Fixed versus variable life, and SEC, FINRA, and New York regulation of variable products (Ins. Law 4240, Regs 47 and 77)

Two ways to back a life policy

Every life insurance policy is a promise, and the question for this objective is who carries the investment risk behind that promise.

A fixed (traditional) life policy, such as whole life, is backed by the insurer's general account. The insurer invests premiums alongside all its other business and guarantees the death benefit, the premium and a schedule of cash values. If the insurer's investments do badly, the insurer absorbs the loss. The policyowner carries no investment risk, so a fixed policy is regulated as insurance only.

A variable life policy shifts that risk to the policyowner. Premiums (after charges) go into a separate account, divided into subaccounts that work like mutual funds. Cash value rises and falls with the subaccounts and is not guaranteed. The death benefit also varies, usually above a guaranteed minimum. Variable universal life adds universal life's flexible premiums and adjustable death benefit to the same separate-account investing. Variable annuities work the same way during accumulation.

The separate account under New York law

Insurance Law section 4240 lets a domestic life insurer set up separate accounts for variable life insurance and variable annuities. Key rules:

• Results stay in the account. Income, gains and losses of the separate account are credited or charged to it without regard to the insurer's other income, gains or losses.
• Owned by the insurer, but insulated. The assets belong to the insurer, which is not a trustee. If the contract so provides, they cannot be charged with liabilities from the insurer's other business.
• Valued at market. Separate account assets are generally valued at market value, which is why unit values change daily.
• Guarantees live in the general account. Reserves for guaranteed minimum death benefits on variable life policies must be held in the general account.
• Prior approval. An insurer may not sell separate account contracts in New York until the superintendent approves its statement of methods of operation.

What a New York variable contract must say

A variable contract delivered in New York must describe how the variable amounts are calculated, state clearly that they may decrease or increase, and say on its first page that its elements are on a variable basis. Individual variable life policies must contain loan, grace, reinstatement and nonforfeiture provisions. Individual variable annuities must give a free look of 10 to 30 days (30 days if sold by mail order). On cancellation, the refund includes the current value of amounts allocated to the separate account, so the owner keeps any gain or loss. Variable annuity death benefits must be paid within seven calendar days of the beneficiary's completed election form.

Three regulators, one product

Because the owner bears investment risk, a variable product is both insurance and a security:

• SEC. Variable contracts are registered under the Securities Act of 1933, and the separate account is normally registered under the Investment Company Act of 1940. A prospectus must be delivered to the buyer no later than the sale.
• FINRA. The selling producer must be a registered representative of a FINRA member broker-dealer, typically after passing the Series 6 or Series 7 exam, and the sale is subject to FINRA's suitability and supervision rules.
• New York DFS. The producer also needs a New York life insurance license. Section 4240 gives the superintendent sole state authority over the issuance and sale of these contracts and the power to issue regulations. Regulation 47 (variable annuities) and Regulation 77 (variable life) are those regulations.

Exam rule of thumb: selling variable life or a variable annuity requires both a state life license and securities registration. A life license alone is not enough, and neither is a securities license alone.

Fixed products, including fixed and fixed indexed annuities, carry no separate account investment risk for the owner, so they need only the insurance license.