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Brandon Unger

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Brandon Unger joined Algren Associates in May of 2016. His role includes consulting and case design with a focus on strategies and options for high net worth, business, and estate planning clients. He was an agent with Prudential for four years prior to serving as the internal case specialist for a top advisor at MassMutual. Unger currently serves as the Young Professionals Chairperson for the New York City chapter of the Society for Financial Services Professionals. Unger can be reached at Algren Associates, 212 West 35th Street, 5th Floor, New York, NY 10001. Telephone: 212-594-9889 x223. Email: Brandon@algren.com.

What You Need To Know About New York’s Regulation 187

The time is nigh. The New York State Department of Financial Services Regulation 187 is upon us. I have seen a great deal of concern and criticism of it. This is my review having torn it apart over the course of a week and a half personally and listened/attended several discussions on it.

The purpose (Section 224.0) is very straightforward and I think most would agree that the Regulation has some merit. It states:

“The Insurance Law… establishes standards of conduct for insurance producers, including that producers must act in a competent and trustworthy manner,” and, “…clarifies the duties and obligations of producers…to help ensure that a transaction is in the best interest of the consumer and appropriately addresses the insurance needs and financial objectives of the consumer at the time of the transaction.”

I personally believe this is a noble goal. We all know producers that are not particularly driven by the best interests of their clients. We work with incredibly sophisticated financial tools. If there is a way to protect consumers, then I embrace any opportunity that rewards those who work to put clients first and holds accountable those who do not.

Having said that, we are in the business of selling life insurance, not “at-the-time-of-the-transaction” insurance. While the suitability questions outlined in the definitions section include popular hits like “Intended use of the policy,” and “Financial time horizon,” nowhere in the 13 pages of the regulation is the concept of a policy review mentioned, though in-force transactions are. This is most surprising given that the last line of the first page acknowledges that this regulation, “…does not guarantee or warrant an outcome.”
If we can all agree that what is suitable and in a clients best interest today might not be so in 20 years, then how can we claim to have the client’s best interest by not addressing that fact?

An example
Up until a few years ago, MetLife offered competitive products that were suitable options for the clients of MetLife’s agency distribution force and independent brokers. When MetLife closed shop and spun off Brighthouse they closed the entire block of business and lowered the dividend interest rate on those whole life contracts.

As of May 1, 2019, their closed-block of business, which includes many of the aforementioned suitable contracts, are now under the responsibility of the CFO with the express written goals of “…improving operating efficiency to generate distributable cash,” and “…to look for opportunities to accelerate the appropriate release of capital and reserves.”

A life insurance advisor with his client’s best interest should be revisiting and reviewing these contracts with their clients. An at-the-time-of-the-transaction insurance advisor has no further requirements to the client under Regulation 187.

Section 224.2 is Exemptions
I have some serious issues with several exemptions. Specifically, exempting the following:

Policies used to fund:
1. Employee pension or Welfare benefit plans
2. 401(a), 401(k), 403(b), 408(k) or 408(p) plans
3. Several varieties of Government or church plans
4. Non-qualified deferred compensation plans

Funding any one of the above plans utilizing life insurance products is more complex than most individual life insurance sales and—done improperly—can have a disproportionately adverse impact on a business owner and/or their employees.

An example
An unscrupulous advisor that understands the pension business can completely wipe out a client’s qualified plan balance and simultaneously put them in a position to pay significant taxes if the plan is ever terminated or they need to transfer the insurance policy out of the plan at any time.

I have seen the aftermath of several of these sales. It is devastating to a business owner who creates a qualified plan during a boom in their business. Then, following their “Trusted Advisor’s” advice, they fund a whole life policy with 49 percent of their max contribution. The next few years are leaner and/or they choose not to fund to the extent of year one, and the policy lapses with minimal cash soon after. The qualified plan ends up with a fraction of the funds contributed over that time and the main recourse is legal action against the advisor—the client is not guaranteed to win. There is no reason that these should be exempted transactions under this regulation.

I will get more in depth into the Definitions section (224.3) later as it becomes appropriate. As stated above, not once is a policy review mentioned.

Section 224.4 – Duties of Insurers and Producers
Now we are getting into the meat of Regulation 187. This section describes how a producer can act in the best interest of a client and what makes for a suitable transaction.

The main paragraph on how an advisor can act in the best interest of a client seeks to make only one point. Any recommendation made to a client should not be influenced by compensation.

The suitability of a sale gets more in-depth treatment. The regulation seeks to influence consumer education more than anything. It suggests that a sale is suitable if:

“…the consumer has been reasonably informed of various features of the policy and potential consequences of the sales transaction, both favorable and unfavorable, such as the potential surrender period and surrender charge, any secondary guarantee period, equity-index features, availability of cash value, potential tax implications if the consumer sells, modifies, surrenders, lapses or annuitizes the policy, death benefit, mortality and expense fees, cost of insurance charges, investment advisory fees, policy exclusions or restrictions, potential charges for and features of riders, limitations on interest returns, guaranteed interest rates, insurance and investment components, market risk, 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…”

There are other guidelines later in the section, but this paragraph (to me) is the one that should be raising the most eyebrows and will likely be the source of future complaints. This section requires advisors to inform consumers on information that carriers consider proprietary and do not divulge.

Take a second to appreciate that last sentence.

This section requires advisors to inform consumers on information that carriers consider proprietary and do not divulge. Amazing!

The next few parts of this section go into some additional details that involve transparency and good business practices. Then we come to j…

“A producer shall not use a title or designation of financial planner, financial advisor or similar title unless the producer is properly licensed or certified and actually provides securities or other non-insurance financial services.”

This is not only odd, it is borderline insulting. Even the simplest term sale is financial advice that can completely alter the financial viability of beneficiaries. I would contest that the life insurance specialist who has worked with business owners and estates for decades is more of a financial advisor than his counterpart at a wirehouse that manages the same client’s wealth but has never broached the subject of risk management.

They prove my above point through some incredible irony. Ten of the thirteen suitability questions—offered in the definition section of this regulation—are financial in nature. If insurance advice is not financial advice, then why is this level of financial suitability underwriting required?

It gets odder in the next part, k, where it dictates that any entity that receives commissions on a sale is liable to the standards put forth, “…regardless of whether the producer has had any direct contact with the consumer…” This is a bombshell to anyone who partakes in overrides. In theory, an advisor that has a brokerage general agency run some term quotes, sells the cheapest one, and then gets sued by the client years later for not selling them a permanent or convertible product, would include the BGA in the lawsuit even though the BGA had never had direct contact with the client.

At this point you are probably concluding that carrier distribution channels will no longer be viable in New York. Fear not, section m states that if you work for a carrier you need only disclose that to the client in advance. I guess suitability is only important when you have access to multiple solutions.

We move along to a small section that discusses duties with respect to in-force transactions (224.5). This is the only section that gets involved with the review process but only if a transaction occurs where the producer is compensated. It is important to note that it does not mandate reviews, it simply discusses that any recommendation made on an in-force policy needs to be done in the client’s best interest.

Section 224.6 follows, and it regards insurer responsibilities and supervision. It describes how to best comply with this regulation, audit producers, compensation, and corrective actions for consumers harmed by violations of the regulation. There is a brief point on carriers “…ensuring that every producer recommending any transaction with respect to the insurer’s policies is adequately trained to make the recommendation…” which I am very interested to see how they will adhere to. Will there be training modules like what we have for annuity products? We shall see.

Section 224.8—Violations—effectively concludes the regulation by declaring any infractions unfair or deceptive acts.

If this entire regulation seems very vague and with little direction it is because it is. I have been told that New York has not made any efforts to explain anything as there are currently two lawsuits against this regulation. As it goes into effect August 1 for annuities and February 1, 2020, for life insurance, it is the opinion of those in the know that the lawsuits will find some conclusions in the coming months and that the rest of us will get much needed clarification.

This regulation may be well meaning but it completely misses the mark in several important respects. I learned recently that one of the main influencers of this regulation was in the compliance department for a major mutual which—if I was a cynical man—explains a lot about what is missed and/or what is specifically regulated.

What Is Next For IUL?

Indexed universal life insurance has been around for 21 years. Through an impressive amount of complexity, it has achieved a nice niche for itself sitting between current assumption and whole life products on the conservative accumulation side and variable products on the moderate/moderate aggressive accumulation side.

The level of complexity built into these products makes them the perfect laboratory for carriers and actuaries to try out new and innovative ideas to bolster returns (on illustrations and hopefully in the real world). For instance, when a product has a cap rate, floor, and participation rate, how hard is it to throw in multipliers and/or bonuses?

If you think about how IULs are created and function, I would argue that we are heading toward the end of its second iteration. The first iteration being all products created prior to the passage of Actuarial Guideline 49–where guidelines were set in place for illustrated rates—and the second iteration being all products since.

Why do I believe we are heading to the end of this iteration? Because Principles Based Reserving is about to crush IRR. While this will be true of other cash accumulation focused products, the complexity of IULs may offer carriers greater flexibility to improve IRRs with the current levers they already have in place on these contracts or new levers they can introduce.

This could lead to IUL eating up even greater market share than it has already. Even with it being one of the most contentious products on the market, not only are IULs here to stay, they are currently buoying our industry. According to LIMRA, in Q2 2018, new annualized premiums from indexed life products increased 14 percent over Q2 2017. Contrast that with, in the same exact quarter, the total annualized premiums from new policies sold only increased two percent. IUL products now account for 64 percent of UL product premiums and, without them, new annualized premiums in Q2 could have looked atrocious.

This news is welcomed for someone who thinks, “The consumer base is getting more comfortable with this product and I can call my clients and talk to them about which one is best for them.”

On the contrary, this news is terrifying for someone who thinks, “This product is incredibly complicated, agents have no idea what they are selling, they are selling them improperly, and clients have no idea what they are buying.”

In my opinion there is some merit to both sides. However, the curveballs that have been hurtling towards us since 2016 are starting to hit the catcher’s mitt. And they may pose the greater threat.

This leads us right back to Principles Based Reserving. PBR brings one of the most significant changes in the laws regarding how insurers are supposed to hold reserves for claims purposes. In addition to new reserve requirements, for every product to adhere to PBR it must adopt the most current Commissioners Standard Ordinary (CSO) Mortality tables. Every product is required to adhere to this standard by January 1, 2020.

Without getting too into the weeds, this regulation should usher in decreases in premiums for most products with an increase in secondary guarantee premiums. However, the largest impact it will have on product performance will be in driving down cash values.

A quick refresher on cash values. To determine whether a policy qualifies as life insurance and not a Modified Endowment Contract (MEC), the contract cannot accept more premiums in the first seven years than what would be required to have the policy paid-up over that time, hence why we have the 7-Pay Test. This is over simplified, but it is enough for this conversation.

In many scenarios, PBR will allow carriers to carry lower reserves on products than they are currently required to (which would lead to a decrease in premiums) and the longer life expectancy on the new CSO tables means that mortality costs should also see a decrease.

So, with the expectation that premiums are decreasing, it stands to reason that less premiums would be required to pay up a policy in seven years.

This is what we, as an industry, have been expecting. It took carriers longer to put out PBR compliant products than we anticipated, but we are finally seeing them rear their faces as time ticks down. One carrier just updated their line of products and for a 55-year-old preferred client the maximum non-MEC premium dropped by 21 percent and the IRR over 30 years dropped by .92 percent sitting in the same exact account.

This decrease in performance is due to the forced premium reductions from lowered reserve requirements and mortality (think 7-pay premium) while operational costs to the carriers did not decrease. This leaves a greater percentage of a reduced premium being consumed by charges than had been before, so less funds are allocated to the investment account.

One positive about the carrier mentioned above is that their new PBR compliant IUL contract does seem to be more transparent than their current line. If this is a trend that other carriers follow, I would consider this a positive consequence.

So, what does the third iteration of IUL look like?

As of right now it is unclear. Carriers are not going to like the numbers that we are currently seeing come out of compliant products. My guess is that it will include greater levering of charges to boost performance in later years. How this could be accomplished is up to the brilliant minds of actuaries.

I would not be surprised if we started seeing more term riders available on accumulation focused products as a means of increasing the amount of premium a contract can take without becoming a MEC.

Then there are “wild,” out of the box ideas that spring up that no one seems to predict. These are generally thought up by one carrier and then copied by others. When we start seeing new definitions in the contract language, they will likely be stemming from these sorts of ideas.

Some or all of these will usher in the third iteration.

A greater issue in all this—that I have not been able to get a good answer to yet—is, “Where are all of these compliant products?”

As I alluded to earlier, there are very few contracts out that are PBR compliant. As of this writing only 31 out of 277, or just over 11 percent, of the products that LifeTrends tracks are PBR compliant. Some carriers are currently putting out new products that are not PBR compliant.

If you are following along, the line of reason goes: If all products need to comply by January 1, 2020, and only a few products currently comply, and state insurance departments are not known for their efficient processes in approving products, then we are fifteen months out with hundreds of products requiring approval…

What happens when August, 2019, rolls around and states have hundreds of new products submitted and awaiting approval by December 31? Could we see a massive logjam for product approvals? Could we start off the era of PBR compliance with a very limited set of products? Could an extension be filed to alleviate the increased load the state insurance departments will receive?

I do not know the answers to any of these questions, but each question is deeply concerning to me and everyone I have discussed them with.

With such an uncertain future I am confident that now is a great time to suggest to advisors that if a client is looking to over-fund a policy as much as possible for cash value growth, but they have been putting it off, now is the time to get off the sideline. The current product lines allow for far greater funding and with (likely) less levers than the next generation of products. Not just IULs, every product that is developed for cash growth should look far better today than it will a year from now.

Now that I have brought you up to speed with my concerns, I would like to end on a lighter note.

On its face the third iteration of IULs will be like every other product line—neither good nor bad. It will be incumbent on us, as always, to make sure that we understand how each product works to provide the best possible advice to our clients.

Lastly, I think it is always important to remember this: While we all have a rough idea of what IRRs we are looking for in a product and how these products work, most clients do not. While a product may not be attractive to us, it might look great to them. It might fit into their plan perfectly and, if it is sold properly, it should allow them to put their heads on their pillows each night for a very long time. So, let’s strap in and get ready for a wild year as the PBR deadline looms. There are always fireworks at midnight on New Year’s Eve. Let’s hope the fireworks at 12:01AM on January 1, 2020, are all in the sky.