The Securities and Exchange Commission seeks a jump in funding to help enforce compliance with its best interest regulation, and life insurers might want to pay attention.
The SEC wants to add more than 250 employees in enforcement, according to a budget request sent to Congress. Overall, it’s looking for a 7.9% increase in staff.
Heightened scrutiny of products under its purview could affect two cash cows for the life insurance industry: variable life insurance and variable annuities. Insurers and affiliated broker dealers that market the products could be closely examined for substandard compliance systems, outdated sales processes, or a lackadaisical attitude to beefed-up oversight of transactions.
“If the distributors and the carriers don't have what they need they're going to be put in a tough situation,” Michael Kazanjian, chief marketing officer of technology vendor Fiduciary Exchange or FIDx, said in an interview. “That could then challenge sales because they're not going to be prepared to deal with these changes.”
Benjamin Edwards, an associate professor of law at the University of Nevada in Las Vegas, identified as low-hanging fruit for SEC enforcement actions instances where agents recommend a product but don’t fully understand its risks and merits. This often happens, he noted, after a change to the product, such as the addition of a rider or other feature.
“That’s a real vulnerability,” he said in an interview. “If you make material changes to a product and there's no record of how the producers have been trained on it after those changes have been made, that’s a real risk.”
Jason Berkowitz, a chief legal and regulatory officer at the Insured Retirement Institute, worries that small insurers and distributors may not be ready for a strengthened SEC enforcement regime, noting that they tend to have fewer resources to ensure compliance with new regulations.
Additional guidance from the SEC on its best interest regulation, he added, could identify additional gaps in existing compliance programs.
“That’s an area that we need to keep an eye on,” he said.
In April, the SEC issued its first formal guidance on Regulation Best Interest since Gary Gensler became chairman in April of last year. The guidance sets forth the conduct expected from broker-dealers, investment advisors and dual registrants when they recommend certain accounts and retirement rollovers.
Request for More Money
In a July 7 letter addressed to the U.S Senate subcommittee on Financial Services & General Government, the Insured Retirement Institute expressed its support for additional funding for the SEC.
The group noted that the money is needed to provide adequate oversight of the best interest regulation. It said the funds are also needed to properly monitor the use of Form CRS: a client or customer relationship summary that informs investors about the types of services an agent or broker offers, as well as fees, costs and conflicts of interest.
Berkowitz said the Insured Retirement Institute’s members have a vested interest in the success of the new regime.
“We would just like to get to a point where this could be settled,” he said of the years-long debate among regulators and companies over an appropriate best interest standard. “Making sure that the SEC can effectively oversee the rollout and compliance with the rule is going to be critical to that.”
In its fiscal 2023 budget request, the SEC asks for almost $2.2 billion.
Micah Hauptman, director of investor protection at the Consumer Federation of America, said in an email that if the SEC gets the requested funding, then he would hope that the agency would closely examine mis-selling of variable insurance products and other high-cost, suboptimal offerings that aren’t in an investor’s best interest.
“The selling of such products, particularly those that include large commissions paid to the broker, would raise questions about whether the broker is complying with its care and conflict-of-interest obligations under the rule,” he said.
Merits of Earlier Compliance Checks
For Kazanjian, a key issue is how product recommendations are checked to ensure they’re suitable for the customer. In many cases, he noted, this vetting happens late in the sales process: after the client has signed the application and paperwork goes back to the insurer or broker-dealer’s office for compliance checks.
This often results in spotting errors and omissions, such as missing pages or unsigned documents that the SEC could flag during an examination. Industrywide, the “not in good order rate” ranges from 40% for applications submitted electronically to 60% for those that are paper-based, according to FIDx.
These problems, and potential lost sales arising from them, can be avoided by shifting the product suitability work to the proposal phase. That’s when the agent or advisor gathers information about the client’s risk tolerance, age, financial objectives and other portfolio investments.
In so doing, the insurer or distributor can screen earlier for unsuitable products or appropriately limit the amount invested in a recommended product that meets the best interest standard.
“The insurance carriers are going to need to work differently with distribution companies that they sell through to think about this process differently,” said Kazanjian.
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