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08-39 FINRA Requests Comments on Proposed New Rules Governing Communications About Variable Insurance Products; Comment Period Expires: September 30, 2008
Variable Insurance Products
Request for Comment
Referenced Rules & Notices
NASD Rule 2210
Legal & Compliance
Communications with the Public
Variable Insurance Products
FINRA requests comment on proposed changes to guidelines on illustrations of tax-deferred versus taxable compounding in advertising and sales literature (NASD Interpretive Material 2210-1) and communications with the public about variable life insurance and variable annuities (NASD Interpretive Material 2210-2). The proposal would:
Questions concerning this Notice should be directed to Joseph P. Savage, Vice President and Counsel, Investment Companies Regulation, at (240) 386-4534; or Thomas A. Pappas, Vice President and Director, Advertising Regulation, at (240) 386-4553.
FINRA encourages all interested parties to comment on the proposed changes. Comments must be received by September 30, 2008. Member firms and other interested parties can submit their comments by:
Marcia E. Asquith
Office of the Corporate Secretary
1735 K Street, NW
Washington, DC 20006-1500
To help FINRA process and review comments more efficiently, persons should use only one method to comment on the proposals.
Important Notes: The only comments that will be considered are those submitted pursuant to the methods described above. All comments received in response to this Notice will be made available to the public on the FINRA Web site. Generally, FINRA will post comments on its site one week after the end of the comment period.1
Before becoming effective, a proposed rule change must be authorized for filing with the SEC by the FINRA Board of Governors, and then must be approved by the SEC, following publication for public comment in the Federal Register.2
Background & Discussion
FINRA proposes to update and consolidate the rules governing member firm communications with the public about variable insurance products. The core of these rules is found in NASD Interpretive Material 2210-2 (Communications with the Public About Variable Life Insurance and Variable Annuities) (Guidelines). FINRA adopted the Guidelines in 1993 and has issued related interpretations in various publications since then. Through the review of communications submitted by firms to FINRA's advertising filings program, the FINRA Advertising Regulation Department staff has developed additional interpretations of the Guidelines.
FINRA proposes to modernize the Guidelines in a number of respects. Certain of its provisions would be shortened and simplified. Other changes would address areas that have seen significant changes since the Guidelines were first issued, particularly with respect to the use of riders and hypothetical illustrations. The proposal also would codify previous FINRA guidance concerning the use of comparative illustrations of the mathematical principles of tax-deferred versus taxable compounding in communications.
Proposed IM-2210-2 would contain for the first time a separate paragraph of defined terms. The purpose of this section is to clarify the meaning of certain terms used throughout the proposed rule. The definitions section is not intended to define insurance-related terms in other contexts beyond the scope of this rule.
Proposed paragraphs (b) and (c) in IM-2210-2 would address product identification and liquidity issues raised by variable insurance products communications. These provisions would shorten and simplify the provisions currently contained in paragraphs (a)(1) and (a)(2) of the Guidelines.
Proposed paragraph (b) would require that all communications clearly identify the type of product discussed and would prohibit communications from representing or implying that a variable insurance product is a mutual fund.
Proposed paragraph (c) would prohibit communications from falsely implying that variable insurance products are short-term, liquid investments. Paragraph (c) also would require any presentation regarding access to account values to be balanced by a description of the potential effect of all charges, penalties or tax consequences resulting from a redemption or surrender. In addition, any discussion of loans and withdrawals would have to explain their impact on account values and death benefits. These requirements generally reflect provisions contained in the Guidelines.3
Communications concerning variable insurance products frequently emphasize guarantees or riders, particularly to the extent that they protect an investor in a down market. FINRA recognizes the need to communicate the features of these guarantees and riders through sales material. However, it is equally important that these communications discuss guarantees and riders in a fair and balanced manner.
Currently, the Guidelines address claims about guarantees but do not specifically address riders. The proposal would incorporate the concepts concerning guarantee claims in the Guidelines and also propose specific provisions regarding riders.4
Similar to the Guidelines, the proposal would prohibit member firms from exaggerating the relative benefits of a guarantee, or an insurance company's financial strength or credit rating. Any discussion of a guarantee would have to disclose all material applicable limitations or qualifications. In addition, communications regarding guarantees would have to disclose that the investment return and principal value of an investment option are not guaranteed and will fluctuate.
Paragraph (d)(3) of the proposal states that communications that discuss the circumstances under which a guarantee or rider will benefit the customer must be fair and balanced considering the circumstances under which the guarantee or rider will not benefit the customer. While this provision would not require exhaustive disclosure of every circumstance in which a rider would not benefit a customer, any presentation regarding riders could not be one-sided and would have to present a fair and balanced description of the circumstances under which the rider would not benefit customers. In addition, paragraph (d)(4) would require rider discussions to explain the nature of the rider, its costs and limitations and the fact that it is an optional feature of the contract.
FINRA previously has expressed concerns with recommendations to purchase a variable annuity through a tax-qualified account, such as an individual retirement account. The concerns relate to the fact that a variable annuity does not provide any additional tax-deferred treatment of earnings beyond the treatment provided by the tax-qualified retirement plan itself. FINRA recognizes that there may be reasons other than tax deferral to recommend the purchase of a variable annuity through a tax-qualified account. However, we have reminded firms that a registered representative should recommend the purchase of a variable annuity through a tax-qualified account only when other benefits, such as lifetime income payments, family protection through the death benefit or guaranteed fees, support the recommendation.5
The same rationale applies to communications concerning a variable insurance product offered through a tax-qualified retirement plan. Accordingly, paragraph (e) of the proposal would prohibit any such communication from indicating that the tax-deferred treatment of earnings is available only through investment in the contract, and would require disclosure that the contract does not provide any additional tax-deferred treatment of earnings beyond the treatment of earnings provided by the retirement plan.
Proposed paragraph (f) would govern the various types of variable insurance product historical performance that a member firm may include in communications. These provisions generally reflect positions that FINRA staff has taken through the filings review program.
Variable Annuity Performance
Proposed paragraph (f)(1) would provide that member firms may present historical performance in communications regarding variable annuities only in accordance with Rule 482 under the Securities Act of 1933 or Rule 34b-1 under the Investment Company Act of 1940, as applicable.
Variable Life Insurance Policy Performance
Proposed paragraph (f)(2) would allow member firms to present historical performance information in communications regarding variable life insurance policies. The standards imposed by this paragraph generally reflect standards that FINRA staff previously has published regarding variable life insurance policy performance information.6 At a minimum, this performance must reflect the deduction of all fees and charges applicable at the investment option level.7
Communications that present variable life insurance policy performance also would have to prominently disclose:
Presentations of investment option performance in variable life insurance communications would have to be consistent with the standards for the presentation of open-end management investment company performance in SEC Rule 482. Thus, such performance would have to be current to the most recent calendar-quarter ended prior to the submission of the communication for publication, and show the average annual total return for one-, five- and ten-year periods, or since its inception if the investment option's registration statement had been in effect for less than those periods.9 This requirement is consistent with current industry practice.
Proposed paragraph (f)(3) would allow, but not require, member firms to present the performance of an investment option that occurred during the period prior to its availability through the separate account of a variable insurance product. For example, this provision would allow a firm to show an investment option's entire performance history, even if the investment option became available through the separate account subsequent to its inception. This provision reflects current FINRA policy to permit pre-dated performance,10 subject to certain conditions:
Proposed paragraph (f)(4) would allow, but not require, a member firm to present the combined performance of multiple investment options, subject to certain conditions:
Proposed paragraph (f)(5) would allow, but not require, a member firm to present an illustration based on the historical performance of individual investment options or combinations of investment options using assumed dollar investments, subject to certain conditions:
In some cases, a firm may present the performance of one or more investment options without presenting the performance of all investment options available through the separate account. In such situations, the member firm would have to disclose that the investment options depicted are not the only ones offered within a product.
Proposed paragraph (g) would address the use of illustrations that are based on assumed rates of return rather than on investment options' historical performance. Firms could present hypothetical illustrations based on assumed rates of return to demonstrate the way a variable insurance product operates, subject to a number of conditions.
Single Assumed Rates of Return
Proposed paragraph (g)(2) would allow, but not require, member firms to show investment results based on an assumed positive gross annual rate of return of up to 10 percent, so long as the results reflected the deduction of the maximum guaranteed charges. Assumed rates of return would have to be reasonable considering market conditions and the available investment options.12
Proposed paragraph (g)(3) would allow, but not require, a member firm to present an illustration based on an assumed negative annual gross rate of return. Typically, a firm will present a negative assumed annual gross rate of return to show the benefits of a rider that is intended to protect investors in a down market. If a negative assumed rate of return is used, the illustration would have to:
Multiple Assumed Rates of Return
Proposed paragraph (g)(4) would allow, but not require, a member firm to present an illustration based on multiple assumed rates of return that vary year by year. Currently, FINRA staff allows multiple-rate illustrations based on so-called "random" rates that are determined by the member firm. Under this provision, any illustration that uses multiple rates of return would have to be based on the actual performance of a broad-based securities market index for the period shown by the illustration. "Random-rate" illustrations would no longer be allowed to the extent that they do not reflect the actual performance of a broad-based securities index.
The broad-based securities market index would have to be one that is used as a basis for comparison in discussions of fund performance in prospectuses of available investment options. Thus, for example, if the prospectus for an equity investment option shows the performance of the Standard & Poor's 500 Index as the basis of comparison, the actual performance of this index could be used in a multiple assumed rate illustration.13
Investment results shown for multiple rate illustrations would have to reflect the deduction of maximum guaranteed charges. The illustration also would have to disclose the broad-based securities market index used and that the index does not reflect the performance of any investment option.
FINRA staff believes that requiring member firms to use the actual performance of a broad-based securities market index, rather than so-called "random" rates, is appropriate for two reasons. First, the historical performance of market indices allows investors to see how a variable insurance product would have operated under actual market conditions, rather than under some assumed random series of returns. Second, the use of broad-based securities market indices would enhance comparisons between products, since many illustrations would use the same index.
While member firms would be permitted to use multiple rates of return based on the actual performance of a broad-based securities market index, communications could not state or infer that index performance reflects or is a proxy for the performance of an investment option available through a variable product.
Assumed-rate illustrations also would have to meet certain other conditions, regardless of whether they employ a single or multiple assumed rates of return:
Proposed paragraph (h) would address the use of rankings in variable insurance products communications. This provision would permit member firms to include rankings in advertisements and sales literature, provided that their use is consistent with the standards contained in Interpretive Material 2210-3 (Use of Rankings in Investment Companies Advertisements and Sales Literature).
Proposed paragraph (i) would address the use of investment analysis tools in connection with the offer or sale of variable insurance products. Investment analysis tools are interactive technological tools that present the likelihood of various investment outcomes for named investments or investment strategies. Often these tools employ Monte Carlo simulations to project a range of possible outcomes for certain investments. Proposed paragraph (i) would allow the use of such tools, provided that the firm complied with Interpretive Material 2210-6 (Requirements for the Use of Investment Analysis Tools). In addition, member firms would have to employ a tool that either:
The proposal also would add new language to paragraph (5) of IM-2210-1 (Guidelines to Ensure that Communications with the Public Are Not Misleading) concerning comparative illustrations of the mathematical principle of tax-deferred versus taxable compounding contained in communications. Much of this language reflects previous guidance that FINRA has provided regarding tax-deferral illustrations.16 By placing this rule language in IM-2210-1, FINRA is clarifying that these standards apply to any illustration of tax-deferred versus taxable compounding, regardless of whether it appears in a communication promoting variable insurance products or some other communication, such as one discussing the benefits of investing through a 401(k) retirement plan or individual retirement account.
Communications concerning such comparative illustrations would have to meet certain requirements:
1 FINRA will not edit personal identifying information, such as names or email addresses, from submissions. Persons should submit only information that they wish to make publicly available. See Notice to Members 03-73 (November 2003) (NASD Announces Online Availability of Comments).
2 Section 19 of the Securities Exchange Act (Exchange Act) permits certain limited types of proposed rule changes to take effect upon filing with the SEC. The SEC has authority to summarily abrogate these types of rule changes within 60 days of filing. See Exchange Act Section 19 and the rules thereunder.
3 See IM-2210-2(a)(2).
4 The proposal would define the term "rider" as "an additional provision to a contract that adds or excludes coverage." See proposed paragraph IM-2210-2(a)(6).
5 See Notice to Members 99-35 (May 1999) (The NASD Reminds Members Of Their Responsibilities Regarding The Sales Of Variable Annuities).
6 See "Presentation Of Variable Life Insurance Performance In Member Communications," NASD Regulation, Inc., Regulatory & Compliance Alert (Winter 2001) pp. 34.
7 "Investment option" would be defined as "an open-end management investment company (or series thereof) offered through the separate account." See proposed IM-2210-2(a)(3). Thus, this provision would require, at a minimum, the deduction of expenses imposed at the underlying fund (sub-account) level, but not the deduction of expenses imposed at the separate account or contract level.
8 See proposed IM-2210-2(a)(5).
9 See SEC Rules 482(d)(3) and 482(g)(1)(i) under the Securities Act of 1933.
10 See IM-2210-2(b)(1). See also "Variable Annuity Performance," NASD Regulatory & Compliance Alert (Summer 2002) pp. 89.
11 The proposal would define "maximum guaranteed charges" as "the maximum recurring and non-recurring charges as disclosed in the prospectus of a variable insurance product that all investors incur at the variable insurance contract level, but does not include charges for optional riders. The term also includes the cost of insurance for purposes of a communication concerning a variable life insurance policy." See proposed IM-2210-2(a)(4).
12 In the past, FINRA has permitted assumed rates of return of up to 12 percent per annum, as long as they were accompanied by illustrations showing a 0 percent assumed rate of return. See, e.g., "Internal Rates of Return in Variable Life Hypothetical Illustrations," NASD Regulation, Inc., Regulatory & Compliance Alert (Winter 1998), pp. 3132. FINRA proposes to decrease the maximum single assumed rate of return to 10 percent.
13 Assumed rates of return based on the actual performance of a broad-based securities market index would not be subject to the 10 percent maximum set forth in paragraph (g)(2). In addition, to the extent a broad-based securities market index reflects negative performance in certain years, the illustration would not be required also to show an assumed positive rate of return as required under paragraph (g)(3).
14 The proposal would define "arithmetic average of investment option expenses" as "the number obtained by dividing the sum of all investment option expenses by the number of investment options offered through the separate account." See proposed IM-2210-2(a)(1).
15 In the past, FINRA has permitted member firms to reflect a weighted average of fund level expenses in variable life insurance hypothetical illustrations used with more than one customer, subject to certain conditions. The illustration had to be accompanied or preceded by a policy prospectus, and it had to be accompanied by a general illustration that reflects the arithmetic average of underlying fund expenses. See "Fund Level Expenses in Variable Life Hypothetical Illustrations," NASD Regulation, Inc., Regulatory & Compliance Alert (Spring 2002) p. 12. FINRA proposes to alter the requirements applicable to the use of a weighted average of expenses with more than one customer by no longer requiring that they be accompanied by a prospectus, and by requiring the illustration to reflect the current actual weighted average of investment options held by all investors through the separate account.
16 See "NASD Reminds Members of Their Responsibilities Regarding Hypothetical Tax-Deferral Illustrations in Variable Annuity Illustrations," NASD Member Alert (May 10, 2004).
Below is the text of the proposed changes to IM-2210-1. New text is underlined.
IM-2210-1. Guidelines to Ensure That Communications With the Public Are Not Misleading
Every member is responsible for determining whether any communication with the public, including material that has been filed with the Department, complies with all applicable standards, including the requirement that the communication not be misleading. In order to meet this responsibility, member communications with the public must conform with the following guidelines. These guidelines do not represent an exclusive list of considerations that a member must make in determining whether a communication with the public complies with all applicable standards.
Below is the text of the proposed changes to IM-2210-2, which replaces the current text in its entirety.
IM-2210-2. Communications with the Public About Variable Insurance Products
This Interpretive Material applies to all communications with the public about variable insurance products other than institutional sales material.
For purposes of this Interpretive Material, the following definitions will apply:
All communications must clearly identify the type of product discussed. The communication may not represent or imply that variable insurance products are mutual funds.
The communication may not falsely imply that variable insurance products are short-term, liquid investments. Presentations regarding access to account values must be balanced by a description of the potential effect of all charges, penalties, or tax consequences resulting from redemption or surrender. Discussions of loans and withdrawals must explain their impact on account values and death benefits.
Any member communication concerning a variable insurance product offered within a tax-qualified retirement plan:
Members may present historical performance information in communications regarding variable annuities only in accordance with SEC Rule 482 under the Securities Act of 1933 or SEC Rule 34b-1 under the Investment Company Act of 1940, as applicable.
Members may present historical performance information in communications regarding variable life insurance policies only in accordance with the following conditions:
Communications may present the performance of an investment option that occurred during the period prior to its availability through the separate account of a variable insurance product ("pre-dated performance"), provided that the communication meets the following conditions:
Members may present combined historical performance of multiple investment options, provided the communication satisfies the requirements of paragraphs (f)(1), (f)(2) and (f)(3), as applicable, and meets the following conditions:
Members may present illustrations based on historical performance of individual investment options or combinations of investment options available through a separate account using assumed dollar investments. Such illustrations must be accompanied by historical performance that satisfies the requirements of paragraphs (f)(1), (f)(2), (f)(3) and (f)(4), as applicable, and must:
To the extent applicable, communications that present historical performance of one or more selected investment options must disclose that the investment options depicted are not the only ones offered within the product.
Members may present hypothetical illustrations based on assumed rates of return in communications to demonstrate the way a variable insurance product operates, provided that the illustration meets the following conditions:
Performance rankings may be included in advertisements and sales literature provided their use is consistent with the standards contained in Interpretive Material 2210-3.
Members that use investment analysis tools in connection with the offer or sale of a variable insurance product must comply with the provisions of Interpretive Material 2210-6. In addition, members must either: