Financial Planning Coalition Lobbies SEC to Broaden Fiduciary Standard

[Lucullus]

Bradley,

Not all indexed products require purchase of options annually because not all indexed products are "annual reset". You can find a lot of very factual information on how index annuities work and how interest is calculated on my partner's website - www.advantagecompendium.org. Or (he says, in shameless self-interest), you can buy our book, "Index Annuities: A Suitable Approach" (Olsen & Marrion LLC, 2011), available at www.indexannuitybook.com.

That said, an indexed annuity IS a "fixed annuity" because (a) its value is reckoned in units fixed in value (i.e.: dollars), rather than in "accumulation units" or "annuity units" which can, and usually do, vary in value each day, in accordance with the performance of the separate accounts chosen. Moreover, an indexed deferred annuity (all indexed annuities issued today are, to my knowledge, deferred ones) is a "fixed annuity" because it always contains the three central guarantees of fixed annuities:

1. Guarantee of principal (if contract is held through end of surrender period)
2. Guarantee of minimum interest rate
3. Value of contract does not vary according to the performance of a separate account (that language is taken directly from Dodd-Frank, Sect. 989J)

- John

[Bradly T.]

Great resources.....and I'll check my opinions to your far superior knowledge of the issue. So, of those EIAs that buy futures/options, whose money is used for that? The insurer's general account resources or the client premium? If not by premium, then those go to the GA just like any FA premium? The FA is so easily explained and understood as a simple spread distribution of GA returns. EIAs, not so easy to explain or understand - but certainty of principal is easy for all and a comfort to many to be sure. You obviously share the concern about liquidity, suitablity, and general lack of disclosure and licensure by those agents responsible for most sales. Do you know how many are sold proportionally by securities licensed folks vs. agent-only licensees? It seems that many issuers here are "using" a distribution network to their advantage and have no real interest in additional requirements for selling these products. I know there are good firms selling good product but when I see the stats, it appears the stinkers are leading this parade/charade. Anyway, always learn from your posts....I have no problem being corrected by those who know better. I wake up every day afraid of what I don't know or what I used to know that's wrong now. =)

[Lucullus]

Bradley,

Here's the example I use in one of my presentations:

Assume a "term end point" design (10 year index period) with 100% participation rate and no cap (that's not typical, or even currently available, but this is a simplified example)

$1 of index annuity premium received
Cost of covering guarantee
If the guarantee is 2% on 90% of premium, insurer will need $1.097 at the end of year 10
If 10 yr bond yield = 3%, buy $0.74 bond now
Expenses =10 cents, 16 cents left to buy call option on index
If $1 10 year option on index =16 cents, can offer 100% participation in index gain
If index gains 100% in 10 years, credit 100% interest
If $1 10 year option costs 25 cents, buy $0.64 option
If index gains 100% in 10 years, credit 64% interest

Now, most IAs are "annual reset", not term end point, but the principle is the same. The insurer buys bonds with the premium received sufficient to pay guarantees. With whatever is left over, it buys call options on the index.

It's not nearly that simple in practice, of course, but that's basically how it's done. The interest to be credited is the positive movement in the index during the interest rate calculation/crediting period, adjusted by the various "moving parts" (participation rate/interest rate spread, "cap rate", and averaging if applicable).

Jack Marrion has lots of examples at http://www.advantagecompendium.org.

Bottom line: Neither the annuity buyer nor the insurer "buys the index", merely call options on same. Nobody gets dividends, but that's OK because nobody paid for them.

If you're going to be at the FPA convention in San Diego, I am giving a presentation that includes a discussion of how index annuities work.

- John

[the observer]

Hi John,

You write: "As for your belief that an insurance agent cannot be a fiduciary, there are state court decisions that have held the opposite. Usually, they involved property/casualty BROKERS"

Not the case in CA. I've been arguing for years, as you know, that an agent owes a fiduciary and agency duty to the insurance carrier. I don't care what CFP Board, the Coalition or anyone else says... They do not make the law in CA and they do not regulate anything. A recent case just settled this year on appeal (citable) reinforces what I've been saying all along.

May 2011:

California law has now been clarified with the California Court of Appeals for the Second Appellate District’s decision in Workmen’s Auto Insurance Company v. Guy Carpenter & Company, Inc., __ Cal. App. 4th __, Cal. App. LEXIS 533 (May 4, 2011), that held insurance brokers do not owe fiduciary duties to their clients.


The court explained that in a typical agency relationship, there is the principal, and the agent looking out for the interests of the principal. The relationship between the agent and the principal, outside of the insurance industry, has been a fiduciary relationship, wherein the agent owes the principal a fiduciary duty. The company argued that insurance case law should not be applied to the reinsurance intermediary-broker relationship due to the “far more complex and comprehensive relationships with their clients.” Therefore it argued, Carpenter did not just owe a duty to exercise reasonable and due care, but owed a higher level duty, those duties owed by a fiduciary.

The Court of Appeals looked at “whether Carpenter was the company’s agent and, if so, whether that agency imposed a fiduciary duty on Carpenter as a matter of law such that Carpenter can be held civilly liable for breaching those duties.”


Under the statute, the reinsurance intermediary-broker can be characterized as a dual agent. Such a broke

[Lucullus]

Observer,

I wrote ""As for your belief that an insurance agent cannot be a fiduciary, there are state court decisions that have held the opposite. Usually, they involved property/casualty BROKERS"

You responded with "Not the case in CA. I've been arguing for years, as you know, that an agent owes a fiduciary and agency duty to the insurance carrier. I don't care what CFP Board, the Coalition or anyone else says... They do not make the law in CA and they do not regulate anything. A recent case just settled this year on appeal (citable) reinforces what I've been saying all along."

OK, the case you cite holds that, in California, a broker does not owe a fiduciary duty to THE APPLICANT. I did not suggest that this may not be the case, merely that some state courts have reached the opposite conclusion. Moreover, there are things an agent or broker can do that will alter the level of duty he or she owes the consumer. These may include -

Holding oneself out as an "independent consultant", acting as an agent/broker within the context of giving "personalized investment advice about securities, claiming credentials or certifications that would lead the consumer to the belief that one is acting as a fiduciary, engaging in insurance agent activities with a consumer to whom you've held yourself out as a RIA or RIA Representative, etc. (that last one has resulted in the attribution of fiduciary duty to the agent in numerous cases(.

I did not presume to state what is law in CA, with respect to insurance agents' standard of duty; I asserted only that the issue is, in some states, not as clear or as decided as you have portrayed it.

- John

[the observer]

Hi John,

We have the insurance analyst license in CA for everything else so anyone holding out as anything in the business of insurance is automatically breaking the law if they are not properly licensed and charge a fee. There are a couple of noted exceptions... Attorneys and RIA's (When acting in that capacity) but the acting in that capacity has long be clarified by the Dept. of Insurance (Despite the claims of too many fee-only planners who thin they're fine) as only when providing advice on matters such as the investment sub-accounts of VA and VUL etc., not the actual insurance matters.

BTW, it's an excellent reason why one should not offer insurance advice through the RIA and register the name of the RIA as an insurance agency with the CA Dept. of Insurance. It further clarifies for the client exactly what services the RIA actually offers.

All this leads me back to my original argument for the past 12-14 years that financial planning should be regulated at the State level, not the federal level and for damned sure without another additional duplicate layer of oversight from the SEC that brings absolutely nothing but costs and headaches, rather than protections.