Broker-dealers selling annuity products in New York will soon need to comply with new best interest requirements imposed by New York’s amended Insurance Regulation 187. These requirements, which will take effect for annuities on August 1, 2019, will also impose new documentation, disclosure and training requirements on broker-dealers that sell annuities.
Background. In 2018, the New York State Department of Financial Services (NYDFS) issued a final version of its First Amendment to Insurance Regulation 187, retitled “Suitability and Best Interests in Life Insurance and Annuity Transactions” (Amended Regulation 187).1 Amended Regulation 187 will impose a best interest standard on recommendations of purchase, replacement and certain other post-issuance transactions involving life insurance2 and annuity products. According to the NYDFS press release announcing the issuance of the final version of Amended Regulation 187, a goal of the amended regulation is to “fill in regulatory gaps” perceived by NYDFS resulting from the elimination of the federal Department of Labor’s Fiduciary Rule.3
Summary of Amended Regulation 187. Under Amended Regulation 187, both insurers and producers are subject to new duties and obligations in connection with annuity transactions. These new duties and obligations are layered on top of the existing suitability standard, calling into question whether broker-dealers distributing annuity products in New York can continue to rely on their existing practices and standards under the suitability rules and guidance of the Financial Industry Regulatory Authority, Inc. (FINRA) to establish their substantial compliance with Regulation 187.
In contrast to the US Securities and Exchange Commission’s Proposed Regulation Best Interest,4 Regulation 187 does not apply across-the-board to all broker-dealers. Rather, it applies only to those broker-dealers licensed as insurance producers in the state of New York for the purpose of distributing life and annuity products.5 Moreover, Regulation 187 applies only when broker-dealers make recommendations to residents of the state of New York involving annuity and life insurance products. To date, the NYDFS has not issued any guidance that would serve to provide additional context and analysis with respect to its scope.
Best Interest Standard for Producers. Amended Regulation 187 will significantly expand the duties and obligations of producers6 by imposing a best interest standard on recommendations to consumers about annuity contracts. In general, when making a recommendation to a consumer, the producer must act in the “best interest” of the consumer as described in Amended Regulation 187.7 In this regard, Amended Regulation 187 applies not only to purchase and replacement transactions (as is currently the case under Regulation 187) but also to post-issuance transactions that are conversions or modifications of an in-force policy, or the exercise of a contractual provision under an in-force policy. Further, in the case of post-issuance transactions, the best interest standard differentiates between modifications and contractual exercises that involve sales compensation and those that do not, subjecting the latter to a more limited best interest standard (best interest lite). Notably, insurance producers must also act in the best interest of the consumer with respect to “hold” recommendations or recommendations not to effect a transaction.8
Sales Transaction Recommendations. In the case of a sales transaction recommendation–which is defined to include the purchase or replacement of a policy, or any modification of or election of a contractual provision under an in-force policy that generates new sales compensation9–the producer is deemed to act in the best interest of the consumer when:
– The producer’s recommendation to the consumer is based on an evaluation of the relevant suitability information of the consumer and reflects the care, skill, prudence, and diligence that a prudent person acting in a like capacity and familiar with such matters would use under the circumstances then prevailing;
– Only the interests of the consumer are considered in making the recommendation;
– The amount of the producer’s compensation or the receipt of an incentive does not influence the recommendation;
– The sales transaction is suitable; and
– There is a reasonable basis to believe that (i) the consumer has been reasonably informed of various features of the policy or contract and the potential consequences of the sales transaction, both favorable and unfavorable; (ii) the consumer would benefit from certain features of the policy or contract; and (iii) the particular policy as a whole and underlying subaccounts, riders and product enhancements, if any, or replacement is suitable.10 Notably, and in particular, there must be a reasonable basis to believe that the consumer has been informed of any differences in features among fee-based and commission-based versions of the policy, and the manner in which the producer is compensated for the sale and servicing of the policy.11
Moreover, at the time of a recommendation of a sales transaction, the producer must disclose to the consumer in a reasonable summary format all relevant suitability considerations and product information, both favorable and unfavorable, that provide the basis for any recommendations, and document (i) the basis for any recommendations made; or, (ii) if relevant, the consumer’s refusal to provide suitability information; and (iii) that a sales transaction is not recommended if a consumer decides to enter into a sales transaction that is not based on the producer’s recommendation.12
In-force Recommendations. The best interest lite standard, which applies to a recommendation relating to any modification of or election of a contractual provision under an in-force policy that does not generate new sales compensation,13 is satisfied when:
– The producer’s recommendation to the consumer reflects the care, skill, prudence, and diligence that a prudent person acting in a like capacity and familiar with such matters would use under the circumstances then prevailing;
– Only the interests of the consumer are considered in making the recommendation;
– The amount of the producer’s compensation or the receipt of an incentive does not influence the recommendation; and
– There is a reasonable basis to believe the consumer has been reasonably informed of the relevant features of the policy or contract and the potential consequences of the in-force transaction, both favorable and unfavorable.14
Thus, in the case of in-force transactions (and unlike sales transactions), there is no obligation on a producer to (i) evaluate the consumer’s relevant suitability information, (ii) ensure that the transaction is suitable, (iii) have a reasonable basis to believe that the consumer would benefit from certain policy features, or that the policy as a whole, underlying subaccounts, riders and product enhancements, or replacements are suitable for the consumer based on the consumer’s suitability information, or (iv) discuss differences in fee-based and commission-based versions of a policy or the manner in which the producer is compensated.
Duties and Obligations for Insurers. Amended Regulation 187 also significantly expands the supervisory obligations of insurers in connection with sales transactions in their annuity contracts. This obligation generally requires that an insurer cannot effectuate a sales transaction involving its policies unless there is a reasonable basis to believe that the sales transaction is suitable based on the suitability information provided by the consumer, although the insurer is not required to take into consideration the availability of products, services, and transactions of companies other than the insurer when complying with this obligation.15 It is important to note that insurers do not have supervisory obligations with respect to in-force transactions.
Amended Regulation 187 will specifically require insurers to:
– Establish, maintain, and audit a system of supervision that is reasonably designed to achieve compliance with the best interest standard of care applicable to sales transactions, including standards and procedures for the collection of a consumer’s suitability information with respect to sales transactions