Annuities - How Much Is Too Much?
Insurance Compact Commission Holds Inaugural Meeting (2006)
Insurance Regulatory History (2006)

Annuities - How Much Is Too Much?
What percentage of a consumer’s assets should be in annuities. Is there a percentage that is too high or too low? Does the correct percentage vary by age? Should it be higher or lower depending on your total assets? I don’t believe you can plug some factoids into some model and figure out what percentage of an individual’s assets should be in annuities, because it isn’t simply an economic decision.

 Is putting 60% of a consumer’s asset in annuities too little? Is 1% too much?

Should a person have no more than 60% of their total assets in annuities? Possibly, if their risk tolerance was low and the remaining 40% of their assets met possible liquidity needs.

What about putting 90% of the money in annuities? If a consumer had a million dollars and an overriding goal of leaving at least $900,000 to their family the annuities could protect the legacy from market risk and still provide access to a lot of penalty-free cash (the penalty free 10% annual withdrawal provisions offered by almost every fixed annuity).

Is 1% too much? It could be if all of the assets might be needed without the year, or if the consumer has such a bugaboo about liquidity constraints that they only buy airline tickets while boarding the plane.

It comes down to how much needs to be safe and the liquidity needs of the consumer

I view a fixed annuity as a safe money place protecting principal and credited interest from market risk. I believe the first question a consumer needs to answer is how much of their money should be in safe money places and how much in risk money places, and I believe the answer comes down to how the consumer feels about risk of loss. For me, that’s a personal question and the “correct” answer will differ from person to person.

Let’s say a consumer does decide that 50% of their money should be not be exposed to market risk of loss, how much of that should be in fixed annuities? That would depend primarily on liquidity needs. Often – but definitely not always – safe money instruments with longer penalties pay higher yields than those without penalties. The reason why is usually because the issuer knows they have the money to work with a little longer so they can afford to pay a little more interest. Again, this is not always true. For example, today a Series EE bond is paying 3.4% and you can find money market accounts yielding well over 4%, even though the liquidity penalty on a savings bond lasts 5 years and there is no penalty on the money market.

Fixed annuities have liquidity penalties that typically range from 1 to 15 years. If you think you would need all of the money in 5 years, it wouldn’t make sense to buy an annuity with 10 years of penalties. But what if the odds were you wouldn’t need the money in 5 years or even 20 years? Then the annuity might be the best place for a portion of the safe money. The questions that need to be answered are how does the consumer feel about market risk and what are the liquidity needs of the consumer. The “correct” answer will vary from consumer to consumer.

Insurance Compact Commission Holds Inaugural Meeting
At their first meeting held November 15-16 in Lansdowne, Virginia the Insurance Compact Commission committed to quickly forming the advisory committees under the Bylaws and to soliciting applications for the eight-member consumer advisory committee. The committee also discussed the System for Electronic Rate & Form Filing (SERFF) and potential enhancements, a proposed fee structure, budget items for 2007 and the proposed services agreement with the NAIC. The Commission continued to make significant progress in implementing a central point of filing and review for asset-based insurance products.  Twenty-seven compacting states participated in the annual meeting, with twenty-two Commissioners in attendance.

The Commission held public hearings to receive comments on the draft Public Access Rule and the five draft Adjustable Life Uniform Product Standards.   It heard comments from representatives from the Commission interim industry and consumer advisory committees, members of the Legislative Committee as well as from states that are considering joining the Compact and other industry representatives and interested parties. The newly-formed Management Committee voted to approve the Public Access Rule and made amendments to the uniform product standards.

Currently, 28 members have joined the Interstate Insurance Product Regulation Commission. The compacting members are Alaska, Colorado, Georgia, Hawaii, Idaho, Indiana, Iowa, Kansas, Kentucky, Maine, Maryland, Massachusetts, Minnesota, Nebraska, New Hampshire, North Carolina, Ohio, Oklahoma, Pennsylvania, Puerto Rico, Rhode Island, Texas, Utah, Vermont, Virginia, Washington, West Virginia and Wyoming. 

Insurance Regulatory History  
Once again in Congress there is movement to add a federal aspect to insurance regulation. Last summer John Sununu (R-N.H.) and Timothy Johnson (D-S.D.) returned attention to the possibility of a federal charter for insurance carriers. The major reasons stated for wanting to change the current regulatory model are that there is too much regulatory duplication on the state side resulting in millions of wasted dollars and man-hours for carriers – money that could be returned to consumers, and too often the state insurance department is used for personal political agendas; views that are strongly contested by the states. Since the banking and securities industries are substantially controlled by the Feds, how did the states manage to retain control of the third leg of the triumvirate?

Massachusetts had the 1st Insurance Dept

The first state laws designed to regulate insurance were passed by Massachusetts in 1799, and in 1852 Massachusetts created the first insurance department. Due to a history of insurance company failures during the various panics of the early 19th century there was a call for federal regulation of insurance, but Congress failed to act. The issue was forced in an 1868 case, Paul v Virginia in which Paul argued that insurance was interstate commerce and fell under the commerce clause of the Constitution. However, the Supreme Court disagreed and left insurance regulation at the state level.

The states realized that coordination between the states was needed, and so on 24 May 1871 the first meeting of the National Convention of Insurance Commissioners was held. In 1936 the name was changed to the National Association of Insurance Commissioners (NAIC).

The Depression resulted in increased federal oversight of financial markets. The FDIC was formed, the Securities & Exchange Commission was created, and many other rules were imposed adding a distinct federal nature to the economy.In 1944 the Supreme Court once again heard a case, U.S. v South-Eastern Underwriters Association, asking for federal oversight of insurance, and this time the court agreed saying insurance regulation was a federal matter. However, before the decision could be implemented Congress passed the McCarran-Ferguson Act – in one of the last hurrahs for state’s rights – that left insurance regulation in the hands of the states, and this is where it sits today.

The voluntary nature of the NAIC changed. The first paid NAIC staff members were hired in 1947 and given an annual budget of $25,000. Offices moved from Raleigh to Chicago to Milwaukee, until finally moving to Kansas City in 1984.

Solvency & Rates 
An ongoing state concern was carrier solvency. Thirty (primarily) property & casualty carriers went out of business in the mid 1800s usually due to simple incompetence and theft. But the industry’s tone didn’t improve even though they told the states they were getting better. A broad look by the Armstrong Committee in 1905 found an industry rife with misconduct, kickbacks, high officer salaries, and collusion on setting premium rates. The result was a focus by state regulators on both the finances of carriers and an attempt to determine that the rates charged were “fair”.

In 1941 NY created the first life insurance guarantee association; no one followed for 30 years.Why was there state opposition to guaranty plans? Some felt a guarantee plan rewarded incompetent management meaning well-run carriers would pay for the mistakes of the bad ones. Others felt regulators would be less thorough in examining the books of carriers if they knew policyholders would always be protected.

By 1983 only 35 states had life/health guaranty funds. Then came the failure of Ballwin-United putting 300,000 policyholders at risk, and when it became apparent Executive Life was going to crash California finally created their own guaranty fund in 1990. By 1992 all states had guaranty funds.

In 1983 the state guaranty associations founded the National Organization of Life and Health Insurance Guaranty Associations. If the insolvency affects three or more states NOHLGA coordinates the development of a plan to protect policyholders. NOHLGA states "every holder of a covered life insurance, annuity, or non-cancelable health insurance policy who has made the required premium payments has been given the opportunity to have the policy assumed by another healthy carrier or had the covered portions of their policies fulfilled by their guaranty association itself.

Future
Both state and federal advocates agree that the current regulatory model needs to change. Insurers need to be able to price based on policy economics and unhindered by price controls, but regulators need to determine that all consumers are treated fairly. Needless duplication of forms, filings, materials and inspections must end. Disclosure, supervision of agents, training all need to be stepped up to cope with the ever-increasing tempo of new products and new solutions. The states are making progress, but only time will tell whether this progress is sufficient to avoid a federal takeover.

Baranoff & Baranoff (2003), Trends in insurance regulation, Review of Business, Fall, 24, 3; pg 11.  
Kimball & Parrett (2000), Creation of the guaranty association system, Journal of Insurance Regulation, Winter, 19, 2; pg. 259-272.  
Eric C. Nordman (2000), The Early History of the NAIC, Journal of Insurance Regulation, Winter, 19, 2; pg. 164-178.

Copyright 2006, 2007, 2008. Annuity Regulatory Compendium is published by Annuity Regulatory Compendium LLC 
 Reproduction is not permitted without written permission. We do not provide investment or tax advice. Information believed accurate, but is not warranted. The information provided is for informational purposes only and is not intended as legal advice. Status and content of each bill may change until approval process is completed. Updated information may be found on the respective state legislature’s website.