Donald Trump's executive order to review the Dodd-Frank financial reform law could wind up complicating the indexed annuity market for insurers and distributors.

Dodd-Frank, signed into law in 2010 under the Obama administration, contained a provision known as the Harkin Amendment, which guaranteed indexed annuities would continue to be regulated as insurance products, rather than securities products like variable annuities.

However, the amendment could be scrapped if the Dodd-Frank Act is ultimately revised or repealed, which would pave the way for indexed annuities to be governed by securities rules, according to industry observers, who say such a move would upend the distribution of the products.

“The review of Dodd-Frank, depending on the focus of the regulatory agencies, might consider a repeal of the Harkin Amendment,” said Joan Boros, counsel at law firm Stradley Ronon Stevens & Young.

“As a supporter of the non-registration of indexed products, I'd say it's a concern,” she added.

Indexed annuities, traditionally recommended as part of an investor's fixed-income portfolio, are a type of fixed annuity. Since the products came to market in the mid-1990s, they've been regulated by state insurance departments.


However, in 2009 the Securities and Exchange Commission issued a rule — Rule 151A, under the Securities Act of 1933 — that would have designated indexed annuities as securities products under the SEC's jurisdiction.

At the time, the SEC was concerned the products weren't registered products despite their tie-in to securities markets, and believed imposing a federal framework would be superior to a patchwork of state insurance laws, according to court documents.

A consortium of insurance companies, led by American Equity Investment Life Insurance Co., filed suit against the SEC, and were ultimately victorious after an appellate court ruled in their favor in 2009.

But the court's decision hinged on procedural grounds — it said the SEC “failed to properly consider the effect of the rule upon efficiency, competition and capital formation,” and remanded the rule for reconsideration.

The court effectively said the SEC could “go back to the drawing board and try again,” said Jamie Hopkins, professor of retirement income at The American College of Financial Services. “That's where we were when Dodd-Frank came out.”

The Harkin Amendment, named for former Sen. Tom Harkin, D-Iowa, effectively superseded the SEC's power to regulate indexed annuities as securities, by saying annuity products meeting certain conditions would be exempt from federal securities regulation.

Now, with Mr. Trump calling Dodd-Frank “a disaster,”and issuing an executive order Feb. 3 to revisit the rules, the amendment could be on the chopping block.


“I definitely think it would pave the way for the SEC to make an attempt at regulating indexed annuities as securities,” according to Sheryl Moore, president and CEO of Moore Market Intelligence, a market research firm.

If that were to happen, it would be hugely disruptive to product distribution, the majority of which comes via independent insurance agents that only have an insurance license, observers say.

“A large portion of those guys would stop selling them or would need to obtain [a securities license] and operate that business through a broker-dealer,” according to Steven Saltzman, principal of Saltzman Associates, a financial services consulting firm.

Such a change would also affect product disclosures, which would closely resemble those of variable annuities and perhaps offer a greater degree of transparency, Mr. Saltzman said.

For example, indexed annuities don't have a prospectus investors can readily access for contract information.

“There's a fair amount of disclosure that happens today. I just wouldn't put it on par” with variable annuity disclosure, Mr. Saltzman said.

Of course, observers point out that there may not be political appetite to scrap the amendment, especially in a Republican-controlled Congress. And, the SEC may have bigger fish to fry, at least initially, such as pushing a uniform fiduciary standard, rather than looking to start a regulatory project similar to Rule 151A, they say.

But some feel the calculus has changed a bit since the SEC's last attempt roughly eight years ago, due to evolutions in the products that would potentially nudge regulators to take a deeper look if the Harkin Amendment went away.

Namely, there's been an uptick in use of “hybrid” indices, which differ from traditional indices well-known to investors, such as the S&P 500 or Russell 2000, and concern some observers due to the inability for investors to easily view performance.

Whereas there were a handful of different “hybrids” in 2013, there are roughly 50 different unique indices today, according to the market research firm Wink Inc.

“I think that there probably is a motivation to do it based on the evolution of the products, as well as Finra's general role and continuing concerns,” Ms. Boros said.

She was referencing investor alerts Finra, the brokerage industry regulator, has issued for indexed annuities in the past. In one, it says they are “anything but easy to understand.”

The DOL, in its final fiduciary rule issued last year, caught the annuity industry off guard by deciding to regulate indexed annuities similarly to variable annuities in retirement accounts. That rule is now being contested by the Trump administration.

Complexity shouldn't in and of itself make the products securities, Ms. Moore argues. However, she sees potential issues in the marketing of hybrid-index products that could cause the products to push the boundaries of securities classification.

“There's some marketing going on of unlimited potential for gains because of these hybrid indices,” she said.


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