Financial Product Sales
Actions Needed to Better Protect Military Members Gao ID: GAO-06-23 November 2, 2005In 2004, a series of press articles alleged that financial firms were marketing expensive and potentially unnecessary insurance or other financial products to members of the military. To assess whether military service members were adequately protected from inappropriate product sales, GAO examined (1) features and marketing of certain insurance products being sold to military members, (2) features and marketing of certain securities products being sold to military members, and (3) how financial regulators and the Department of Defense (DOD) were overseeing the sales of insurance and securities products to military members.
Thousands of junior enlisted service members have been sold a product that combines life insurance with a savings fund promising high returns. Being marketed by a small number of companies, these products can provide savings to service members that make steady payments and have provided millions in death benefits to the survivors of others. However, these products are much more costly than the $250,000 of life insurance--now $400,000--that military members already receive as part of their government benefits. In addition, the products also allow any savings accumulated on these products to be used to extend the insurance coverage if a service member ever stops making payments and fails to request a refund of the savings. With most military members leaving the service within a few years, many do not continue their payments and, as a result, few likely amassed any savings from their purchase. Several of the companies selling these products have been sanctioned by regulators in the past and new investigations are underway to assess whether these products were being properly represented as insurance and whether their terms were legal under existing state laws. Thousands of military members were also purchasing a mutual fund product that also requires an extended series of payments to provide benefit. Known as contractual plans, they expect the service member to make payments for set periods (such as 15 years), with 50 percent of the first year's payments representing a sales charge paid to the selling broker-dealer. If held for the entire period, these plans can provide lower sales charges and comparable returns as other funds. However, with securities regulators finding that only about 10 to 40 percent of the military members that purchased these products continued to make payments, many paid higher sales charges and received lower returns than had they invested in alternatively available products. Regulators have already taken action against the largest broker-dealer that marketed this product and are investigating the few remaining sellers for using inappropriate sales practices. With the wide availability of much less costly alternative products, regulators also question the need for contractual plans to continue to be sold. Financial regulators were generally unaware of the problematic sales to military members because DOD personnel rarely forwarded service member complaints to them. Insurance products also usually lacked suitability or appropriateness standards that could have prompted regulators to investigate sales to military members sooner. Securities regulators' examinations of contractual plan sales were also hampered by lack of standardized data showing whether customers were benefiting from their purchases. Although recognizing a greater need for sharing information on violations of its solicitation policies and service member complaints, DOD has not revised its policies to require that such information be provided to financial regulators nor has it coordinated with these regulators and its installations on appropriate ways that additional sharing can occur.
RecommendationsOur recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.
Director: Team: Phone:GAO-06-23, Financial Product Sales: Actions Needed to Better Protect Military Members
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Report to the Committee on Banking, Housing, and Urban Affairs, U.S.
Senate:
November 2005:
Financial Product Sales:
Actions Needed to Better Protect Military Members:
GAO-06-23:
GAO Highlights:
Highlights of GAO-06-23, a report to the Committee on Banking, Housing,
and Urban Affairs, U.S. Senate.
Why GAO Did This Study:
In 2004, a series of press articles alleged that financial firms were
marketing expensive and potentially unnecessary insurance or other
financial products to members of the military. To assess whether
military service members were adequately protected from inappropriate
product sales, GAO examined (1) features and marketing of certain
insurance products being sold to military members, (2) features and
marketing of certain securities products being sold to military
members, and (3) how financial regulators and the Department of Defense
(DOD) were overseeing the sales of insurance and securities products to
military members.
What GAO Found:
Thousands of junior enlisted service members have been sold a product
that combines life insurance with a savings fund promising high
returns. Being marketed by a small number of companies, these products
can provide savings to service members that make steady payments and
have provided millions in death benefits to the survivors of others.
However, these products are much more costly than the $250,000 of life
insurance”now $400,000”that military members already receive as part of
their government benefits. In addition, the products also allow any
savings accumulated on these products to be used to extend the
insurance coverage if a service member ever stops making payments and
fails to request a refund of the savings. With most military members
leaving the service within a few years, many do not continue their
payments and, as a result, few likely amassed any savings from their
purchase. Several of the companies selling these products have been
sanctioned by regulators in the past and new investigations are
underway to assess whether these products were being properly
represented as insurance and whether their terms were legal under
existing state laws.
Thousands of military members were also purchasing a mutual fund
product that also requires an extended series of payments to provide
benefit. Known as contractual plans, they expect the service member to
make payments for set periods (such as 15 years), with 50 percent of
the first year‘s payments representing a sales charge paid to the
selling broker-dealer. If held for the entire period, these plans can
provide lower sales charges and comparable returns as other funds.
However, with securities regulators finding that only about 10 to 40
percent of the military members that purchased these products continued
to make payments, many paid higher sales charges and received lower
returns than had they invested in alternatively available products.
Regulators have already taken action against the largest broker-dealer
that marketed this product and are investigating the few remaining
sellers for using inappropriate sales practices. With the wide
availability of much less costly alternative products, regulators also
question the need for contractual plans to continue to be sold.
Financial regulators were generally unaware of the problematic sales to
military members because DOD personnel rarely forwarded service member
complaints to them. Insurance products also usually lacked suitability
or appropriateness standards that could have prompted regulators to
investigate sales to military members sooner. Securities regulators‘
examinations of contractual plan sales were also hampered by lack of
standardized data showing whether customers were benefiting from their
purchases. Although recognizing a greater need for sharing information
on violations of its solicitation policies and service member
complaints, DOD has not revised its policies to require that such
information be provided to financial regulators nor has it coordinated
with these regulators and its installations on appropriate ways that
additional sharing can occur.
What GAO Recommends:
Matters that Congress should consider include banning contractual
plans, requesting that insurance regulators conduct reviews to ensure
that products being sold to military members meet existing insurance
requirements, and ensuring development of appropriateness or
suitability standards for such sales. GAO also recommends that DOD and
financial regulators work cooperatively to help improve the oversight
of such products. DOD and the financial regulators provided comments
generally agreeing with this report and its recommendations.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Richard Hillman at (202)
512-8678 or hillmanr@gao.gov.
[End of section]
Contents:
Letter:
Background:
Results in Brief:
Sales of Costly Insurance Products to Service Members Raise Sales
Practice Concerns:
A Unique Securities Product with High Sales Charges Sold to Military
Members Has Also Raised Sales Practice Concerns:
Lack of Complaint Sharing Prevented Earlier Identification of Improper
Sales to Military Members:
Conclusions:
Matters for Congressional Consideration:
Recommendations:
Agency Comments:
Appendixes:
Appendix I: Objectives, Scope, and Methodology:
Appendix II: Actions Taken Against Financial Companies that Have
Frequently Marketed to Military Members:
Appendix III: Performance of Contractual Plans Compared to Alternative
Investments:
Appendix IV: Jurisdictions in Which at Least One of the Six Insurance
Companies That Target Military Members Were Licensed to Sell Insurance:
Appendix V: Comments from the Department of Defense:
Appendix VI: Comments from the Securities and Exchange Commission:
Appendix VII: Comments from NASD (Formerly Called the National
Association of Securities Dealers):
Appendix VIII: Comments from the National Association of Insurance
Commissioners:
Appendix IX: GAO Contact and Staff Acknowledgments:
Tables:
Table 1: Regulatory Actions or Activities Involving Companies that Have
Frequently Marketed to Military Members:
Table 2: Investment Performance of a $100 Monthly Contribution into a
Contractual Plan, Conventional Mutual Fund, and TSP C Fund, Assuming
Each Earns a 7 Percent Return:
Figures:
Figure 1: Number of Service Members by Military Pay Grade Groupings (as
of Year-end 2004):
Figure 2: Sample Payment Allocations of $100 per Month for a Term Life
Insurance Product Sold to Military Service Members with a 7-Year
Premium Period and a Side Savings Fund Crediting 4 Percent:
Figure 3: Sample Payment Allocations of $100 per Month for a Modified
Whole Life Insurance Product Sold to Military Service Members with a
Side Savings Fund Crediting 4 Percent (First 20 Years Shown):
Figure 4: Total Approximate Future Values of Insurance Products'
Savings Fund and TSP with Payments Ceasing after Year 4:
Figure 5: Mutual Fund Sales Load as a Percentage of Investment by Year:
Abbreviations:
DFAS: Defense Financial and Accounting Service:
DOD: Department of Defense:
DOJ: Department of Justice:
IMSA: Insurance Marketplace Standards Association:
NAIC: National Association of Insurance Commissioners:
NASAA: North American Securities Administrators Association:
NASD: National Association of Securities Dealers:
PCS: Permanent Change of Station:
SEC: Securities Exchange Commission:
TSP: Thrift Savings Plan:
SGLI: Servicemembers' Group Life Insurance:
VGLI: Veterans' Group Life Insurance:
Letter November 2, 2005:
The Honorable Richard Shelby:
Chairman:
The Honorable Paul S. Sarbanes
Ranking Minority Member:
Committee on Banking, Housing, and Urban Affairs:
United States Senate:
In 2004, a series of media reports highlighted allegations of financial
firms marketing expensive and potentially unnecessary insurance and
other financial products to members of the military. These accounts
included claims of insurance companies improperly selling insurance as
investment products and marketing them during personal finance
briefings on military bases in violation of Department of Defense (DOD)
regulations. In addition, these accounts raised concerns about a firm
that employed retired and former military members to market a mutual
fund product with high up-front sales charges that was rarely being
offered to civilians. As a result of these media accounts, Congress and
others have become concerned over whether the men and women in the
armed services are as adequately protected from inappropriate financial
product sales as their civilian counterparts.
As a result of these allegations, you asked us to review the sales of
financial products to members of the U.S. military. This report
identifies (1) the extent to which certain insurance products were
being sold to military members and how these products were being
marketed, (2) the extent to which certain securities products were
being sold to military members and how these products were being
marketed, and (3) how financial regulators and DOD oversaw the sales of
insurance and securities products to military members.
To identify the extent to which certain insurance products were sold
and how they were marketed to military members, we contacted state
insurance regulators in several states with active investigations of
insurance sales involving service members. During this work, we
interviewed regulatory staff and reviewed available information and
materials as part of these regulatory investigative activities. We also
reviewed documents and met with Department of Justice (DOJ) staff
involved in investigating sales by insurance companies to military
members. Additionally, we interviewed officials from six insurance
companies that market to service members and reviewed their marketing
materials. We also interviewed military personnel at two large training
bases and reviewed documents pertaining to sales and complaints at
these locations.[Footnote 1] Furthermore, we obtained data on insurance
sales to military members from DOD's Defense Finance and Accounting
Service (DFAS), which maintains military personnel pay records. To
identify the extent to which certain securities products were being
sold and how these were being marketed to military members, we
interviewed staff from federal, state, and other securities regulators;
the largest broker-dealer firm that markets to military members; and
two of the investment management firms that manage the mutual funds
underlying some of the contractual plans sold to military members. To
assess how financial regulators and DOD were overseeing financial
product sales to military members, we interviewed state insurance and
federal, state, and other securities regulators. We also reviewed
materials pertaining to investigations and regulatory actions involving
firms marketing to military members. Additionally, we contacted DOD
officials, conducted fieldwork at two large military training
installations, and reviewed findings from other recent work concerning
supplemental life insurance sales conducted at several other military
installations throughout the country. We conducted this work between
November 2004 and October 2005 in accordance with generally accepted
government auditing standards. (Additional information on our
methodology is included in appendix I.)
Background:
Members of the U.S. military serve in different branches in locations
across the country and around the world. The various branches within
DOD include the Department of the Air Force, the Department of the
Army, and Department of the Navy, which also incorporates forces of the
Marine Corps. DOD also oversees the members of the Coast Guard along
with the Department of Transportation. As of 2004, approximately 1.4
million active duty military personnel served in the various branches
in more than 6,000 locations. In addition, 2 million retirees receive
pay and benefits from the department. DOD is also the largest employer
and trainer of young adults in the United States, recruiting about
200,000 individuals into active duty in 2004--the majority of them
recent high school graduates. As shown in figure 1, the pay of typical
junior enlisted staff--grades E-1 through E-3--ranges between $1,143
and $1,641 per month.
Figure 1: Number of Service Members by Military Pay Grade Groupings (as
of Year-end 2004):
[See PDF for image]
[End of figure]
Entry-level military personnel are generally young and have limited
education and incomes. A 2002 private research organization report that
examined the financial situation of military members noted that the
military hires primarily young, untrained, entry-level
employees.[Footnote 2] Comparing data from various surveys done of
large numbers of civilians and military members, this report found that
less than 5 percent of junior enlisted personnel held bachelor's
degrees compared to 27 percent of the civilians.[Footnote 3] In terms
of income, this report found that 87 percent of junior enlisted
personnel had total monthly family incomes of $3,000 or less. However,
a DOD commission that reviews military compensation has found that
military members are paid at the 70th percentile or higher of
comparably educated civilians. In addition, military members receive
housing and subsistence benefits, with about half living in on-base
housing and many having access to military facilities that provide
meals.
Various aspects of the military life can increase the challenges that
service members face in managing their finances. According to the
private research report, factors that appeared to increase the
financial distress among military members were the family separations
resulting from changes in duty stations and deployments away from home.
According to our report on military relocations, DOD reported that
about one-third of all military members make Permanent Change of
Station (PCS) moves every year.[Footnote 4] The average length of time
spent at each location can also be brief, with 20 percent of such
relocations lasting less than 1 year and about 50 percent lasting 2
years or less. Leaving or retiring from the service also represents the
last major transition in a service member's career, with data
indicating that most enlisted personnel leave after their initial duty
commitment.[Footnote 5]
As with their civilian counterparts, military service members may be
offered various types of financial products, including life insurance.
Types of life insurance commonly sold include term, whole, universal,
and variable life insurance products. Many companies offer term life
insurance, which generally provides basic death benefits for a
specified time period, such as 10 or 20 years. At the end of this term,
the insured can usually renew the coverage at a higher premium rate for
another set term period. The coverage on a term policy may also end if
the insured person ceases making the required periodic premium
payments. Under a whole life policy, an insured person can make level
premium payments, which will provide the specified amount of death
benefits. Because the premium generally stays the same throughout the
time that the policy is in force, premiums for whole life insurance are
generally higher initially than for comparable amounts of term life
coverage. Whole life insurance policies can build cash value, which can
be borrowed upon, though this will reduce death benefits until the loan
is repaid in full. Some whole life policies are known as "modified
whole life insurance" in which the policyowner pays a lower than normal
premium for a specified initial period, such as 5 years, after which
time the premium increases to a higher amount that is payable for the
life of the policy. Universal life products may also provide permanent
insurance--like a whole life policy--but may also offer their
purchasers more flexibility. Under such policies, the holder can vary
the amount of the premium to build up the cash value of the policy by
increasing the amount of the payment, or can pay less into the policy
at other times, when money is needed for other purposes. Similarly,
under a variable life policy, a cash value accumulates that can be used
to invest in various instruments, such as common stocks, bonds, or
mutual fund investments. However, with a variable life policy, the
policyholder (and not the company) assumes the investment risk tied to
the product. If these investments perform well, the death benefits paid
on the policy can increase; conversely, if the investments perform
poorly, the purchaser may have to increase their premiums to keep the
policy in force.
The federal government offers service members life insurance as part of
their total benefits package. Each member is eligible for inexpensive
coverage under Servicemembers' Group Life Insurance (SGLI), which
provides group term life insurance. Until September 1, 2005, service
members were automatically covered for the maximum amount of $250,000
of insurance on their first day of active duty status, unless they
decline or reduce their coverage, but Congress has now increased this
amount to $400,000.[Footnote 6] Service members leaving the military
can also opt to continue coverage through the government-sponsored
coverage provided to veterans. Although many life insurance policies
exclude coverage for deaths resulting from acts of war, these
government-sponsored policies do not contain this exclusion.
State government entities are the primary regulators of insurance
companies and agents in the United States.[Footnote 7] When first
establishing operations, an insurance company must obtain a charter or
license in order to write business in a state. This state becomes its
state of domicile. Insurers may obtain approval to market products in
multiple states, and therefore the sales by insurers can be overseen by
multiple state regulators, though financial solvency of each company is
primarily overseen by the regulator in the company's state of domicile.
Some insurance companies market their products using their own
proprietary sales force. Some companies may also use agents employed by
independent firms who may be marketing the products of multiple
companies to their customers. The state insurance regulators oversee
the insurance companies and agents that do business in their
jurisdictions in several ways, including reviewing and approving
products for sale and examining the operations of companies to ensure
their financial soundness or proper market conduct behavior.
Although each state has its own insurance regulator and laws, the
National Association of Insurance Commissioners (NAIC) provides a
national forum for addressing and resolving major insurance issues and
for allowing regulators to develop consistent policies on the
regulation of insurance when consistency is deemed appropriate. This
association consists of the heads of each state insurance department,
the District of Columbia, and four U.S. territories. It serves as a
clearinghouse for exchanging information and provides a structure for
interstate cooperation for examinations of multistate insurers. NAIC
staff also coordinate the development of model insurance laws and
regulations for consideration by states. Its staff also review state
insurance departments' regulatory activities as part of its national
financial accreditation program.
To meet their financial investment needs, military members may also be
offered various securities products. These can include stocks issued by
public companies that are traded in various markets, or debt
securities, such as bonds that provide interest income to their
holders. A common securities product that many investors purchase is a
mutual fund. Mutual funds are investment companies that pool the money
of many investors, and then invest them in other assets, such as stocks
or bonds. By holding the shares of the mutual fund, investors can
benefit from owning a broad portfolio of diversified securities managed
by professional money managers, whose services they might otherwise be
unable to obtain or afford. Investors are charged mutual fund fees,
which cover the day-to-day costs of running a fund. Mutual funds are
sold through a variety of distribution channels. For instance,
investors can buy them directly by telephone or mail, or they can be
sold by sales forces, such as the account representatives of third
party broker-dealers. Some mutual funds assess sales charges (also
called "loads"), which are generally paid at the time of purchase to
compensate these sales personnel.[Footnote 8]
Securities--and the firms that market them--are overseen by various
regulators. At the federal level, the Securities and Exchange
Commission (SEC) oversees securities issued by public companies. The
firms that market securities to investors, known as broker-dealers,
must also register and subject themselves to SEC oversight. This
includes complying with various requirements for regulatory reporting,
financial soundness, and sales practice regulations designed to protect
investors. In addition to oversight by SEC, broker-dealers also are
overseen by private entities known as self-regulatory organizations.
The New York Stock Exchange and NASD (formerly called the National
Association of Securities Dealers) are two examples of such
organizations. State regulators also oversee securities activities.
Congressional concerns over the adequacy of military member's financial
literacy and the processes in place to address financial product sales
have prompted recent reviews and legislative actions. In response to a
Congressional committee's request to review military members' financial
condition, we recently reviewed and reported on the financial condition
of active duty service members and their families. We also reported on
DOD's efforts to evaluate programs to assist deployed and non-deployed
service members in managing their personal finances and the extent to
which junior enlisted members received required personal financial
management training.[Footnote 9] As part of this study, we found that
the financial conditions of deployed and non-deployed service members
and their families are similar, but deployed service members and their
families may face additional financial problems related to pay. We also
found that DOD lacks an oversight framework for evaluating the
effectiveness of its personal financial management training programs
across services, and that some junior enlisted service members were not
receiving personal financial management training required by service
regulations. In addition, we reviewed and reported on the extent of
violations of DOD's policies governing the solicitation of supplemental
life insurance to active duty service members and DOD personnel's
compliance with procedures for establishing payroll deductions
(commonly referred to as allotments) for supplemental life insurance
purchases.[Footnote 10] The findings of this review are discussed later
in this report.
In response to concerns over the sale of questionable financial
products to military members, the House of Representatives passed
legislation in 2004 and 2005 requiring additional protections for
service members.[Footnote 11] In February 2005, a similar bill was
introduced in the U.S. Senate.[Footnote 12] Both bills contain various
congressional findings, including the finding that military members are
being offered high-cost securities and life insurance products by some
financial services companies engaging in abusive and misleading sales
practices. According to the bills, Congress finds that the regulation
of these products and their sale on military bases has been clearly
inadequate and requires congressional legislation to address these
issues. These bills have been referred to the Senate Committee on
Banking, Housing, and Urban Affairs for further consideration.
Results in Brief:
State regulators in various states have found that a small number of
insurance companies have been marketing a type of high-cost insurance
product to thousands of low-ranking service members at military
installations across the United States and around the world. According
to state insurance regulators, at least six companies were targeting
military members and selling a product that combines life insurance
with a savings or investment fund that promises high returns but
includes provisions that reduce the likelihood that military purchasers
will benefit. Although military members already receive considerable
low-cost life insurance as part of their government benefits, these
companies' products usually provide small amounts of additional death
benefits and survivors of some service members that died have received
millions in death benefit payments from these companies. However, the
products sold by these companies had much higher premiums than those
that military members pay on policies offered by the government or
other companies. In addition, these products raise concerns because
they have a provision that depletes any accumulated savings to pay the
insurance premiums if the military members, many of whom move
frequently and leave the service within the first few years, ever stop
making the scheduled payments. With state insurance regulators
indicating that most military members halt their payments within the
first few years and often fail to request refunds of their savings,
most purchasers were left with little or no savings in exchange for a
small amount of expensive insurance coverage. Insurance regulators and
others have already taken actions to seek remediation on behalf of
service members from several companies selling these products and
additional investigations are underway in as many as 14 states.
Regulators are examining allegations of whether representatives of
these companies misrepresented the products as investments rather than
insurance, including investigating cases in which premiums for the
products were alleged to have been fraudulently identified as going
into savings accounts on forms used to deduct premium payments from the
military members' pay. Information from our work, DOD, DOJ, and other
organizations have documented that these companies have frequently been
found to have violated DOD restrictions on selling products on military
installations for years. During the course of our work, we also
referred several potential fraud-related concerns to our special
investigators, who have initiated contacts with federal law enforcement
authorities, state insurance regulators, and DOD criminal investigative
organizations.
Financial regulators have also found that a securities product known as
a "mutual fund contractual plan" was also being widely marketed to
military members.[Footnote 13] Although rarely marketed to civilians
since less expensive products have become widely available, securities
regulators found that a small number of broker-dealers have been
selling contractual plans that expect the purchaser to invest a set
amount for a set period, such as 15 years. Although 50 percent of the
contractual plan's first-year payments represent a sales charge paid to
the selling broker-dealer, its total sales charges are generally less
than for other load funds if held for the entire period. However,
securities regulators found that only between 10 to 43 percent of the
military members that purchased contractual plan funds completed their
plans, and as a result, the majority of service members purchasing this
product paid higher sales charges and likely received lower returns
than had they invested in other available products. In addition to
being less beneficial for those that stop making payments before
completing the full term, regulators have also found that firms
marketing contractual plans were using inappropriate sales practices.
In a settlement reached with securities regulators in late 2004, the
largest marketer of these contractual plans, a broker-dealer with
nearly 300,000 clients, was censured for, among other things, using
market materials that misrepresented the advantages of these plans
compared to other investments. Investigations at other firms are
continuing. Because these contractual plans have been periodically
involved in sales scandals for decades, regulators questioned whether
they should continue to be allowed to be sold, particularly since the
innovations of the last 20 years have resulted in wide availability of
lower-cost alternatives, such as no-load mutual funds and a government-
provided retirement savings plan.
Financial regulators did not identify the problems occurring with sales
to military members until they were brought to light by press reports
for various reasons. Most state insurance regulators generally only
conduct investigations of insurance company sales practices when they
receive customer complaints. Although some state insurance regulators
review insurance companies' product sales practices as part of market
conduct reviews, few insurance products are subject to any suitability
or appropriateness standards. However, DOD personnel were rarely
forwarding service member concerns or complaints about potentially
inappropriate insurance sales. As a result, insurance regulators in
some states were not made aware of problems involving sales to military
members. Although sales of securities products are covered by
suitability standards, securities regulators also rely on receiving
complaints to initiate actions and were, therefore, not generally aware
of problems involving military members and contractual plans until
press reports appeared. In addition, prior securities regulatory
examinations of the broker-dealers selling these products did not
reveal problems because firms lacked standardized data on the extent to
which their customers were successfully completing their contractual
plans. Some state insurance and securities regulators also expressed
concerns about whether they had clear jurisdiction over sales of
financial products taking place on military installations. DOD is also
attempting to improve its oversight of financial product sales on its
installations, and has indicated that it plans to share additional
information with financial regulators. However, it has not yet revised
its policy relating to financial product sales to require its personnel
to share information about service member concerns or complaints, or on
violations of DOD policies by sellers of financial products. DOD was
also reviewing various perceived barriers to sharing information, such
as military privacy regulations, with external organizations, but has
also not coordinated on procedures for overcoming these barriers with
its installations or with financial regulators.
This report presents various matters for congressional consideration
and includes recommendations to DOD and financial regulators. Given
that service members already receive considerable low-cost insurance,
Congress should consider directing DOD and requesting insurance
regulators to develop standards applicable to the sale of insurance
products to military members, and require that DOD take steps to
improve its sharing of information with financial regulators. Given the
availability of less expensive alternative products, Congress should
also consider banning contractual plans. This report also includes
recommendations to insurance and securities regulators to proactively
seek information about sales to military members, and take other
actions to improve the oversight of such products. We obtained comments
on a draft of this report from DOD, NAIC, NASD, and SEC. Each of these
organizations provided written comments expressing general agreement
with our report and its recommendations (these comments appear in
appendixes V through VIII).
Sales of Costly Insurance Products to Service Members Raise Sales
Practice Concerns:
A limited number of insurance companies that appear to target junior
enlisted military members nationwide and around the world have sold
certain costly, problematic insurance products, sometimes using
inappropriate sales practices. These insurance products combine life
insurance coverage with a side savings fund. The insurance products
typically provide small amounts of death benefits and are considerably
more costly than coverage offered to service members by the government
or other private firms. Although they combine insurance with a savings
component promising high returns, many military personnel did not
benefit because any savings accumulated on these products can be used
to extend the insurance coverage if service members ever stop making
payments and fail to request a refund of their savings. A number of
financial regulators are also investigating the claims that these
companies have been using inappropriate sales practices when soliciting
military members, including examining allegations that agents have been
inappropriately marketing the insurance products as "investments." Some
of these companies have also been subject to past disciplinary actions
by insurance regulators and for violations of DOD regulations governing
commercial solicitation on military installations.
Small Number of Firms Are Targeting Junior Military Personnel with
Expensive Insurance Products with Adverse Provisions:
According to state insurance regulators we contacted, at least six
insurance companies were marketing products combining insurance and
savings funds with provisions that reduce the likelihood that military
purchasers would accumulate any lasting savings with such products.
These state insurance regulators are currently reviewing the operations
of these companies. Several of these companies share common ownership,
with three owned by the same firm and two others having key executives
from the same family. These companies operate extensively throughout
the United States, with four licensed to sell insurance in at least 40
states, and the other two licensed in at least 35 states. In addition,
as of July 2005, DOD approved five of these companies to conduct
business at U.S. military installations overseas.[Footnote 14]
These insurance companies also appeared to market primarily to junior
enlisted service members. According to state insurance regulators we
contacted, the companies primarily sold insurance policies to military
personnel during their first few years of service, including during
their initial basic training or advanced training provided after basic
training. Although the exact number of service members that have
purchased these products is not known, regulators told us that these
companies sell thousands of policies to military personnel each year.
We also found evidence that large numbers of these products were being
sold. For example, base personnel at one naval training facility we
visited said they regularly received several hundred allotment forms
each month to initiate automatic premium payment deductions from
military members' paychecks for these insurance products.
Products Couple High-Cost Insurance with a Savings Component Promising
High Rates of Return:
The insurance companies that target military service members are
primarily marketing a hybrid product that combines a high-cost
insurance policy with a savings component. According to insurance
regulators we contacted, and company marketing materials that we
examined, the insurance component generally consists of either a term
or modified whole life policy that would provide death benefits
generally ranging from $25,000 to $50,000 for premiums of approximately
$100 per month in the first year with different variations in the
premium amounts for subsequent years, depending on the product. In
addition to the insurance component, part of the total monthly payment
is allocated to a savings fund. Based on our review of these products,
most (or all) of the service member's payments in the first year are
applied to the insurance component of the product. In subsequent years,
more money is allocated to the savings fund to varying degrees,
depending on the specific product.
The companies marketing these products advertised that they paid
relatively high rates of return on these savings funds. At the time we
conducted our work, all of the companies were promising to pay 6.5
percent interest, or higher, on the savings fund portions of their
products with a minimum of no less than 4 percent interest guaranteed.
In contrast, as of August 30, 2005, the average national interest rate
paid for a money market account was 2.16 percent.[Footnote 15] Company
officials also told us that in the past they had paid much higher
interest rates. For example, one company's marketing materials for
their product stated that over the past 25 years they had paid an
average rate of 11.4 percent on the savings fund. Further, another
company's marketing material stated that their saving fund interest
rate for the past 10 years averaged over 10 percent.
The six companies that were marketing primarily to military members
were selling two primary variations of these combined insurance and
saving products. Three of the companies sold a product that provided 20
years of term life insurance. However, the premium payments for this
product were structured so that purchasers would pay for the entire 20
years of life insurance coverage within the first 7 years. As a result,
most of the service member's monthly payment for the first 7 years was
allocated to the life insurance premium, not the savings fund. After
the seventh year, all subsequent payments are to be deposited into the
savings fund. In addition, this product also promised the full return
of the total premiums paid for the insurance at the end of the 20TH
year, although state insurance regulators told us they were not aware
of any policies that had reached this 20-year point and received this
refund. Figure 2 provides an example of how the payments would be
allocated for a service member purchasing this "7-year premium" term
insurance product, assuming a monthly payment of $100 and a savings
portion crediting the guaranteed 4 percent simple interest paid
annually.
Figure 2: Sample Payment Allocations of $100 per Month for a Term Life
Insurance Product Sold to Military Service Members with a 7-Year
Premium Period and a Side Savings Fund Crediting 4 Percent:
[See PDF for image]
Notes:
For purposes of this illustration, we used a specific policy of a firm
offering $30,000 of life insurance coverage to a 20-year-old male
coupled with a savings fund in which the insurance portion of the
product is prepaid in the first seven years.
[A]Aside from interest credited in the side savings fund, the increased
value of the fund at the end of year 20 includes $6,600 that the
company declares will be deposited into the fund representing the
return to the purchaser of the total insurance policy premiums paid in
the first 7 years (with no additional interest).
[End of figure]
Three other companies marketing primarily to military members sold
other variations of the combined insurance and savings product.
Generally, these products combined a modified whole life insurance
policy with a savings fund. Under the basic terms of these products,
most of the service members' first year's payments would be applied to
the life insurance premium and the remainder allocated to the savings
fund. From the second year on, the allocation proportions reverse where
most of the money is applied to the savings fund. Premium payments on
these products could continue for the life of the purchaser, although
the face value of the death benefit would be reduced to half its
initial amount after a certain period or when the policyholder reached
a certain age, depending on the product. Figure 3 provides an example
of how the payments could be allocated for a service member purchasing
this type of product with a $100 total monthly payment and 4 percent
simple interest credited on the savings fund.
Figure 3: Sample Payment Allocations of $100 per Month for a Modified
Whole Life Insurance Product Sold to Military Service Members with a
Side Savings Fund Crediting 4 Percent (First 20 Years Shown):
[See PDF for image]
Note: For purposes of this illustration, we used specific policies of a
modified whole life product offered by two companies. A policy of one
company provided $25,000 of life insurance for a 28-year-old service
member. The cash value associated with the insurance portion of the
product was $325 in year 4, $1,142 in year 10, and $2,706 in year 20. A
policy of another company provided $38,054 of life insurance coverage
to a 22-year-old service member for the first 10 years, dropping in
half to $19,027 thereafter. The cash value of the insurance portion of
the product was about $57 in year 5, $476 in year 10, and $2,055 in
year 20.
[End of figure]
These insurance products also cost significantly more than other life
insurance coverage available to service members. Prior to September
2005, all service members could purchase $250,000 of term life
insurance through SGLI for $16.25 per month. Since September 1, 2005,
the total coverage has increased to $400,000 for $26 per month.
According to the Department of Veterans Affairs, which administers the
SGLI program, 98 percent of all service members opt to receive this
coverage. After leaving the service, service members can convert their
SGLI coverage to a Veterans' Group Life Insurance (VGLI) policy which
now also provides up to $400,000 of low-cost term life insurance for
veterans, with rates dependent upon age. For example, veterans between
the ages of 40 and 44 years of age can purchase $50,000 of life
insurance for less than $10 per month. In addition to government-
sponsored coverage, service members can also purchase similar coverage,
including covering combat deaths, from other insurance companies. For
example, according to officials of one company that sells insurance and
other financial products to military personnel directly, they could
provide a 20-year-old service member an additional $250,000 of life
insurance to supplement SGLI for $15 to $20 per month.
In addition to being many times more expensive than other products
already available to military members, companies have been selling
insurance products to service members who generally do not appear to
need additional life insurance, according to state regulators we
contacted. These regulators also said the companies that targeted
military members typically marketed their products to junior enlisted
service members, who often have no dependents. During our review, we
obtained data from the Defense Finance and Accounting Service (DFAS),
which maintains military personnel pay records, indicating that most
service members that appeared to have purchased life insurance products
from some of these insurance companies had no dependents. For example,
according to DFAS data on Marine Corps service members, over 6,500 pay
deduction allotments to send premium payments to banks used by three of
these insurance companies, starting between July 2004 and June 2005,
indicated that approximately two-thirds were unmarried service members
with no other dependents. Data available from other Services on
allotments sent to these insurance companies during the same period
also indicated that most of the service members had no dependents.
Regulatory officials we contacted noted that the amount of coverage
available to these members from SGLI would likely be adequate for their
insurance needs, and thus no additional insurance coverage would be
necessary.
Officials with one of the companies that targeted military members told
us that the insurance they sell has benefited some service members. For
example, their company has paid $37 million in death claims for service
members in the last 5 years, including $1.5 million to survivors of
service members killed in the recent conflict in Iraq.
Certain Product Provisions Prevented Many Service Members from
Receiving Favorable Investment Returns:
The insurance products with combined insurance and savings components
being sold by several companies to service members had provisions that
reduced their benefits to purchasers that could not--or did not--pay
into the product for a long-term period. According to regulators we
contacted and our review of selected policies, the products being sold
by at least six companies had an automatic premium payment provision,
which allows the companies to use money accumulated in the service
member's savings fund to automatically pay any unpaid insurance
premiums. The provision extends the period of time that the service
member is covered under the life insurance policy if the service member
does not proactively contact the insurance company to cancel the
insurance policy and request a refund of the savings fund. After the
automatic premium payment provision is triggered and the savings fund
becomes depleted, the policy then terminates, or lapses. Regulators we
contacted were critical of the impact that this provision can have on
purchasers of these products. For example, an official at one state
regulatory agency described this provision as allowing the company to
"parasitize" the savings fund for its own benefit. In contrast,
representatives of one company told us that this provision allows the
service member to receive extended life insurance coverage.
Many military members that purchased these products only made their
payments for a short period of time. State insurance regulators we
contacted believed that most service members that purchased these
products from these companies stopped making payments within the first
few years, and that the lapse rates were significantly higher than
industry norms. During our review, we received data on the percentage
of policies that lapsed or terminated during the first year on products
offered by four insurance companies that substantiated lapse rates
above industry averages. For instance, information we obtained from one
company that targets the military market segment indicated that
approximately 40 percent of products purchased had lapsed or terminated
within the first year. Data provided to us from three other firms
indicated that the majority of policies had lapsed after being held
between two and three years.
The characteristics of the military population that these companies
were marketing to increases the likelihood that service members will
stop making payments and not receive any savings they have accumulated
in these products. Regulatory officials we spoke with said that one of
the reasons so many service members discontinue making payments is that
they leave the service and thus the automatic deductions of their
premium payments to these companies also stop. Company officials we
spoke with told us that service members ceasing payments can request
and receive refunds of the amounts accumulated in their savings
accounts. However, according to regulators we contacted, companies do
not always receive such requests from service members at the time
payments cease. According to these regulators, many service members may
not have received refunds of any accumulated savings given that such
funds are automatically depleted to pay for the insurance policy for an
extended period until such amounts were exhausted. As a result, many of
the service members who simply stop paying into the product likely did
not receive any of the money they had paid into the savings portion of
the product. As such, they obtained some extended life insurance
coverage after their payments ceased that, as shown previously, was
more expensive than insurance they already receive and that they would
not likely have purchased except for the promised savings provision.
According to our analysis, the amount of time that it takes for a
service member's savings fund on the products these six companies were
selling with a monthly payment of $100 to become totally depleted
through the automatic payment provision varied. Figure 4 shows the
impact on a service member that purchases the 20-year term life product
with the 7-year premium period with $30,000 of insurance coverage,
makes $100 monthly payments for 4 years totaling $4,800, and then stops
making payments. As the figure shows, the money in this service
member's savings fund would be totally depleted to pay the subsequent
insurance premiums in just over 1 year. This occurs because the policy
requires that the entire 20 years of coverage be paid for in the first
7 years, which results in the monthly premium being larger than
comparable policies. In addition, because almost all of the service
member's payments during the first few years are allocated to the
insurance policy, the accumulated value of the savings fund is modest.
For the modified whole life product previously discussed, which
required lower premium payments and larger savings accumulation after
the first year, the savings fund of service members that ceased making
their payments after 4 years would be sufficient to extend the $30,000
of life insurance coverage for another 13 years. In contrast, a service
member could have used the $100 monthly payment to instead purchase
$30,000 of SGLI term coverage at a cost of only about $23 per year--
totaling $92 for 4 years--and invest the remaining $4,708 into the
Thrift Savings Plan (TSP), which is the low-cost retirement savings
plan available to military members and federal employees. Although
ceasing payments on SGLI after 4 years would terminate the service
member's life insurance, the money contributed to the TSP and left to
earn just 4 percent interest would grow to about $9,545 in 20
years.[Footnote 16]
Figure 4: Total Approximate Future Values of Insurance Products'
Savings Fund and TSP with Payments Ceasing after Year 4:
[See PDF for image]
[End of figure]
In addition to the high costs associated with the insurance portion of
these combination products, other provisions diminished the value of
the savings component as well. According to regulators we contacted,
withdrawal penalties and unique methods of interest crediting
significantly reduced the advertised rate of return for these products.
Typically, service members withdrawing all or part of the accumulated
money in the savings fund any time after purchase within the first 10
years would be assessed early withdrawal penalties. For example, one of
the companies assessed an early withdrawal fee of 10 percent in the
first year, with this fee declining by 1 percent each subsequent year
until reaching zero in the 10TH year. Several companies credit the
amount accumulated on the basis of either the year-end balance or the
average balance--whichever is less.[Footnote 17] For sufficiently large
withdrawals, a service member would not receive any interest at the end
of that policy year on the money withdrawn from the fund. Under this
methodology, amounts withdrawn during the year earn no interest,
thereby reducing (in some instances significantly) the advertised rate
of return.
Allegations of Improper Sales Practices often Associated with Companies
Targeting Military Members:
Insurance companies that market primarily to military members have been
frequently accused of using inappropriate sales practices by
regulators, DOD, and others. As part of our review, we identified at
least 15 lawsuits or administrative actions that had been taken against
companies that market primarily to military members. In many of these
actions taken by state and federal regulators, federal law enforcement
organizations, or others, the companies were accused of misrepresenting
the products as investments or identifying themselves as
representatives of independent benefit or fraternal organizations.
(Appendix II lists these actions.) For example, in December 1998, two
of the insurance companies that target military members settled a
lawsuit filed by DOJ in Washington state that alleged that their agents
had misrepresented their insurance policies as investment plans. As
part of the settlement the companies had to offer refunds to
approximately 215 service members in certain states who purchased life
insurance polices between 1994 and 1997. In an agreement with the
Attorney General's Office in the state in which one of the companies
was domiciled, each of the companies also made $1 million donations to
a university in that state. More recently, after the Georgia Insurance
and Safety Fire Commissioner initiated investigations to review
allegations of improper insurance sales practices at military
installations in that state, two insurance companies have agreed to
make refunds of about $2.4 million to soldiers who had purchased
insurance products.
After a series of articles in The New York Times raised concerns over
sales of financial products to military members, state regulators in as
many as 14 states began new investigations into the practices of
companies that target service members.[Footnote 18] According to
regulators in these states, various sales practice concerns are being
examined. As of September 2005, the investigations by these states
generally had not been concluded. In addition to efforts by insurance
regulators, law enforcement organizations and securities regulators are
also reviewing the activities of some of the insurance companies that
target military members.
One of the issues that is again a focus of regulators and others in
their new investigations, is whether the companies and their agents
were inappropriately marketing these products--not as insurance--but
primarily as investment products. State insurance laws generally
require any product with an insurance component to be clearly
identified and marketed as insurance. However, regulators in various
states raised concerns that the companies targeting service members
were deemphasizing the insurance aspects of the product. Some state
officials told us that the companies would have considerable incentive
to obscure the insurance aspects of the product because 98 percent of
service members already obtain a substantial amount of life insurance
through the government-offered SGLI program. Insurance regulators we
contacted told us that when marketing to military members these
companies typically emphasize the investment provision of the products
even though most, if not all, of the payments in the first year are
used to pay the insurance premiums. Furthermore, most of this amount is
then used by the companies to pay sales commissions to the selling
agents.
The marketing materials for the companies that we examined also
emphasized the savings component of the products. For example, a script
from a sales presentation of one company mentions the insurance
coverage third, after describing other product benefits. It also
highlighted that the cost of the insurance was "free" if the service
member completes the product terms. Insurance regulators with whom we
spoke mentioned that such a sales presentation is designed to overcome
objections from service members that they did not need any additional
life insurance. In addition, examiners in one state reported in 2002
that one of the companies' materials referred to the premium payments
for the insurance product being sold to service members as
"considerations" or "contributions," which were terms that they said
were typically used when selling investment products. Our review of
information provided by legal offices at Fort Benning, Georgia, and
Great Lakes Naval Training Center, Illinois, also indicated issues
related to insurance products being marketed and sold primarily as
investment products.
The design of the products themselves may have also been misleading.
Despite emphasizing the investment returns and high rates of promised
interest earnings that were possible with these products, regulators in
one state told us that the companies may have assumed that their actual
policyholders would not generally attain these returns. As part of a
class action case previously filed against one of these companies,
presented as evidence were a series of internal company memorandums
dating from around the time the company was proposing to begin selling
a combined insurance and saving fund product. In one of these
documents, a company official states the assumption that product
purchasers would not earn the initially-promised 11 percent interest,
or any amount even close to that, because the product's savings fund
"is inextricably coupled with a rather expensive traditional life
insurance policy," and has restrictive interest crediting and
withdrawal provisions.
According to a deposition taken of a former company official, the
company also assumed that many purchasers would not hold the product
for very long. For example, this official stated that the company
assumed that as many as 45 percent of purchasers would stop paying into
the product within 1 year and another 25 to 30 percent would stop
paying by years 2 and 3. In contrast, data from a service that tracks
the rates at which insurance policyholders stop paying on their
policies--called lapse rates--indicates that the lapse rate in the
first year on term life policies requiring monthly premium payments
averaged less than 15 percent.[Footnote 19]
Other federal regulators are also investigating the extent to which the
companies that market primarily to military members were marketing
insurance as investment products. According to SEC officials with whom
we spoke, insurance products marketed as investments may need to be
registered as securities. Currently, insurance policies and annuity
contracts issued by an entity subject to supervision by state insurance
or banking regulators are exempt from securities registration.[Footnote
20] Under existing case law, one factor that is important in
determining whether an insurance product is entitled to this exemption
is the manner in which the product is marketed.[Footnote 21] Under a
safe harbor created by SEC Rule 151, one condition for annuity
contracts to avoid being subject to the federal securities laws is to
not be marketed primarily as an investments. As of September 2005, SEC
staff told us their inquiries into some of these companies' operations
were continuing. In addition, DOJ officials also confirmed that they
are investigating some insurance companies that market primarily to
military members.
Officials with several of the companies that market primarily to
military members told us that they clearly inform service members that
the product they are offering is insurance. For example, officials at
one of the companies showed us documents that they said are to be
initialed and signed in multiple places by purchasers of their product
that indicate that the product is insurance. An investigation by DOD
personnel into sales at one naval facility indicated that many members
knew they were buying insurance as well. However, an investigator of
one of the states that previously sanctioned one of these companies
told us that they had received information indicating that the
company's sales agents may have found ways to present the products
without the service members realizing they were buying insurance. Such
allegations illustrate the difficulties that regulators face in
determining whether inappropriate sales practices were being used.
Irregularities on Pay Allotment Forms Used for Deducting Premium
Payments Being Investigated:
Insurance regulators and other investigators are also investigating
whether some of the companies have been misrepresenting the nature of
the products in the forms used to initiate deductions for the premiums
from service members' pay. According to DOD staff responsible for
personnel pay systems, service members can have various types of
allotments deducted from their pay, including deductions to be sent to
savings accounts or to pay for insurance they purchase. However, for
insurance allotments for junior enlisted members (those at rank E-3 and
below), a 7-day "cooling off period" is required to pass before the
allotment can be processed. Although these companies were selling
insurance products, state regulatory officials we contacted were
concerned that, in some cases, the companies were mislabeling the
government pay deduction forms to reinforce the appearance that these
purchases were investments and not insurance. For example, we reviewed
pay allotment documents that appeared to indicate the service member
purchasing this product was initiating a pay deduction that would be
sent to a savings account in the member's name at a bank. In addition,
the service member would also be asked to complete a form that
authorized the recipient bank to withdraw the premiums due on the
insurance product from the service member's account at that bank.
However, state insurance regulators told us that the service members
did not actually have accounts at these banks; rather, the money was
deposited in a single account belonging to the insurance company. After
we contacted officials at some of the banks to which these insurance
companies were having service member payments routed, bank officials
confirmed to us that the service members did not have accounts at the
bank, but rather, contributions were sent to accounts belonging to the
insurance companies. Thus, routing the payments to a bank with the
allotment appearing as a bank allotment on the service member's pay
statement, rather than an insurance allotment, could reinforce the
impression that the service member had purchased an investment product
rather than insurance. Insurance regulators in one state also told us
that they found instances in which insurance agents were assisting
service members to access online military pay systems to add allotments
for insurance premiums.
Our own review found additional evidence of possible irregularities
involving pay allotment forms and other activities by agents selling
these combined insurance and saving products. During a review of
documents used to initiate allotments from service members' pay at two
military installations we visited, we also found several examples of
allotment deduction forms that seemed as though the service member
involved had a savings account at a bank used by the insurance company.
We also noted several other potentially irregular activities. In some
instances, insurance agents mailed allotment forms to the finance
office that processes pay transactions for service members stationed at
one of these bases using bank envelopes that had a bank's address as
its return address. The use of bank envelopes could help convince base
personnel that these were savings rather than insurance allotments, and
thus not subject to any required "cooling off period." In another
example of insurance company agents attempting to make the service
member allotments used to pay for these insurance products appear to be
savings allotments, we saw multiple instances of the use of an
allotment form bearing the signature of the same bank official as the
initiator of the allotment. After we contacted this bank official, he
told us that he had once signed such a form but that the repeated use
of the form with his signature was being done by the insurance agents
without his knowledge. The results of these reviews and indications of
potential fraud were referred to our special investigators, who are
conducting further reviews and have initiated contacts with other law-
enforcement organizations, DOD investigative agencies, and state
regulatory departments.
Our review of allotment forms raised questions about whether agents
marketing products targeting military members were encouraging service
members to reduce tax withholdings and other savings contributions,
thus providing a source of income to invest in the insurance products.
Specifically, we found several examples of forms canceling service
members' TSP contributions and altering the number of exemptions
claimed on service members' W-4 forms (reducing the amount of tax
withheld from their pay) that were submitted along with insurance
allotment forms. Forgoing investment in TSP (which is generally
recognized as being one of the lowest-cost ways to invest for
retirement available anywhere) to purchase expensive insurance would
not generally be in the service member's best interest financially. By
reducing the member's withholdings and TSP contributions, the agents in
these cases may have been attempting to overcome service member
objections about affording the additional payment for the insurance
product. In addition, reducing a service member's withholdings could
potentially result in additional taxes due at year's end.
Concerns Exist over Whether Insurance Company Personnel Represent
Themselves as Members of Other Organizations:
Another sales practice issue that insurance regulators we contacted
have been concerned about is whether some individuals that are selling
insurance were not clearly representing themselves as insurance agents
when marketing to military service members. In the past, DOD has found
that insurance agents who have marketed to service members frequently
identify themselves as counselors from benefits associations. Such
entities provide counseling on obtaining government benefits or other
services and may also offer their members discounts on other products,
such as auto services. By representing themselves as benefits
counselors, insurance agents may more readily gain access to service
members.
However, regulators and others have documented prior instances in which
insurance agents marketing to military members misrepresented
themselves as benefits association employees. For example, in December
2002, DOJ announced a settlement against an insurance company that
targeted military members whose agents had misrepresented themselves
solely as employees of a benefits association. According to the DOJ
complaint, this company had allegedly defrauded military service
members who purchased life insurance policies from the company by
having its agents pose as independent and objective counselors
representing a non-profit fraternal organization that offered as one of
its benefits the ability to purchase the company's life
insurance.[Footnote 22] However, the company's agents allegedly failed
to disclose to the service members that they only were compensated
through commissions from the insurance company, and that the company
was making undisclosed payments to the benefits association for every
policy sold. Under the terms of the settlement, the company agreed to,
among other things, increase the face amount of all in force coverage
by 6.5 percent, pay $2.7 million to all service members who canceled
their policies during a specific period, and to never again sell
another insurance policy or reapply for DOD permission to conduct
business on U.S. military installations.[Footnote 23] According to a
state insurance department investigation that was finalized in January
2002, agents from an insurance company that is currently being
investigated by other states portrayed themselves as benefit
association representatives without disclosing that they were insurance
agents. As a result these agents were allowed to conduct military
training during which they would solicit insurance to groups of service
members. According to the report, the service members believed that the
benefit association was part of the military establishment.
Regulators Are Reviewing Whether Some Insurance Product Sales Comply
With State and Federal Laws:
Another aspect of the operations of the companies that market primarily
to military members that state insurance regulators were examining was
whether the products comply with applicable state laws and regulations.
For example, regulators in several states have been examining whether
the saving funds that some of the companies had labeled as annuities
may not actually qualify as such under their laws. After concerns arose
about the sale of these combined insurance and savings products,
insurance regulators in Washington state rescinded approval to sell the
products that had previously been approved for sales by one of the
companies that targeted the military in June 1997 and for three
additional companies in October 2004. In taking these actions, the
state's insurance department noted that it had determined that the
savings fund provision of these products the companies were marketing
were not properly structured to meet the requirements of this state's
regulations pertaining to annuities.
Insurance Companies Targeting Military Members Also Frequently Accused
of Violating DOD Solicitation Policies:
In addition to raising concerns among financial regulators, the
companies that target military members also have been accused of
violating DOD's own solicitation policies. For example, DOD personnel
conducted an April 2005 proceeding in Georgia to review the practice of
one of the companies currently being investigated by state insurance
regulators regarding allegations of multiple violations of the DOD
directive on insurance solicitation. Among the practices alleged at
this hearing were misleading sales presentations to captive audiences
and solicitations in unauthorized areas, such as in housing or barracks
areas. DOD recently began maintaining an online listing of actions
taken against insurance companies or their agents by various DOD
installations.[Footnote 24] Last updated on August 11, 2005, this web
site lists 21 agents from some of the 6 companies that are permanently
barred--or have had their solicitation privileges temporarily
suspended--at 8 different military installations.
Concerns over such violations are longstanding. For example, in March
1999, the DOD Inspector General also found that insurance companies
were frequently employing improper sales practices as part of marketing
to service members. Among the activities prohibited by DOD that the
Inspector General report found were occurring included presentations
being made by unauthorized personnel, presentations being made to group
gatherings of service members, and solicitation of service members
during duty hours or in their barracks.[Footnote 25] Similarly, a May
2000 report commissioned by the Office of the Under Secretary of
Defense for Personnel and Readiness also reviewed insurance
solicitation practices on DOD installations and identified many of the
same concerns and recommendations as those the DOD Inspector General
had identified.[Footnote 26] As result of these two reports, DOD
officials began efforts to revise its directive governing commercial
solicitation on military installations.
A Unique Securities Product with High Sales Charges Sold to Military
Members Has Also Raised Sales Practice Concerns:
A few broker-dealers have marketed a unique securities product, often
referred to as a contractual plan, to military service members that has
proven to be more costly than other commonly available products. These
contractual plans were primarily being sold by one large firm and
several smaller firms that generally marketed only to service members.
These products involve making periodic investments into a mutual fund
under contractual agreements with much of the first year's investments
going to pay a sales load that compensates the selling broker-dealer.
Purchasers that make all required payments for the entire term of the
contractual mutual fund plan would pay charges slightly less than the
amount charged by other load funds. However, regulators found that most
military purchasers were not making all required payments, resulting in
them paying higher sales charges than would have been paid on other
commonly available mutual funds. Regulators indicated that contractual
plans are rarely sold to civilians and the products have been
associated with sales practice abuses for decades. Regulators recently
sanctioned the largest seller of these plans for inaccuracies in its
marketing materials. Investigations into the activities of other broker-
dealers selling contractual plans are also underway.
Most Contractual Plans Were Sold in the Military Market by One Firm:
Although being sold to large numbers of service members, contractual
mutual fund plans were being marketed by only a few broker-dealers. SEC
and NASD staff told us that their investigations have identified only
about five broker-dealer firms that were marketing these plans.
According to regulators, one of the broker-dealers accounted for over
90 percent of the $11 billion invested in contractual plans as of year-
end 2003. Unlike the insurance companies that targeted junior service
members, this broker-dealer generally marketed its products to more
experienced military members, including commissioned officers and
senior noncommissioned officers.
According to its marketing materials, this firm had nearly 300,000
military customers, and indicated that one-third of all commissioned
officers and 40 percent of active duty generals or admirals were
clients. The firm employs about 1,000 registered representatives in
more than 200 branch offices throughout the United States, as well as
locations in Europe and in the Pacific region. The great majority of
the firm's sales representatives are former commissioned or
noncommissioned military officers. From January 1999 through March
2004, the firm received approximately $175 million in front-end load
revenue from the sale of contractual plans. Officials with the firm
announced in December 2004 that they would be voluntarily discontinuing
sales of contractual plans after being sanctioned by SEC and NASD.
The other four firms that continue to sell contractual plans were
smaller broker-dealers. Of these, regulators told us that three also
principally targeted military service members although, unlike the
largest broker-dealer, these three firms generally sold contractual
plans to junior enlisted personnel. According to regulators, the fourth
broker-dealer appeared to be marketing to civilians. However, given the
availability of other alternative low-cost mutual fund products in the
marketplace that allow investors to make relatively small contributions
on a regular basis, regulators indicated that they rarely see
contractual plans being sold to civilians by other firms.
Contractual Payment Plans Feature High Up-Front Sales Charges that Are
Not Typical of Other Securities Products Available:
Under the terms of the contractual plans being sold to military service
members, the purchaser enters into a contract to make periodic
investments for a set term (such as 10 to 15 years).[Footnote 27] These
payments are invested into funds offered by some of the largest mutual
fund companies.
Under the contractual plan, the firm deducts a sales load of up to 50
percent from each of the first year's monthly payments but generally no
further sales loads are applied thereafter. In contrast, a conventional
mutual fund with a sales load will deduct a certain percentage--
currently averaging about 5 percent--from each contribution made into
the fund. While sales charges for contractual plans are initially much
higher than those of other mutual fund products, the effective sales
load--the ratio of the total sales charge paid to the total amount
invested--becomes lower as additional investments are made. Over time
the effective sales load for a contractual plan will decrease to a
level comparable to--or even lower than--other conventional mutual
funds with a sales load.[Footnote 28] As illustrated in Figure 5, if
all 180 monthly payments are made under a contractual plan, the
effective sales load on the total investment decreases to 3.33 percent
by year 15.
Figure 5: Mutual Fund Sales Load as a Percentage of Investment by Year:
[See PDF for image]
[End of figure]
At one time, contractual plans were the only way for small investors to
invest in mutual funds. Regulators told us that in the past, many
mutual funds required large initial investments that prevented them
from being a viable investment option for many individual investors.
However, today, other lower-cost alternatives exist for small investors
to begin and maintain investments in mutual funds. For example, many
mutual fund companies now allow investors to open a mutual fund account
with a small initial investment, such as $1,000, if additional
investments--including amounts as low as $50 per month---are made
through automatic withdrawals from a bank checking or savings account.
According to a recent study by the mutual fund industry association,
over 70 percent of the companies offering S&P 500 index mutual funds in
2004 had minimum initial investment amounts of $1,000 or less, with 9
having minimum investment amounts of $250 or less.[Footnote 29]
Securities regulators saw the wide availability of such products as the
reason that contractual plans were rarely being offered to most
investors. Another alternative investment option available to service
members since 2002 is the government-provided TSP. Comparable to 401(k)
retirement plans available from private employers, service members can
invest up to 10 percent of their gross pay into TSP without paying any
sales charge. The various funds offered as part of TSP also have much
lower operating expenses than other mutual funds, including those being
offered as contractual plans. Service members could also choose to
invest as many other investors do in mutual funds offered by companies
that do not charge any sales load. Called no-load funds, these are
available from some of the largest mutual fund companies through toll-
free numbers, the Internet, or by mail.
According to industry participants, contractual plans provide their
purchasers with the incentive to invest for the long term. Officials
from the most active broker-dealer that marketed contractual plans told
us that the larger upfront sales load encourages the investor to
maintain a long-term investment plan because of the financial penalty
that results from halting their payments too early. They also said that
the contractual nature of the product helps purchasers make regular
investments. In addition, these officials explained that the clients
they serve are not high-income individuals with considerable
accumulated wealth available for investment. As a result, they said
that other broker-dealers do not provide financial services to these
individuals. The officials from this firm said that their sales
representatives spend many hours explaining the products and preparing
and updating financial plans for their military clients. As a result,
the higher up-front sales charge compensates their staff for the amount
of time spent with clients. Officials from this firm told us that
clients who purchased contractual plans and received financial plans
from their firm generally benefited as the result of an improved
financial condition overall.
Many Service Members Failed to Benefit from Contractual Plans:
However, according to data obtained from securities regulators, many
service members did not benefit from purchasing contractual plans.
Although such plans can prove beneficial to an investor that makes all
of the required periodic payments, regulators found that many service
members were not investing in their plans for the entire term. For
example, SEC and NASD found that only 43 percent of the clients that
purchased plans between 1980 and 1987 from the largest broker-dealer
had completed the full 15 years required under the contract. Instead,
35 percent of these clients that bought during this period had
terminated their plans early. Another 22 percent had not cancelled
their plans but were not making regular payments. According to
securities regulatory staff, most of the clients that stopped making
payments into this broker-dealer's contractual plans ceased doing so
after about 3 years.
SEC staff told us that the customers of the other broker-dealers that
were marketing contractual plans to military members had the same or
even lower success rates of contracts completion. For example, they
said that only about 43 percent of the clients of one of these broker
dealers had made all required payments for a full 15-year period and,
at another firm, just 10 percent of the customers had successfully
completed a plan.
Because of the manner in which sales charges are assessed, terminating
a contractual plan or halting payments early can greatly reduce the
benefits to an investor. If the investor does not continue paying into
the plan, the effective sales load can be much higher than industry
norms. For example, as shown previously in Figure 5, an investor
terminating after 3 years pays an effective sales load of 17 percent of
the amount invested, which is more than three times the current average
sales load in the mutual fund industry. As result, many of the service
members that purchased contractual plans from these firms likely paid
much higher sales charges than they would have under other alternative
investments. Even if an investor makes all required payments under a
contractual plan, we found that the amount accumulated on a contractual
plan investment earning a 7 percent annual return is lower than that of
a conventional mutual fund with a 5 percent sales load earning the same
projected return until at least year 16 (this analysis is shown in
appendix III).
Long Associated with Sales Practice Abuses, Firms Marketing Contractual
Plans Again Raising Regulatory Concerns:
Contractual plans have long been associated with sales practice
concerns and recently regulators have taken action against the largest
seller of these products. According to an SEC study, contractual plans
to sell mutual fund securities were first introduced to the public in
1930.[Footnote 30] However, concerns over the sale of these products,
including excessive sales charges, arose and, as a result, the
subsequently-enacted Investment Company Act of 1940 included a
provision that limited the sales load that could be charged on
contractual plans. After the passage of the Act, sales of contractual
plans declined, with most of the companies selling such plans halting
their marketing of such products.
However, during the 1950s and 1960s sales of contractual plans
significantly increased. With researchers finding that many contractual
plan purchasers were not continuing to invest in their plans, SEC
recommended that the Investment Company Act of 1940 be amended to
prohibit future sales of contractual plans. Although Congress chose not
to ban contractual plans, it amended the Act in 1970 to increase
protections for contractual plan investors. Specifically, Section 27
was revised to allow investors who cancel their plans within the first
18 months of purchase to obtain refunds on that portion of the sales
charges which exceeds 15 percent of the gross payments made.[Footnote
31] In addition, investors terminating their plan within the first 45
days could receive their full investment back with no sales charge
deductions. Even with such limitations, sales charges associated with
contractual plans can still be much higher than those of other mutual
fund products and industry norms.
However, regulators again found inappropriate sales practices
associated with contractual plans even after this provision was
changed. For example, in the early 1990s, federal and state securities
regulators took action against a broker-dealer, First Investors
Corporation, for improper marketing of contractual plan investments,
including its alleged failure to notify investors that they could
invest in the same funds without having to pay the high sales charge
required under the contractual plan. During this period, other low-cost
mutual fund products emerged in the marketplace, allowing investors to
make relatively small monthly payments into a mutual fund product with
low fees. The contractual plan product generally disappeared from the
civilian marketplace but continued to be sold in the military market by
a few firms, with one emerging as the dominant player in this niche
market.
Recently, securities regulators have taken actions against a firm
marketing contractual plans to military service members. In December
2004, SEC and NASD sanctioned the broker-dealer firm that was the
dominant seller of such plans to service members. According to
settlements reached with these regulators, the firm's marketing
materials were alleged to have been misleading and to have
inappropriately disparaged other viable investment options available to
their clients. For example, according to the regulators, the firm's
marketing materials allegedly included various misleading comparisons
of contractual plans to other mutual funds, including characterizing
non-contractual funds as attracting only speculators, and erroneously
stating that withdrawals by investors in other funds force the managers
of those funds to sell stocks. The regulators also alleged that the
firm's materials did not present the low-cost TSP as a viable
alternative to their contractual plans. The SEC and NASD settlements
also alleged that the firm mischaracterized the contractual plan's high
up-front sales load as the only way to ensure that purchasers remain
long-term investors and presented comparisons of contractual plans
using a holding periods of more than 14 years despite having data
within the firm that showed that many of its customers were not
successfully completing their plans. As a result, securities regulators
found that the firm's service member clients paid higher than normal
sales charges because they frequently did not continue making enough
payments into such plans to reduce the effective sales charges to a
level comparable to typical mutual fund sales charges in the industry.
The regulators also took action against the firm for inappropriate
handling of customer complaints. As part of its investigation into this
firm's practices, NASD sanctioned the firm for the actions of one of
its supervisors who made improper statements to a service member who
had previously expressed dissatisfaction with the broker-dealer. The
regulatory settlement provides a summary of a call made to this
customer in which the firm's supervisor appeared to threaten the
service member with adverse consequences from his military superiors,
including possible cancellation of his previously approved temporary
duty orders.
In settling with SEC and NASD, the broker-dealer agreed to pay a total
of about $12 million, including restitution to compensate customers who
paid an effective sales charge of more than five percent on investments
made since January 1999. As of October 6, 2005, $4.3 million has been
paid to investors. The remaining money is to be used to fund an
educational program for service members that NASD will administer (this
program is described later in this report). As previously stated, this
broker-dealer announced that it has voluntarily discontinued sales of
contractual plan products. SEC and NASD continue to investigate the
other smaller broker-dealer firms that are marketing contractual plan
products to military members and others. In addition, SEC staff also
began conducting reviews of sales to military members in overseas
locations and at installations in the United States. Two bills before
the U.S. Senate (one of which passed the House of Representatives)
would amend Section 27 of the Investment Company Act of 1940 to ban
further sales of contractual plans.[Footnote 32]
Lack of Complaint Sharing Prevented Earlier Identification of Improper
Sales to Military Members:
A lack of routine complaint sharing between financial regulators and
DOD was the primary reason that regulators did not identify problematic
sales of financial products to military service members before such
issues were raised in press accounts, although other limitations among
regulators' practices also contributed. Insurance companies are
generally required to submit products for regulatory approval before
marketing them but the review processes in most states may not have
addressed the appropriateness of their features for service members.
Although insurance regulators in some states review sales activities
periodically, insurance regulators in most states generally rely on
complaints from purchasers to indicate that potentially problematic
sales are occurring. One reason that insurance company sales activities
are not reviewed more extensively is because most states lack any
appropriateness or suitability standards for insurance products.
Although some states had taken action, other state insurance regulators
were not generally aware of problems involving military members until
recent press reports, in part because DOD personnel were not usually
sharing complaints or information about other inappropriate practices
regarding the companies that targeted service members. However, we
found evidence that concerns over inappropriate sales to service
members exist widely at various military installations. Similarly,
securities regulators also did not identify recent problems involving
contractual plan sales to service members until such press accounts
appeared. These regulators' ability to detect problems was also
hampered by the lack of information on the extent to which broker-
dealer customers purchasing contractual plans were successfully making
their payments. In light of the problems surrounding sales of financial
products to military members, DOD has efforts underway to revise its
policies regarding such sales and has reviewed ways in which it could
share additional information. However, DOD has not coordinated these
efforts with military installation personnel or with regulators.
Without Complaints, Regular Insurance Regulatory Processes Did Not
Identify Problems:
The product approval processes followed by many insurance regulators
did not allow them to identify the products being marketed to military
members as potentially problematic. One of the ways that state
insurance regulators ensure that the products being sold in their
states comply with insurance laws and regulations is through product
approval requirements. Although insurance regulators in most states
require insurance companies to submit products for approval before
marketing them, state insurance officials in the states we contacted
explained that the processes for approving products varied. In several
of these states, insurance companies must submit products to the state
regulators for reviews that are intended to assess whether the
provisions and terms of the products comply with existing insurance
regulations in those states. Companies sometimes submit additions to
existing products, called riders, which change terms or provide
additional features to their policies. However, according to some
regulators in the states we contacted, the entire product may not be
reexamined by their reviewers when such riders are submitted. In at
least 2 states we contacted, different components of products sold to
military members were filed and approved separately but then marketed
and sold as a single product. For example, the savings fund of the
insurance product being sold by four of the companies that target
military members was submitted as a rider to a previously approved
policy. However, regulators found that it was being sold as an integral
part of the entire product, not as an optional feature to a life
insurance policy. In at least one state we contacted, many insurance
products are not reviewed but can be sold immediately upon filing
notification with their department of the company's intent to market
the products.
Additionally, insurance product approval processes may not necessarily
reveal how a product is to be marketed or the target market for the
product. According to officials in the state insurance departments we
contacted, none of these states required insurance companies to provide
descriptions of the target market for a particular product during the
form filing process. As part of the investigations that state insurance
regulators are conducting of the companies that target military
members, some of the regulators are also reexamining the products these
companies sell to ensure that they meet existing state requirements.
For example, insurance regulators in Virginia issued an order in
September 2005 to three companies to cease and desist from selling such
products. However, the extent to which this review is occurring in
other states is not clear.
Insurance Regulatory Examinations Generally Focus on Financial
Soundness:
State insurance regulators may conduct various types of reviews of the
insurance companies they oversee. Many of the routine reviews that
these regulators conduct focus on insurance companies' financial
soundness. During such examinations, the regulators assess the quality
of insurance companies' assets and whether their income is sufficient
to meet present and future financial obligations to their
policyholders.
Some state insurance regulators also review some aspects of insurance
product sales as part of market conduct examinations. Designed to help
protect consumers from unfair practices, market conduct reviews are
done for a wide range of company practices, including sales,
underwriting, and claims processing and payment.[Footnote 33] For
example, a regulator may review a sample of sales by a particular
company to ensure that its agents have not misrepresented products or
otherwise violated the requirements of their particular state. Although
some states routinely perform market conduct reviews of the companies
they oversee, most states only conduct such investigations when they
receive complaints from customers or otherwise obtain information that
raises concerns about the activities of an insurance company.
Many States Lack Appropriateness or Suitability Standards:
One reason that insurance regulators do not review insurance company
sales practices more routinely is that standards requiring that any
insurance products sold be appropriate or suitable for the purchaser do
not generally exist. As a result, when an insurance regulator receives
a complaint or other information indicating that potentially
problematic sales have occurred, they can review the marketing
practices of any insurance companies involved to assess whether any
misrepresentations or other fraudulent activities occurred. However,
under most state insurance laws, insurance regulators do not have the
authority to evaluate whether the product sold was appropriate or
suitable given the customer's needs. In contrast, broker-dealers
selling securities products are required to assess the financial
circumstances of their customers to ensure that any products they
recommend to these customers are suitable. Specifically, broker-dealers
are required to consider such factors as their customer's income level,
investment objectives, risk tolerance, and other relevant
information.[Footnote 34]
State regulators and others have tried to establish suitability
standards for insurance products, but these efforts have generally not
been successful. For example, in 2001, NAIC formed a working group to
collect and analyze data, prioritize key issues for examination, and
assess interstate cooperation in developing guidelines for market
conduct standards. These market conduct standards would be intended to
protect consumers from abuses in the insurance market, including those
related to the availability and affordability of insurance. Using such
standards, state insurance regulators would review the underwriting and
marketing practices of insurance companies and their agents.
However, after being unable to come to consensus on suitability
standards that would apply to all insurance sales, the NAIC working
group narrowed its approach. Instead, the group drafted a model law
that provided standards for annuity products sold to seniors age 65 and
over.[Footnote 35] This draft model legislation would require that
before insurance agents recommend the purchase or exchange of an
annuity, they must take into account the purchaser's financial
situation (including other investments or insurance policies owned) and
reasonably believe that the recommendation is suitable for the
purchaser. As of July 2005, NAIC reported that only nine states had
fully or partially adopted this model law, 10 others already had
similar or related legislation, and 35 states or territories had yet to
take any action.
Other organizations have also attempted to develop suitability
standards. For example, the Insurance Marketplace Standards Association
(IMSA) has developed various standards applicable to insurance
companies' marketing practices. IMSA also provides qualification to
companies that comply with its marketing practices standards.[Footnote
36] After becoming IMSA qualified, a company's salesforce would be
expected to assess a potential buyer's need for insurance before
recommending its purchase. A representative of IMSA told us that
insurance companies and agents following IMSA's guidelines for
conducting a needs-based selling analysis would review a customer's
insurable needs and financial objectives to determine the appropriate
life insurance product, if any, to be offered. In many cases, junior
service members with no dependents may not need additional life
insurance beyond that available through the low-cost, government-
offered SGLI. However, none of the six companies that were primarily
marketing to military members with the combined insurance and savings
product were IMSA qualified.
Legislation has been proposed that would require insurance regulators
and DOD to work together to study ways to improve the quality of--and
practices used to sell--life insurance products sold on military
installations. For example, one option offered by these bills would be
to only allow those companies that have met best practice procedures
(such as those developed by IMSA) to sell insurance on military
installations. These bills also propose that standards that would apply
to the sale of products to military members could be
developed.[Footnote 37]
Concerns and Complaints Existed at Military Installations:
Although concerns or complaints involving insurance sales existed on
DOD installations, insurance regulators we contacted mentioned that
they generally have not historically received complaints from DOD
officials about potentially problematic sales of products to service
members. The actual extent to which service members have concerns or
complaints involving insurance product sales is not known because, as
we reported in June 2005, DOD only recently began systematically
collecting information on violations of DOD's solicitation policy by
sellers of financial products.[Footnote 38] However, the DOD reports
described earlier in this report, and work we conducted for this report
and several other reports we recently issued, appears to indicate that
concerns over inappropriate practices related to product sales among
military members was widespread. For example, for our April 2005 report
on the financial condition of military members, we surveyed 175 U.S.
installation-level managers of DOD's personal financial management
program, which provides service members with financial literacy
training, financial counseling, and other assistance to avoid or
mitigate the adverse effects associated with personal financial
problems.[Footnote 39] We reported in June 2005 that about 25 percent
of the managers surveyed believed that insurance company
representatives occasionally made misleading sales presentations at
their installations during 2004, and 12 percent believed that such
presentations were made routinely.
At the two bases visited as part of work for this report, we also found
evidence that service members had concerns or complaints about the
marketing practices used by sales personnel from some of the companies
that targeted military members. After complaints were raised by some
service members at these bases, military personnel conducted
investigations of the matters. For example, at Fort Benning, Georgia,
statements were taken from several service members that were solicited
insurance products between 2001 and 2004. Of the 41 statements in the
investigative files that we were able to review, more than 70 percent
indicated that the sales personnel had described the product as a
savings or investment product. Additionally, almost all of these
service members indicated that the insurance company sales personnel
had taken actions that violated one or more of the restrictions in
DOD's solicitation policy, such as making these sales presentations
during group training sessions.
At Great Lakes Naval Training Center, base legal advisers told us they
do not receive many complaints because service members were often being
solicited shortly before they transferred to other installations.
However, legal staff at Great Lakes Naval Training Center showed us
documentation related to 5 complaints pertaining to insurance products
from service members between January and June 2005. In addition, they
also indicated that they have also seen complaints arising from other
military installations after leaving Great Lakes Naval Training Center.
We also spoke with finance office personnel at this base who had become
concerned about the sale of insurance to service members occurring
there. As a result, these personnel had retained copies of some of the
pay deduction allotment forms submitted for processing between June and
September 2004. Numbering over 100, the copies represented forms that
had been used to initiate pay deductions for products purchased by base
service members from three different insurance companies, according to
military pay personnel. We attempted to contact a random selection of
these service members. We were able to speak with three of the service
members and a spouse representing a service member who had purchased
these products, and all indicated that the insurance product they had
purchased had been generally represented as an investment.
However, state insurance regulators we contacted generally were not
aware of the potentially problematic sales to military members because
they generally were not receiving information about concerns or
complaints from military personnel. These state insurance regulators
and NAIC officials told us that they had received few complaints
involving military members. For example, as part of our June 2005
report, we surveyed insurance regulators in 50 U.S. states and 4
territories and received 48 responses. Of these, regulators in only 8
states indicated that they had received life insurance related
complaints from service members or on their behalf between October 2003
and December 2004.
According to the director of the DOD office that oversees commercial
solicitations on military installations, information about service
member concerns or complaints involving financial product sales are not
generally shared with state regulators for several reasons. In some
cases, service members expressing reservations about purchasing one of
these products might have received advice from other members or from
superior officers to cancel, rather than complain to a regulator. In
other cases, DOD officials told us that base personnel will work
directly with the selling company to resolve a matter rather than
involving a financial regulator. For example, a service member with
concerns about a purchase of a financial product could consult with the
installations' legal advisers from the judge advocate general staff.
However, DOD officials stated that interactions between service members
and these staff are covered by attorney-client privilege and thus are
more difficult to share with external parties, such as financial
regulators. Attorneys representing two state insurance departments
believed that DOD attorneys should be forwarding such complaints
because this would be in the best interest of the service members. They
emphasized that complaints related to financial products should be
forwarded to the financial regulators that can take action on behalf of
the service members. They emphasized that failure to notify regulators
that there are service members with concerns about financial product
sales deprives regulators of important information necessary for their
oversight processes to function properly.
In some cases in which military installations have reported concerns or
complaints, regulators have been able to take action against insurance
companies that conduct business with military service members. For
example, regulators in Maryland were notified in the 1990s about
potential improprieties involving sales of insurance products to junior
enlisted personnel by a concerned official at one military training
base in their state. In an examination report issued in January 2002,
insurance regulators found that companies (including some of those that
are currently being investigated by other states) marketing combined
insurance and savings products to military personnel in Aberdeen
Proving Grounds and other locations had violated various state laws and
regulations and had misled some service members about the nature of the
products, including misrepresenting insurance products as
investments.[Footnote 40]As noted previously, regulators in Washington
state also became aware of problematic sales at military installations
in their state in the 1990s. This state eventually took action to
rescind approval of certain insurance products where the side savings
fund did not meet the state's requirements for an annuity, a premium
deposit fund, or a universal life product. In addition, regulators in
Virginia have also ordered that some companies that target military
members to cease selling certain products in their state However,
regulators in the other states that are currently conducting
investigations of the companies targeting military members were not
generally aware of such sales until recent press reports because DOD
personnel were not generally sharing information about any service
member complaints or concerns they received.
Lacking Complaints and Data on Actual Customer Experiences with
Contractual Plans, Securities Regulators Were also Unable to Identify
Problems Involving Sales to Service Members:
Lacking information on complaints and data on the extent to which
broker-dealer customers were successfully completing contractual mutual
fund plans, securities regulators, similar to insurance regulators,
also did not identify problems involving military members until press
reports appeared. Although SEC and NASD, which has primary regulatory
responsibility over the broker-dealers that were marketing contractual
plans to service members, took enforcement actions against the firm
that was the largest marketer of these products in late 2004, both
regulators had conducted earlier examinations of this firm and did not
identify any significant problems. SEC and NASD staff told us that
identifying the problems involving the sale of this product was made
more difficult because neither of the regulators had previously
received any complaints about the firm from service members. However,
NASD staff told us that after a DOD online periodical reported in 2003
that securities regulators were reviewing contractual plan sales, DOD
staff received several inquiries from service members who had concerns
about the products they had purchased. To the securities regulator
staff, this provided evidence that concerns or complaints from military
members were not being directed to the regulators--either by the
service members themselves, or by the DOD personnel aware of such
concerns.
Securities regulators' ability to detect problems was also hampered by
the lack of standardized data on the extent to which customers were
completing contractual plans. For example, in response to an article in
The Wall Street Journal in 2002 that raised questions about the
appropriateness of the sales of such plans to military members, SEC
staff reviewed the operations of the largest seller of contractual
plans.[Footnote 41] According to SEC staff, their review did not raise
any major concerns because they found no evidence that military members
were complaining about their purchases from this firm. In addition, the
firm provided the SEC staff with documents that purported to show that
the persistency rate for the contractual plans--which represented the
proportion of plans that were still open---was over 80 percent for the
previous 3 years. The SEC staff told us that their examiners accepted
these statistics as valid because they were also able to obtain data
from one of the major mutual fund companies whose funds represented the
majority of those in which this broker-dealer's customers had invested.
The data showed that most of this broker-dealer's customers still had
open plans with the company.
After an article that raised concerns about contractual plan sales to
military members appeared in Kiplingers, a personal financial magazine,
in 2003, NASD staff also initiated an examination of this broker-
dealer.[Footnote 42] According to NASD staff, although they had
concerns over the sales of the contractual plan product, obtaining data
on the extent to which the firm's customers were continuing to make
payments and successfully completing their plans was difficult,
particularly since no specific requirement mandates that broker-dealers
maintain records or standardized data. According to NASD staff, this
firm maintained various sets of data on its contractual plan customers
and becoming familiar with the differences in the information and
determining what would be most useful for their reviews proved to be
difficult and time consuming. They also noted that their existing
examination procedures did not address issues such as persistency rates
that were found to be relevant to examining contractual plans.
However, these regulators were able to identify concerns after they
required the firm to provide comprehensive data on all customers that
purchased such products. According to SEC and NASD staff, they were
able to determine how successful this firm's customers were being with
their contractual plans only after they required the firm to provide
specific data on all customers that purchased contractual plans
covering a full 15-year period. After obtaining this data, regulators
determined that the actual proportion of customers making all required
payments for the 15-year term of the plans was only 43 percent. This
percentage was about half of the persistency or success rate shown in
documents that the firm had previously provided to the regulators
during their prior examinations, because the previously supplied data
had excluded any customer whose account remained open but had not made
any payments in the last year. However, in the view of regulators,
investors that were no longer making payments into their plans should
be taken into consideration when determining the overall extent to
which a firm's customers were successfully completing their plans.
DOD also Taking Actions to Address Problematic Sales to Military
Members, but Remains Reluctant to Fully Share Information with
Financial Regulators:
DOD has also taken some actions to address potentially problematic
sales of financial products to service members, although it does not
currently share all relevant information with financial regulators. The
primary way that DOD attempts to protect service members from
inappropriate sales is through its directive on commercial solicitation
on military installations. This directive, DOD Directive 1344.7, is
administered by the Office of the Under Secretary of Defense for
Personnel and Readiness. The directive currently places various
requirements and restrictions on financial firms seeking to market
products on military installations in the United States and overseas.
For example, it prohibits sales from occurring as part of group
meetings and instead requires financial institution personnel to make
an advance appointment and meet with service members individually. In
addition, sales personnel that are former military members are also
prohibited from using their military identification to gain access to
an installation. In the event that a company, its agents, or
representatives violate DOD's solicitation policy, installation
commanders can permanently withdraw the company's or individuals'
solicitation privileges through a ban or can temporarily suspend those
privileges for a specified period.
Following the DOD reports that detailed issues and concerns associated
with insurance sales to military members, staff within the Office of
the Undersecretary for Defense for Personnel and Readiness began
efforts to revise DOD's solicitation directive. In April 2005, DOD
sought public comments on a revised directive that incorporates new
requirements. For example, the revised directive expressly prohibits
insurance products from being sold as investments. In addition, it also
includes a new evaluation form that is intended to be completed by each
service member that has been solicited. The form would allow service
members to indicate, with yes or no answers, whether the individual
soliciting them violated certain aspects of DOD's policy, such as
contacting them during duty hours. The evaluation form also has
questions relating to salespersons' conduct during any solicitation,
such as whether they pressured the service member into making a
purchase, failed to provide adequate information, or implied that they
were endorsed by the military.
In addition to revising its solicitation directive, DOD personnel have
also taken enforcement actions against several insurance agents for
improper solicitations at several military installations. For instance,
at Fort Benning, an insurance company and its agents that operate in
the military market segment were banned from conducting sales on the
base. Additionally, several military personnel in supervisory positions
were also disciplined for allowing improper insurance solicitations to
occur and not properly enforcing existing solicitation policies.
DOD Lacks Requirements to Comprehensively Share Violations and
Complaints with Financial Regulators:
Although DOD has taken some steps to better protect its service members
from inappropriate financial products, DOD does not currently require
its personnel to share all relevant information with financial
regulators, including complaints from service members. DOD's current
policy regarding financial product solicitation only requires
installation commanders to notify the appropriate regulatory
authorities if they determine that an agent or company does not possess
a valid license or has failed to meet other state or federal regulatory
requirements. However, the draft of the revised solicitation directive
includes provisions that would require installation personnel to report
all instances in which they ban or suspend the solicitation privileges
of any companies or individuals selling financial products to the
Principal Deputy Under Secretary of Defense for Personnel and
Readiness. The legislation being considered in Congress would also
require DOD to maintain a list of names, addresses, and other
appropriate information of any individuals selling financial products
that have been barred, banned, or limited from conducting business on
any or all military installations or with service members.[Footnote 43]
DOD has already begun collecting and publishing information on actions
taken by individual installations for violations of the solicitation
policy. As noted previously, DOD has already consolidated this
information from its installations and posted it on a web site. Under
the legislation before Congress, DOD would also be required to promptly
notify insurance and securities regulators of those individuals
included or removed from this list. DOD officials have indicated that
financial regulators can access the information about the actions taken
against individuals or companies that have violated DOD solicitation
policies from the web site and that, if these additional requirements
become law, they will provide the information on their listing to
financial regulators as it changes.
Although DOD is planning to share more information with financial
regulators, DOD officials remained reluctant to share all information
on violations of DOD policies that do not result in bans or
suspensions. We recommended in our June 2005 report that DOD implement
a department-wide searchable database to capture all violations of its
own solicitation policy and provide this information to financial
regulators. However, DOD officials told us that violations of some DOD
policies, such as when sales personnel solicit without an appointment
or solicit groups of service members, would probably not represent
violations of financial regulations and therefore would be of little
concern to such regulators. DOD officials also said that being required
to report every time even minor violations occur, such as when a
retired military member uses military identification to obtain base
access for a solicitation visit, would be burdensome to their
personnel.
However, financial regulators' staff told us that receiving information
related to violations of DOD's commercial solicitation policies also
would be very helpful in determining whether further action, such as
revocation of licenses, was warranted. For example, officials from one
state insurance department told us that insurance agents have the
obligation to be trustworthy and that if such individuals are violating
any DOD regulations, this information could help them determine whether
the conduct of the agents also violate their state's requirements.
Although DOD personnel had not routinely shared service member
complaints with financial regulators in the past, DOD officials have
also told us that they intend to require their personnel to report more
of that type of information to regulators. Under the current
solicitation policy directive, DOD personnel are not required to share
information relating to service member concerns or complaints with
other parties, and the revised draft that was published for comment
also lacked any provisions relating to such information. However, staff
in the office that oversees the policy directive told us that, as part
of addressing the comments they have received, they intend to
specifically require in the new directive that base personnel report to
financial regulators any service member concerns or complaints that
relate to the quality of the financial products offered to them or
regarding the appropriateness of the practices used to market these
products.
Financial regulators indicated that receiving such information from DOD
would greatly improve their ability to recognize and act on potentially
problematic financial product sales involving service members.
Insurance and securities regulator staff told us that promptly
receiving concerns or complaints raised by service members would allow
their normal regulatory oversight processes to function properly, which
rely on complaints as an important indicator of potential problems
involving insurance company or broker-dealer practices.
Congress also may be increasing the amount of information that both
regulators and DOD have about potentially problematic practices by
insurance sellers. Both of the bills currently under consideration in
Congress would prohibit insurers from using agents that sell life
insurance on military installations unless the insurer has a system to
report to the state insurance regulators in its state of domicile and
in the state of residence of an agent any disciplinary actions known to
have been taken by any government entity and any significant
disciplinary action taken by the insurer itself against an agent with
regard to the agent's sales on military installations.[Footnote 44]
Furthermore, the bills would require that state insurance regulators
develop a system for receiving such information and the ability to
disseminate it to all states and to DOD.
However, some barriers appear to make sharing between DOD and financial
regulators more difficult. As part of conducting their investigations
of contractual plan sales, securities regulator staff told us that
personnel at some DOD installations were reluctant to share any
information involving specific service members for various reasons.
According to these regulators, the installation personnel cited
military privacy regulations and the restrictions that arise from
attorney-client privilege if the service member was being assisted by
military legal counsel. According to the director of the DOD office
responsible for administering the solicitation policy, such issues can
affect their ability to share information with entities outside the
military. However, he explained that they have researched these issues
with their legal staff and believe that they can share information that
is deemed to be necessary for the official needs of the requesting
organization, including financial regulators. This DOD official also
acknowledged that more coordination could be done to ensure that both
its own military installation personnel and financial regulatory staff
understand how additional sharing could appropriately occur. In
addition, to improve financial regulators' ability to obtain
information from DOD, officials from NASD told us that the financial
regulators could create liaisons on their staff to receive complaints
and be the primary person responsible for seeking information from the
military as part of examinations.
Inadequate Financial Literacy and Lack of Jurisdictional Clarity Are
also Concerns:
Although increased financial literacy could also help protect military
service members from inappropriate financial product sales, concerns
exist over the adequacy of such efforts to date. In a report on the
extent to which consumers understand and review their credit reports,
we noted that individuals' ability to understand credit matters
differed across various demographic characteristics. For example, we
found that college-educated individuals with high incomes and credit
experience exhibited more expertise than those without such
characteristics.[Footnote 45] Similarly, many military members also
tend to lack advanced education or high incomes. As our April 2005
report on the financial condition of military members noted, almost 40
percent of service members reported having some trouble managing their
financial affairs and studies by private consultants have found that
the overall financial literacy among service members is not
high.[Footnote 46]
DOD is attempting to increase financial literacy among military
members. As noted previously, DOD has developed personal financial
management programs to provide service members with financial literacy
training, financial counseling, and other assistance to avoid or
mitigate the adverse effects associated with personal financial
problems. However, as we reported in April 2005, not all service
members were receiving the training required as part of these programs.
As a result, our report recommended that DOD implement a monitoring
plan to ensure that all junior enlisted members receive the required
personal financial management training.
Similarly, financial regulators have also begun working with DOD to
increase financial literacy and awareness among service members, but
these efforts have not been completed. For example, approximately $7
million of the settlement that SEC and NASD reached with the largest
broker-dealer selling contractual plans to military members will be
used to fund financial education efforts among service members. Using
the proceeds of the settlement, NASD staff told us that the staff of
the NASD Investor Education Foundation plan to conduct research to
determine current levels of service members' investment knowledge and
use this to plan and develop its military education efforts. Among the
efforts currently being designed are a military-specific online
resource center to provide unbiased information on saving and
investing. In addition, they plan to develop training to support the
military's current personal financial management program by
establishing a coordinated and uniform financial education program.
They also plan to conduct a public outreach campaign to promote saving
and investing to members of the military and their families. These
efforts are anticipated to be publicly launched in late 2005 with many
national and local activities taking place in 2006.
To help convey information to service members about insurance
regulatory organizations outside the military that can receive and help
resolve their complaints, NAIC and DOD staff have also been working
together on materials to help educate service members. As of October
2005, their efforts have produced a consumer brochure for military
members that contains information to help service members better
understand factors to consider when purchasing life insurance and
regulatory entities that service members can contact should they have
complaints concerning insurance sales. According to NAIC officials,
they are also working on information to be presented on a NAIC Web
site.
Congress has also recognized the need for additional information to
better protect military service members from inappropriate product
sales. For example, both versions of the bill currently under
consideration in Congress would require that, for any sales taking
place on a military installation, insurance representatives disclose
that subsidized life insurance may be available from the government to
the service member and that the government has not sanctioned,
recommended, or encouraged the sale of the product being
offered.[Footnote 47] In addition, this legislation also would require
that service members be provided with information about where to
complain regarding any problems involving an insurance sale on a
military installation. Specifically, both bills would generally require
that, for any sales taking place on federal land or facilities located
outside the United States, insurance sellers provide a disclosure that
lists the address and phone number where consumer complaints are
received by the applicable state insurance regulator.[Footnote 48]
Although DOD currently has a program to provide financial literacy
training to junior personnel, not all levels of the services receive
such information. Currently, the personal financial management training
that the various branches offer to service members are provided only to
junior enlisted members. However, an officer in one branch of the
service also told us that she and other more senior members of the
military are also solicited by financial firms and thus having such
training, including addressing proper procedures for directing concerns
or complaints, offered to more than just junior personnel would be
helpful.
Another concern over whether military members are adequately protected
from inappropriate sales stems from uncertainty over financial
regulators' jurisdiction on U.S. military installations. Although most
of the insurance and securities regulators we contacted believed they
had jurisdiction over the sales of financial products on military
installations, some regulators expressed uncertainty over their
authority to regulate sales on military installations, where the
federal government may have "legislative jurisdiction."[Footnote 49]
For example, regulators from Maryland conducting work on a market
conduct examination mentioned that they had asked an agent from the
Federal Bureau of Investigation to accompany them when visiting the
military installation in case installation personnel questioned the
insurance regulators' authority to conduct an investigation on the
installations. Further, according to a Texas insurance department
official, he had trouble getting access to complaints information at a
military installation because installation personnel question his
authority to request such information. In addition, Georgia officials
told us that a military installation in their state had an "exclusive
federal jurisdiction" designation that could potentially present a
jurisdictional issue. However, regulators in Virginia noted that they
have been able to conduct examinations after seeking and obtaining
written permission from base commanders. As part of the work on DOD's
oversight of insurance sales that we reported on in June 2005, we
surveyed the various state and territorial insurance
commissioners.[Footnote 50] Of those that responded to the question
regarding whether they had authority over sales of life insurance on
military installations, four commissioners indicated that they did not
have such authority. State insurance regulators also noted they lack
jurisdiction over sales taking place outside the United States at
overseas installations.
While securities regulators also generally believed they had
jurisdiction over sales on military installations, they too indicated
that greater clarity would be beneficial. At least one state securities
regulator responded to a North American Securities Administrators
Association survey that it did not have adequate authority over sales
taking place on military installations. Of the legislation under
consideration in the Congress, the bill that passed the House of
Representatives includes language stating that any state law,
regulation, or order pertaining to the regulation of insurance or
securities sales is generally applicable to any such activity conducted
on Federal land or facilities in the United States and abroad,
including military installations. The version introduced in the U.S.
Senate includes similar language but would only apply to insurance
sales.[Footnote 51]
Conclusions:
Large numbers of military service members are being targeted by a few
firms offering products that provide limited benefits unless held for
long periods, which most military purchasers were failing to do.
Thousands of service members across the United States and around the
world are purchasing products from insurance companies that combine
insurance and savings. Although some service members and their
survivors have benefited from these products, many have not. Most of
the purchasers of these products were unmarried individuals with no
dependents and thus little need for any more coverage than that already
provided by the low-cost government insurance service members receive.
Instead, they were likely attracted to these products for their
investment features. However, by being tied to expensive life
insurance, these products appeared to be a poor investment choice for
service members because they include provisions that allow the
accumulated savings to be used to keep the life insurance in force if
the service member ever stops making payments and does not request a
refund of this savings. Given that military members move frequently and
often leave the service within a few years, many did not continue their
payments and failed to request refunds, and as a result, few likely
amassed any savings from their purchase. The few companies that sell
these products also have been accused of using inappropriate sales
practices in the past, have been sanctioned, and are again being
investigated by numerous federal and state regulatory and law
enforcement authorities.
With concerns over potentially inappropriate insurance sales to
military members being longstanding, the need to take definitive
actions to better protect service members appears overdue. The
legislation that passed the House of Representatives and is being
considered in the U.S. Senate includes various provisions that, based
on our work, would appear to improve the protections for military
members. Some of the provisions of these bills are of particular
importance. Currently, both would direct insurance regulators and DOD
to work together to develop measures to address sales to military
members. Given that many service members were obtaining only limited
benefits from purchasing these combined insurance and savings products,
we believe that congressional action that results in state regulators
undertaking reviews to ensure that only products that comply with state
insurance regulations, an area in which regulators in some states now
have developed concerns, is warranted to provide protections to
military personnel in all U.S. jurisdictions. In addition, having
insurance regulators and DOD work cooperatively to develop suitability
or appropriateness standards could ensure that companies offer only
products that address actual service member needs for insurance and
that take into account service members' itinerant lifestyles, income
levels, and likely inability to make payments for extended periods of
time. This could also provide protection for service members that are
located in overseas installations not directly overseen by state
regulators.
Similarly, military members were also being widely marketed a
securities product--the contractual plan--that has largely disappeared
from the civilian marketplace. Although potentially providing returns
equivalent to other products if steady investments are made over the
required 15-year term, these products were likely less beneficial to
the many service members that failed to make payments for that extended
length of time. In the many years since contractual plans were first
offered, a variety of alternative investments have become widely
available for individuals with modest incomes, including other load
funds, no-load funds, and TSP, which is now available to service
members and likely offers the lowest investment expenses of any
product. Given the longstanding history of sales practices abuses
associated with the contractual plans and the availability of viable
alternative investments, we believe that congressional approval of the
legislation currently under consideration, which includes language to
ban these products, would remove products that appear to have little
need to continue to exist.
Although insurance and securities regulators have taken actions since
allegations of inappropriate sales to military members have come to
light, additional actions could mitigate some of the limitations that
hampered regulators' ability to address these problems. As our work
found, state insurance and securities regulators sometimes were
uncertain of the adequacy of their authority over sales taking place on
military installations. As a result, some of these regulators and
officials from associations representing state insurance and securities
regulators expressed support for congressional action to clarify that
state financial regulators have jurisdiction over sales taking place in
such locations.
In addition, congressional action could serve to better ensure that
financial regulators are made aware of potentially inappropriate sales
involving military members. As we found, federal and state insurance
regulators' ability to more promptly identify inappropriate sales of
financial products involving military members was hampered by the lack
of information sharing by DOD. DOD officials have expressed their
willingness to provide financial regulators with information on actions
taken against individuals or firms that violate DOD's solicitation
policies. They have also indicated their intention to require their
personnel to provide information regarding service member complaints
and concerns. However, they note that privacy requirements can pose
perceived barriers to such sharing. In addition, they remain reluctant
to share information about all instances in which sellers of financial
products violate DOD solicitation policies. However, such information
could allow financial regulators to determine whether such situations
also represent potential violations of federal or state laws. As a
result, we believe that congressionally-mandated direction is needed to
ensure that DOD identifies ways to overcome these barriers and
coordinates with its installation personnel and with financial
regulators about ways to share additional information about problematic
company behavior and service member concerns.
Additional DOD actions also could help protect service members from
firms using unscrupulous sales practices. DOD officials have indicated
that having their personnel share some information relating to service
member concerns and complaints is appropriate. Including such a
requirement in the revision of DOD's solicitation policy would better
ensure that financial regulators receive this important information.
DOD is also currently attempting to provide personal financial
management training to improve financial literacy and competence among
military members. Such training would also appear to be a useful forum
for informing military personnel about proper procedures for submitting
concerns or complaints. Given that more senior officers were customers
of some of the financial firms that target military members,
periodically providing such training to service members at all levels
throughout the military would also likely raise awareness and assist
them in making sound financial decisions.
Financial regulators also appear to have opportunities to improve their
ability to protect military members from inappropriate sales. Because
complaint information is a critical input to their regulatory
processes, proactively seeking such information from DOD and its
installations would likely improve regulators' oversight efforts. Given
the uniqueness of the military environment, having staff or offices
within regulators' own organizations that serve as liaisons with DOD
and individual installations could allow both DOD and financial
regulators to build trust and gain experience in sharing information
and assisting investigations of potentially problematic financial
product sales. Ensuring that financial regulators' staff also make use
of any listings compiled by DOD of individuals or firms that have been
sanctioned by the military for activities relating to financial product
sales to target examination and investigation resources would also
likely improve the protections that are afforded to military members.
SEC and NASD efforts to oversee broker-dealers marketing contractual
plan mutual funds were hampered by a lack of standardized data at these
firms on the success of clients in investing in these plans. In the
event that such plans continue to be legally sold, having these
regulators evaluate how best to ensure they will have such information
in the future would improve their ability to oversee these products.
Some possible ways to ensure such information is readily available
would be to implement a rule requiring broker-dealers to maintain
standardized records that show how successfully their customers are
completing any contractual plans purchased. Alternatively, SEC and NASD
examiners could routinely request such information prior to conducting
a review of the broker-dealers selling these products.
Matters for Congressional Consideration:
To better protect military service members from financial products with
limited benefits to them, the Congress should consider taking the
following five actions:
* Provide that products being marketed primarily to military members
are reviewed by state insurance commissioners to ensure that all such
product provisions are in compliance with existing state laws, and
provide for reports through NAIC to relevant congressional committees
on the results of these reviews within 12 months.
* Provide that state insurance commissioners work cooperatively with
DOD to develop appropriateness or suitability standards for sales to
military service members.
* Ban the sale of contractual mutual fund plans.
* Specify that state insurance and securities regulators have full
access to persons and information necessary to oversee sales taking
place on military installations or involving service personnel.
* Require DOD to work cooperatively with financial regulators to
develop mechanisms that overcome existing barriers to sharing
information about insurance and securities firm activities and service
member concerns and complaints that can allow financial regulators to
determine whether violations of existing federal or state laws or
regulations are occurring.
Recommendations:
To better protect service members from unscrupulous sales of financial
products, the Secretary of Defense should take the following two
actions:
* Issue a revised DOD solicitation policy requiring that information on
service member complaints related to financial product sales be
provided to relevant state and federal financial regulators.
* Include in the personal financial management training for all service
members information and materials developed in conjunction with
insurance and securities regulators that explains how and to whom
service members should raise concerns or complaints about potentially
inappropriate sales of financial products, including providing the
information necessary for contacting these regulators. Such training
should also periodically be offered to service members of all levels.
To better ensure that federal, state, and other financial regulators
can oversee sales of insurance and securities products to military
members, the heads of SEC, NASD, and state insurance and securities
regulators should designate staff to receive complaints from DOD and
conduct outreach with DOD headquarters and individual installations to
proactively learn of issues or concerns regarding product sales.
These staff should also make use of any listings that DOD maintains of
individuals or firms that have been sanctioned by the military for
improper solicitation practices.
In the event that contractual mutual funds are not banned, the Chairman
of SEC and the Chairman of NASD should consider various means of better
assuring that their staff has adequate information to assess the sales
of contractual plans.
Agency Comments:
We provided a draft of this report to DOD, NAIC, NASD, and SEC for
comments. Each of these organizations provided written comments
expressing general agreement with our report and its recommendations
(these comments appear in appendixes IV through VII). In concurring
with our recommendation that DOD require that information on service
member complaints be provided to financial regulators, a letter from
DOD's acting principal deputy for the Undersecretary for Personnel and
Readiness indicated that their revised solicitation directive will
require installations to report such information to regulators. The
principal deputy's letter also indicates they concur with our
recommendation to provide all service members with information during
personal financial management training on how to complain to regulators
and states that they have developed a strategic plan for programs to
assist members with determining appropriate financial products for
their needs and how to remedy concerns or complaints. They also intend
to approach state regulatory agencies to assist in providing
educational information to all service members and provide such
information during new comer orientations and through toll-free
assistance lines.
In SEC's letter, the director of that agency's Office of Compliance
Inspections and Examinations stated that they shared our concerns that
securities products be properly marketed to military members. She also
stated that in the event that Congress does not ban the sale of
contractual plans they will consider our recommendation that SEC
consider ways to ensure that it have adequate information to assess
sales of such products. In NASD's letter, the NASD Chairman and Chief
Executive Officer states that men and women of the U.S. armed forces
deserve the same protection from inappropriate financial product sales
as their civilian counterparts and that our report will help NASD and
others to ensure that this is achieved. NASD's letter also describes
the actions the organization has taken against the largest seller of
contractual plans, including noting, as our report acknowledged, that
they began reviewing this firm in 2003. NASD's letter also describes
their efforts to develop education for military members.
In its letter, NAIC's Executive Vice President and Chief Executive
Officer notes that we ask Congress to direct the states to review
currently approved products being marketed to military members. In
response, she indicates that a number of states are examining companies
that have engaged in questionable practices involving these products
and that an NAIC committee plans to review life insurance sold with a
side fund to recommend a position on products being offered in the
marketplace in 2006. Regarding our request that Congress direct DOD and
the insurance regulators to work together to improve information
sharing, NAIC's letter indicates that they are in the process of;
* compiling a list of insurance department contacts to ensure that DOD
has the proper contact information for further state assistance;
* updating NAIC's Complaint Database System form to identify complaints
that are submitted by military personnel; and:
* providing DOD with a state-by-state premium volume summary for those
companies that state insurance regulators know are soliciting or have
solicited insurance products on military bases.
Regarding our recommendation that DOD and regulators work together to
develop training materials, NAIC's letter indicates that they have
worked with DOD to develop a consumer brochure and a Web site
specifically addressing life insurance information for military
personnel and remain committed to developing other materials to fill
any financial literacy needs that DOD identifies.
We also received technical comments from each of these organizations
that we incorporated where appropriate.
As agreed with your offices, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days
after the date of this report. At that time, we will send copies of
this report to the Chairman and Ranking Minority Member, Senate
Committee on Armed Services; Chairman and Ranking Minority Member,
House Committee on Armed Services; and Chairman and Ranking Minority
Member, House Committee on Financial Services. We will also send copies
of this report to the Secretary of Defense, Chairman, SEC; and
Chairman, NASD. We will also make copies available to others upon
request. In addition, the report will be available at no charge on
GAO's Web site at [Hyperlink, http://www.gao.gov].
If you or your staff have any questions regarding this report, please
contact me at (202) 512-8678 [Hyperlink, hillmanr@gao.gov]. Contact
points for our Offices of Congressional Relations and Public Affairs
may be found on the last page of this report. Key contributors to this
report are listed in appendix VIII.
Signed by:
Richard J. Hillman:
Managing Director, Financial Markets and Community Investment:
[End of section]
Appendixes:
Appendix I: Objectives, Scope, and Methodology:
To identify the insurance products being sold and how these were being
marketed to military members, we reviewed prior Department of Defense
(DOD) reports, spoke to officials at the National Association of
Insurance Commissioners (NAIC), and met with regulatory officials from
several state regulators that are currently conducting or have
previously conducted reviews of insurance companies that market
primarily to military members. This work included interviewing
regulatory officials and reviewing available documentation from the
Georgia Insurance and Safety Fire Commissioner, the Texas Department of
Insurance, the Florida Office of Insurance Regulation, and the Illinois
Department of Insurance, and the Virginia State Corporation Commission
Bureau of Insurance. In addition, we contacted staff from the Maryland
Insurance Administration and the Washington Office of the Insurance
Commissioner to discuss their past investigations of certain insurance
companies targeting junior enlisted service members and reviewed
documents pertaining to such investigations. We also visited Fort
Benning, Georgia, and Great Lakes Naval Training Center, Illinois, to
better understand the insurance solicitation issues present at two
large military training installations. During these site visits we
interviewed staff judge advocate personnel and reviewed documents
pertaining to current and past investigations of sales of insurance
products at these locations. Furthermore, we obtained data on the
characteristics of military members making allotments to three
different insurance companies in this market from DOD's Defense Finance
and Accounting Service (DFAS), which maintains military personnel pay
records. In our prior report, we were unable to reliably determine the
total number of service members who have allotments for supplemental
life insurance products or the number of dollars that service members
pay to life insurance companies through the DFAS systems because not
all allotments for insurance were identified as such. To provide
accurate information for this report, we instead obtained from DFAS the
dependent status of service members for allotments that were being
routed to specific banks being used by some of the insurance companies
that market primarily to military members, which produced results that
we did believe were sufficiently reliable to highlight that a
significant percentage of service members who had made allotments to
specific companies had no dependents. Further, we contacted officials
from the six insurance companies identified by the multistate
investigation as being those companies that primarily market to service
members, and reviewed their marketing materials for the product sold to
service members.
To illustrate the cost and the possible performance of sample insurance
policies offered by these companies we obtained and analyzed sample
policies for a junior enlisted service member from six companies. We
also compared the cost and performance of these products to other
products offered to service members by the government including
Servicemembers' Group Life Insurance (SGLI), Veterans' Group Life
Insurance (VGLI), and the Thrift Savings Plan (TSP), as well as
insurance products offered by a private insurance company. We chose the
TSP G Fund as the savings component to be coupled with the government-
offered insurance because of its low risk and its comparable return
rate to the minimum rates claimed by the insurance companies. We
assumed a 4 percent rate of return for all of our analysis based on the
guarantee rate claimed on the policies typically marketed to service
members by the six companies we reviewed. For approximating the
projected TSP return, we compounded the 4 percent rate on a monthly
basis. To project the return on the insurance products' savings
components, we used the method of crediting interest in the products'
terms, in which interest is credited on the lesser of the average
balance during the year or the year-end balance. We also conducted
analysis to illustrate the performance of the products after a service
member stops making payments at the end of the fourth policy year.
Further, the analyses we conducted are for illustrative purposes only
and do not necessarily depict actual policy, plan schedules, or are
adjusted according to various proprietary risk classes that could apply
for a particular individual.
To identify the securities products being sold and how these were being
marketed to military members, we interviewed staff from NASD (formerly
called the National Association of Securities Dealers), Securities and
Exchange Commission (SEC), and North American Securities Administrators
Association (NASAA).[Footnote 52] We also interviewed officials from
the largest broker-dealer firm that markets to military members, which
represents 90 percent of the military market segment, and two of the
investment management firms that manage mutual funds underlying the
contractual plans sold to service members. To determine the cost and
performance of the contractual plan product offered by this broker-
dealer firm, we conducted analysis to illustrate a contractual plan
product typically marketed to career service members using a $600 front-
end load. To illustrate how this product compared to other similar
products we analyzed the cost and performance of a typical fund using
the Investment Company Institute recommended 5 percent load and TSP C
Fund with no load. We chose the TSP C Fund because it invests in common
stocks and was therefore comparable to the contractual plan product. We
analyzed these products for a 15 year--or "full term"-- period. We
assumed a 7 percent annual return that we compounded monthly for all
products. Further, we reviewed SEC and NASD investigation files of the
sales of securities products to military service members.
To assess how financial regulators and DOD were overseeing financial
product sales to military members, we interviewed state insurance and
federal, state, and other securities regulators. We also reviewed
available materials pertaining to product approval, investigations, and
regulatory activities and actions involving firms marketing to military
members. Specifically, to assess how insurance regulators were
overseeing sales of insurance products to military service members, we
interviewed officials from NAIC, including the staff working on the
multistate investigation of insurance sales involving service members.
We also spoke with officials and reviewed available documents on
activities and actions from several state insurance departments,
including those in Florida, Georgia, Illinois, Maryland, Texas, and the
state of Washington, that have previously investigated, or are
currently investigating, companies targeting military members. Further,
we reviewed legal actions taken against certain insurance companies as
part of Department of Justice (DOJ) investigations and law suit cases.
To determine the extent to which state insurance regulators received
complaints from military service members or had any concerns about
their jurisdiction on military installations, we relied on an E-mail
survey to the insurance commissioners for the 50 states, the District
of Columbia, and four territories: American Samoa, Guam, Puerto Rico,
and the Virgin Islands administered as part of our June 2005
report.[Footnote 53] We received completed surveys from 46 states, the
District of Columbia, and one U.S. Territory, yielding an overall
response rate of 87 percent. Further, to make the same determination in
regards to the sales of securities products to military members, we
relied on the results of a survey administered by NASAA. Additionally,
we contacted DOD officials, conducted fieldwork at Fort Benning,
Georgia and Naval Station Great Lakes, Illinois--two large military
training installations--and reviewed findings from other recent work
concerning supplemental life insurance sales conducted at several other
military installations throughout the country.
We performed our work from November 2004 to October 2005 in accordance
with generally accepted government auditing standards.
[End of section]
Appendix II: Actions Taken Against Financial Companies that Have
Frequently Marketed to Military Members:
Table 2 summarizes various actions that we identified during the course
of our review that have been taken by regulators or others against
companies that were identified as primarily marketing products to
military members. As indicated, many of the actions were settlements in
which the companies did not admit to any wrongdoing.
Table 1: Regulatory Actions or Activities Involving Companies that Have
Frequently Marketed to Military Members:
Entity taking action: Virginia State Corporation Commission Bureau of
Insurance.
September 2005.
Cease and Desist Settlement Order, Case No. INS-2005-00211, Sept. 29,
2005;
Alleged violations: The regulatory
forms for three insurance companies' combined insurance and savings
product allegedly failed to comply with the state's insurance
nonforfeiture laws;
Resulting actions: The companies agreed to stop marketing or soliciting
the particular products which failed to comply.
Entity taking action: Georgia Commissioner of Insurance. May 2005.
Commissioner of Insurance Press Release, May 25, 2005;
Alleged violations: An insurance company was investigated when
allegations surfaced that certain agents violated various DOD and state
insurance regulations by identifying themselves as disinterested
financial advisors while selling policies to soldiers in training;
Resulting actions: The company agreed to refund about $1.1 million in
premiums to soldiers who were solicited and sold term life insurance
policies while they were training at two Army bases in Georgia.
Entity taking action: Georgia Commissioner of Insurance. January
2005.
Commissioner of Insurance Press Release, January 7, 2005;
Alleged violations: An insurance company was investigated when
allegations surfaced that certain agents violated various DOD and state
insurance regulations by identifying themselves as disinterested
financial advisors while selling policies to soldiers in training;
Resulting actions: The company agreed to issue refunds totaling about
$1.3 million to certain soldiers at an Army base in Georgia.
Entity taking action: U.S. Securities and Exchange Commission and NASD.
December 2004.
SEC Administrative Proceeding File No. 3-11770, December 15, 2004.
NASD News Release, December 15, 2004;
Alleged violations:
broker-dealer allegedly:
* offered and sold contractual plans by, in part, making misleading
statements and omissions;
* violated NASD rules when one of the company's supervisors
inappropriately confronted a former customer who had made negative
comments about the company; and
* violated requirements to maintain books and records in connection
with the retention and accessibility of certain E-mail communications;
Resulting actions: Without admitting any wrongdoing, the firm agreed to:
* accept a censure from NASD;
* pay a fine of $12 million, including about $4 million for customer
restitution and about $8 million for an investor education program for
members of the U.S. military and their families; and
* hire an independent consultant to oversee the payment of restitution
and review its sales practices.
Entity taking action: Washington Office of Insurance Commissioner.
October 2004.
Office of Insurance Commissioner Letter, October 21, 2004;
Alleged violations: The regulatory forms for four insurance companies'
combined insurance and savings products allegedly failed to comply with
the state's insurance laws;
Resulting actions: As a result of the withdrawal of approval of the
forms, these companies' products could no longer be sold in the state
of Washington.
Entity taking action: Department of Justice. December 2002.
DOJ
Press Release, December 19, 2002;
Alleged violations:
The government alleged that an insurance company engaged in a scheme to
defraud military members who purchased life insurance policies from the
company between 1991 and 1998.
Resulting actions: The company agreed to settle the claims without
admitting liability under the terms of a settlement agreement that the
company:
* pay a $1 million civil penalty;
* pay the U.S. $505,965 to cover the costs of its investigation;
* increase the face amount of all in-force coverage by 6.5%, for a
total in-force increase in death benefits coverage of approximately
$160 million;
* pay $2.7 million to all policyholders who canceled their policies
during the relevant time period; and
* never again sell another insurance policy or reapply to DOD for
permission to conduct business on military installations.
Entity taking action: Maryland Insurance Administration (Commissioner).
January 2001.
Insurance Administration Market Conduct Examination Report No. 490-01,
January 25, 2002.
Maryland Insurance Administration Consent Order, Case No. MIA-360-7/00
(January 7, 2001);
Alleged violations:
The agents for one insurance company allegedly:
* did not disclose to military personnel that the products being sold
were insurance;
* did not disclose to military personnel that they were insurance
agents; and
* misrepresented the product sold as something other than insurance.
Resulting Actions:
The company generally disputed the allegations but voluntarily agreed
to, among other things:
* submit to the Commissioner the policies and procedures material for
approval;
* distribute the approved policies
and procedures manual to its Maryland agency force; and
* pay an administrative penalty to the state of Maryland in the amount
of $100,000, with $50,000 suspended.
Entity taking action:
Florida Department of Insurance. February 2000;
Florida Department of Insurance Consent Order, Case No. 23227-97-CO,
February 17, 2000.
Florida Department of Insurance Letter, April 5, 2000;
Alleged violations:
Two insurance companies allegedly:
* failed to provide their customers with Buyers Guides and Policy
Summaries;
* failed to properly refund or escheat significant amounts of funds
misdirected to the companies from the pay of military service members;
and
* improperly made unilateral reinstatements of lapsed policies.
Resulting actions:
The companies generally denied the allegations but each voluntarily
agreed to:
* look for and refund certain military members military pay allotments
received by the companies;.
* set up and run a special Complaint and Alternative Dispute Resolution
Program;
* make a mandatory payment of $200,000 to cover the costs of the
investigation; and
* contribute a gift of $1 million to a Florida university.
Entity taking action:
Department of Justice. December 1998.
Complaint, U.S. Dist. Ct., W.D. Wa., Case No. C98-5211(Apr. 21, 1998).
Settlement Order, U.S. Dist. Ct., W.D. Wa., Case No. C98-5211RJB (Dec.
7, 1998);
Alleged violations: The government alleged that two insurance companies:
* committed mail and wire fraud;
* made false statements; and
* conspired to defraud the United States;
Resulting Action:
The companies denied the allegations but agreed to:
* not sell or market the life insurance product other than as life
insurance;
* abide by and observe all DOD directives and military regulations
related to commercial solicitation on military installations;.
* conclude a comprehensive and final accounting of all funds paid to
the companies in error, and provide a copy to the United States;.
* offer refunds of any unallocated moneys to payers who can be located
through the exercise of due diligence; and
* refund the full amount of all premiums paid by 215 specific
individuals who requested a refund.
Entity taking action:
Washington Office of Insurance Commissioner.
June 1997.
Office of Insurance Commissioner Letter, June 10, 1997;
Alleged violations: The product of an insurance company allegedly did
not comply with the state's insurance laws.
Resulting actions:
Withdrew approval to sell the policies within the state of Washington
Entity taking action: United States Court of Appeals, Ninth Circuit.
February 1997.
108 F.3d 1123, (9th Cir. 1997);
Alleged violations:
Private claimants alleged that an insurance company violated the
Racketeer Influenced and Corrupt Organizations Act (RICO) and committed
fraud, and misrepresentation to facilitate sales of insurance as part
of a tax avoidance scheme.
Resulting actions:
Appeals court affirmed jury verdict that the firm was liable for
conspiracy to violate a provision of RICO in connection with a tax
avoidance scheme. The jury awarded the plaintiffs:
* $259,366 in actual damages (which were trebled pursuant to RICO);.
* $87,000 in damages for fraud and negligent misrepresentation; and
* $500,000 in punitive damages under state law.
Source: GAO analysis.
[End of table]
[End of section]
Appendix III: Performance of Contractual Plans Compared to Alternative
Investments:
Because of the structure of their sales charges, contractual plans are
not likely to offer superior returns to a long-term investor compared
to other alternative products. Table 1 illustrates that investing $100
per month for 15 years in a contractual mutual fund plan that earns a 7
percent return would result in an account worth less than one in a
conventional mutual fund with a 5 percent sales load in which the same
payments were made and the same projected return was earned. As shown
in the table, the amount that would be accumulated in a contractual
plan does not exceed that of a conventional mutual fund until after 16
years. The contractual plan's accumulated value lags behind the
conventional fund because its high up-front sales charge reduces the
amount of money that is invested and available to earn the return of
the underlying mutual fund from the beginning. In contrast, investing
$100 monthly in TSP and earning a 7 percent return would result in an
account worth $1,600 more than that accumulated in the contractual plan
after 15 years.[Footnote 54]
Table 2: Investment Performance of a $100 Monthly Contribution into a
Contractual Plan, Conventional Mutual Fund, and TSP C Fund, Assuming
Each Earns a 7 Percent Return:
Payment contributions: Policy year: 1;
Payment contributions: Yearly payments: $1,200.00;
Contractual Plan: (50% load): Sales load: $600.00;
Contractual Plan: Total value: $623.24;
Conventional mutual fund (5% load): Sales load: $60.00;
Conventional mutual fund (5% load): Total value: $1,184.16;
Thrift Savings Plan C Fund: (No load): Sales load: $0.00;
Thrift Savings Plan C Fund: Total value: $1,246.49.
Payment contributions: Policy year: 2;
Payment contributions: Yearly payments: 1,200.00;
Contractual Plan: (50% load): Sales load: 0.00;
Contractual Plan: Total value: 1,914.79;
Conventional mutual fund (5% load): Sales load: 60.00;
Conventional mutual fund (5% load): Total value: 2,453.93;
Thrift Savings Plan C Fund: (No load): Sales load: 0.00;
Thrift Savings Plan C Fund: Total value: 2,583.08.
Payment contributions: Policy year: 3;
Payment contributions: Yearly payments: 1,200.00;
Contractual Plan: (50% load): Sales load: 0.00;
Contractual Plan: Total value: 3,299.69;
Conventional mutual fund (5% load): Sales load: 60.00;
Conventional mutual fund (5% load): Total value: 3,815.49;
Thrift Savings Plan C Fund: (No load): Sales load: 0.00;
Thrift Savings Plan C Fund: Total value: 4,016.30.
Payment contributions: Policy year: 4;
Payment contributions: Yearly payments: 1,200.00;
Contractual Plan: (50% load): Sales load: 0.00;
Contractual Plan: Total value: 4,784.72;
Conventional mutual fund (5% load): Sales load: 60.00;
Conventional mutual fund (5% load): Total value: 5,275.47;
Thrift Savings Plan C Fund: (No load): Sales load: 0.00;
Thrift Savings Plan C Fund: Total value: 5,553.13.
Payment contributions: Policy year: 5;
Payment contributions: Yearly payments: 1,200.00;
Contractual Plan: (50% load): Sales load: 0.00;
Contractual Plan: Total value: 6,377.09;
Conventional mutual fund (5% load): Sales load: 60.00;
Conventional mutual fund (5% load): Total value: 6,841.00;
Thrift Savings Plan C Fund: (No load): Sales load: 0.00;
Thrift Savings Plan C Fund: Total value: 7,201.05.
Payment contributions: Policy year: 6;
Payment contributions: Yearly payments: 1,200.00;
Contractual Plan: (50% load): Sales load: 0.00;
Contractual Plan: Total value: 8,084.58;
Conventional mutual fund (5% load): Sales load: 60.00;
Conventional mutual fund (5% load): Total value: 8,519.70;
Thrift Savings Plan C Fund: (No load): Sales load: 0.00;
Thrift Savings Plan C Fund: Total value: 8,968.10.
Payment contributions: Policy year: 7;
Payment contributions: Yearly payments: 1,200.00;
Contractual Plan: (50% load): Sales load: 0.00;
Contractual Plan: Total value: 9,915.50;
Conventional mutual fund (5% load): Sales load: 60.00;
Conventional mutual fund (5% load): Total value: 10,319.75;
Thrift Savings Plan C Fund: (No load): Sales load: 0.00;
Thrift Savings Plan C Fund: Total value: 10,862.90.
Payment contributions: Policy year: 8;
Payment contributions: Yearly payments: 1,200.00;
Contractual Plan: (50% load): Sales load: 0.00;
Contractual Plan: Total value: 11,878.78;
Conventional mutual fund (5% load): Sales load: 60.00;
Conventional mutual fund (5% load): Total value: 12,249.93;
Thrift Savings Plan C Fund: (No load): Sales load: 0.00;
Thrift Savings Plan C Fund: Total value: 12,894.66.
Payment contributions: Policy year: 9;
Payment contributions: Yearly payments: 1,200.00;
Contractual Plan: (50% load): Sales load: 0.00;
Contractual Plan: Total value: 13,983.99;
Conventional mutual fund (5% load): Sales load: 60.00;
Conventional mutual fund (5% load): Total value: 14,319.64;
Thrift Savings Plan C Fund: (No load): Sales load: 0.00;
Thrift Savings Plan C Fund: Total value: 15,073.31.
Payment contributions: Policy year: 10;
Payment contributions: Yearly payments: 1,200.00;
Contractual Plan: (50% load): Sales load: 0.00;
Contractual Plan: Total value: 16,241.38;
Conventional mutual fund (5% load): Sales load: 60.00;
Conventional mutual fund (5% load): Total value: 16,538.97;
Thrift Savings Plan C Fund: (No load): Sales load: 0.00;
Thrift Savings Plan C Fund: Total value: 17,409.45.
Payment contributions: Policy year: 11;
Payment contributions: Yearly payments: 1,200.00;
Contractual Plan: (50% load): Sales load: 0.00;
Contractual Plan: Total value: 18,661.96;
Conventional mutual fund (5% load): Sales load: 60.00;
Conventional mutual fund (5% load): Total value: 18,918.74;
Thrift Savings Plan C Fund: (No load): Sales load: 0.00;
Thrift Savings Plan C Fund: Total value: 19,914.46.
Payment contributions: Policy year: 12;
Payment contributions: Yearly payments: 1,200.00;
Contractual Plan: (50% load): Sales load: 0.00;
Contractual Plan: Total value: 21,257.52;
Conventional mutual fund (5% load): Sales load: 60.00;
Conventional mutual fund (5% load): Total value: 21,470.54;
Thrift Savings Plan C Fund: (No load): Sales load: 0.00;
Thrift Savings Plan C Fund: Total value: 22,600.57.
Payment contributions: Policy year: 13;
Payment contributions: Yearly payments: 1,200.00;
Contractual Plan: (50% load): Sales load: 0.00;
Contractual Plan: Total value: 24,040.71;
Conventional mutual fund (5% load): Sales load: 60.00;
Conventional mutual fund (5% load): Total value: 24,206.81;
Thrift Savings Plan C Fund: (No load): Sales load: 0.00;
Thrift Savings Plan C Fund: Total value: 25,480.86.
Payment contributions: Policy year: 14;
Payment contributions: Yearly payments: 1,200.00;
Contractual Plan: (50% load): Sales load: 0.00;
Contractual Plan: Total value: 27,025.11;
Conventional mutual fund (5% load): Sales load: 60.00;
Conventional mutual fund (5% load): Total value: 27,140.89;
Thrift Savings Plan C Fund: (No load): Sales load: 0.00;
Thrift Savings Plan C Fund: Total value: 28,569.36.
Payment contributions: Policy year: 15;
Payment contributions: Yearly payments: 1,200.00;
Contractual Plan: (50% load): Sales load: 0.00;
Contractual Plan: Total value: 30,225.24;
Conventional mutual fund (5% load): Sales load: 60.00;
Conventional mutual fund (5% load): Total value: 30,287.07;
Thrift Savings Plan C Fund: (No load): Sales load: 0.00;
Thrift Savings Plan C Fund: Total value: 31,881.12.
Payment contributions: Policy year: 16;
Payment contributions: Yearly payments: 1,200.00;
Contractual Plan: (50% load): Sales load: 0.00;
Contractual Plan: Total value: 33,656.71;
Conventional mutual fund (5% load): Sales load: 60.00;
Conventional mutual fund (5% load): Total value: 33,660.69;
Thrift Savings Plan C Fund: (No load): Sales load: 0.00;
Thrift Savings Plan C Fund: Total value: 35,432.30.
Payment contributions: Policy year: 17;
Payment contributions: Yearly payments: 1,200.00;
Contractual Plan: (50% load): Sales load: 0.00;
Contractual Plan: Total value: 37,336.25;
Conventional mutual fund (5% load): Sales load: 60.00;
Conventional mutual fund (5% load): Total value: 37,278.18;
Thrift Savings Plan C Fund: (No load): Sales load: 0.00;
Thrift Savings Plan C Fund: Total value: 39,240.19.
Payment contributions: Policy year: 18;
Payment contributions: Yearly payments: 1,200.00;
Contractual Plan: (50% load): Sales load: 0.00;
Contractual Plan: Total value: 41,281.77;
Conventional mutual fund (5% load): Sales load: 60.00;
Conventional mutual fund (5% load): Total value: 41,157.19;
Thrift Savings Plan C Fund: (No load): Sales load: 0.00;
Thrift Savings Plan C Fund: Total value: 43,323.36.
Payment contributions: Policy year: 19;
Payment contributions: Yearly payments: 1,200.00;
Contractual Plan: (50% load): Sales load: 0.00;
Contractual Plan: Total value: 45,512.52;
Conventional mutual fund (5% load): Sales load: 60.00;
Conventional mutual fund (5% load): Total value: 45,316.61;
Thrift Savings Plan C Fund: (No load): Sales load: 0.00;
Thrift Savings Plan C Fund: Total value: 47,701.69.
Payment contributions: Policy year: 20;
Payment contributions: Yearly payments: 1,200.00;
Contractual Plan: (50% load): Sales load: 0.00;
Contractual Plan: Total value: 50,049.12;
Conventional mutual fund (5% load): Sales load: 60.00;
Conventional mutual fund (5% load): Total value: 49,776.71;
Thrift Savings Plan C Fund: (No load): Sales load: 0.00;
Thrift Savings Plan C Fund: Total value: 52,396.54.
Source: GAO analysis.
Note: If the conventional mutual fund offers breakpoints, which are
discounts on the sales loads to investors who invest certain amounts of
money such as investments over $25,000, the investor would earn even
more with a conventional load fund due to lower sales charges for
investments of that amount.
[End of table]
As table 1 also shows, investors that terminate their periodic
investments earlier than the full 15 years are even more likely to be
better off with a conventional mutual fund or TSP. For example, an
investor ceasing payments after 4 years in the contractual plan would
have an account worth about $4,785. However, after 4 years, the account
of the conventional mutual fund would be worth almost $5,275 and the
TSP account would be worth about $5,553.
[End of section]
Appendix IV: Jurisdictions in Which at Least One of the Six Insurance
Companies That Target Military Members Were Licensed to Sell Insurance:
Alabama;
Missouri.
Alaska;
Montana.
Arizona;
Nebraska.
Arkansas;
Nevada.
California;
New Jersey.
Colorado;
New Mexico.
Connecticut;
North Carolina.
Delaware;
North Dakota.
District of Columbia;
Ohio.
Florida;
Oklahoma.
Georgia;
Oregon.
Hawaii;
Pennsylvania.
Idaho;
Rhode Island.
Illinois;
South Carolina.
Indiana;
South Dakota.
Iowa;
Tennessee.
Kansas;
Texas.
Kentucky;
Utah.
Louisiana;
Virginia.
Maryland;
Washington.
Massachusetts;
West Virginia.
Michigan;
Wisconsin.
Minnesota;
Wyoming.
Mississippi.
Source: NAIC data.
[End of table]
[End of section]
Appendix V: Comments from the Department of Defense:
Office Of The Under Secretary Of Defense:
4000 Defense Pentagon:
Washington, D.C. 20301-4000:
Personnel And Readiness:
Mr. Richard Hillman:
Director:
Financial Markets and Community Investment:
U.S. Government Accountability Office:
441 G Street, NW:
Washington, DC 20548:
Dear Mr. Hillman:
This is the Department of Defense (DoD) response to the GAO draft
report, GAO-06-23, "FINANCIAL PRODUCT SALES: Actions needed to Better
Protect Military Members," dated September 29, 2005 (GAO Code 250166).
The Department's responses to the report's two recommendations are
enclosed.
Sincerely,
Signed by:
Gail H. McGinn:
Performing the Duties of the Principal Deputy:
Enclosure:
As stated:
GAO DRAFT REPORT DATED SEPTEMBER 29, 2005 GAO-06-23 (GAO CODES 250166):
"FINANCIAL PRODUCT SALES: Actions Needed to Better Protect Military
Members"
DEPARTMENT OF DEFENSE COMMENTS TO THE GAO RECOMMENDATION:
RECOMMENDATION 1: The GAO recommended that the Secretary of Defense
revise the DoD solicitation policy to require that information on
servicemember complaints related to financial product sales be provided
to relevant state and federal financial regulators.
DOD RESPONSE: Concur. Existing DoD policy requires installations to
report matters concerning the eligibility of an agent or company to
hold a State license or to meet other regulatory requirements to
appropriate authorities. The revised Directive will include a
requirement for installations to report concerns or complaints
involving the quality or suitability of financial products and concerns
or complaints involving marketing methods used to sell these products
to DoD personnel to the appropriate regulatory agency. ECD: January 1,
2006:
RECOMMENDATION 2: The GAO recommended that the Secretary of Defense
include in the personal financial management training for all
servicemembers information and materials developed in conjunction with
insurance and securities regulators that explains how and to whom
servicemembers should raise concerns or complaints about potentially
inappropriate sales of financial products, including providing the
information necessary for contacting these regulators. Such training
should also periodically be offered to servicemembers of all levels.
DOD RESPONSE: Concur. DoD Instruction 1342.17 on Personal Financial
Management Programs for Service Members, requires all entry-level
Service members be able to demonstrate competency on several topics
concerning personal finance, to include insurance, savings and
investing. DoD has developed a strategic plan to develop programs and
systems designed to assist them in becoming capable of discerning what
is appropriate and inappropriate for their needs and how to remedy
concerns or complaints arising from suspect sales of financial
products. An important aspect of the proposed approach will be
evaluating their competency to ensure the intended lesson has been
learned. DoD Instruction 1342.17 further instructs the Military
Services to make information and instruction available to support the
life events of Service members and their families. The intent of this
policy is to support Service members and their families in making
decisions affecting their personal finances as their individual/family
circumstances change, based on the basic competencies obtained at entry
level. DoD has obtained the assistance of several federal agencies and
nonprofit organizations in accomplishing this information and education
requirement, to include the National Association of Securities Dealers
Foundation. As part of this on-going effort, DoD will approach state
regulatory agencies to assist in providing awareness and educational
materials to assist in making Service members and their families aware
of their rights and opportunities to seek remedy. Among other
opportunities for increasing awareness, installation-level new comers
orientations and the Military OneSource toll free assistance line will
be used to enhance awareness and direct Service members and their
families to assistance resources. ECD June 30, 2006:
[End of section]
Appendix VI: Comments from the Securities and Exchange Commission:
United States Securities And Exchange Commission:
Washington, D.C. 20549:
Office Of Compliance Inspections And Examinations:
October 20, 2005:
Richard J. Hillman:
Director, Financial Markets and Community Investment:
United States Government Accountability Office:
Washington, DC 20548:
Dear Mr. Hillman:
Thank you for the opportunity to comment on your draft report
concerning Financial Product Sales, Actions Needed to Better Protect
Military Members. We share your concerns that securities products be
properly marketed and sold to members of the military. As your report
describes, SEC examinations and enforcement investigations have
revealed unsuitable sales of financial products to members of the
military. As a result, the SEC and the NASD brought an enforcement
action against First Command Financial Planning, Inc. (Admin. Proc.
File No. 3-11770). The SEC staff has also established ongoing contact
with the Department of Defense, and initiated two examination sweeps
focusing on broker-dealer firms that sell securities products to
military personnel and that maintain sales offices located near large
military facilities. These examinations are ongoing.
We wish to emphasize the level of productive cooperation in our
dealings with personnel in the Department of Defense. Staffs of the SEC
and Department of Defense have established regular meetings to share
information and discuss issues as they relate to securities sales to
the military. As part of this cooperation, Department of Defense staff
has provided us with key information that has helped us target
particular securities firms for examination. This cooperation has also
extended to base commands, including overseas base commands. Finally,
Department of Defense and base staff have been working with us to
identify complaints regarding abusive securities sales and to establish
procedures whereby future complaints can be brought directly to our
attention.
Your report also recommends that, in the event that contractual mutual
funds are not banned by Congressional action, the SEC and NASD consider
various means of better ensuring that regulators have adequate
information to assess the sales of contractual plans. We will certainly
consider this recommendation.
We appreciate the GAO's attention to these important issues.
Sincerely,
Lori A. Richards:
Director:
[End of section]
Appendix VII: Comments from NASD (Formerly Called the National
Association of Securities Dealers):
Robert R. Glauber:
Chairman and Chief Executive Officer:
October 18, 2005:
The Honorable David M. Walker:
Comptroller General of the United States:
U.S. Government Accountability Office:
441 G Street NW:
Washington, DC 20548:
Dear Mr. Walker:
NASD appreciates the opportunity to comment on GAO Report 06-23,
"FINANCIAL PRODUCT SALES: Actions Needed to Better Protect Military
Members." Men and women of the U.S. armed forces deserve the same
protection from inappropriate sales of financial products as their
civilian counterparts. This report will help NASD, other financial
regulators, and Congress ensure that such is the case. In addition to
the technical comments we have already provided, NASD would like to
make the following more general comments.
Background on NASD:
NASD is the leading private-sector provider of financial regulatory
services, dedicated to investor protection and market integrity through
effective and efficient regulation and complementary compliance and
technology-based services. NASD touches virtually every aspect of the
securities business - from registering and educating all industry
participants, to examining securities firms, enforcing both NASD rules
and the federal securities laws, and administering the largest dispute
resolution forum for investors and member firms.
Summary of First Command Investigation and Settlement:
In December 2004, NASD censured First Command Financial Planning Inc.,
a Fort Worth, TX broker-dealer, and imposed a fine of $12 million for
making misleading statements and omitting important information when
selling mutual fund investments. In particular, the misleading
statements and omissions were made in connection with Systematic
Investment Plans sold primarily to commissioned and non-commissioned
military officers. Under Systematic Investment Plans, an investor makes
monthly payments for a fixed term, typically 15 years, and those
payments are invested in underlying mutual funds. The purchaser is
charged a 50 percent sales load on the first twelve payments. Over the
remainder of the term, payments are not subject to sales charges so
that the effective sales charge decreases so long as the purchaser
continues to make additional investments. However, if the investor does
not terminate within 45 days, and then fails to complete the term, he
or she will pay a sales charge of up to 50 percent of the amount
invested.
NASD found that First Command emphasized in its sales scripts that the
50 percent sales load would decrease to 3.3 percent upon completion of
the term and that the high up-front sales charges increased the
likelihood that an investor would complete the plan. However, the
firm's own data showed that only 43 percent of its customers completed
the 15-year term. First Command also failed to inform its customers of
the lost earnings potential as a result of the sales charges deducted
from the customer's first 12 months' investments. First Command also
made misleading statements when comparing the Systematic Investment
Plan with other mutual fund investments.
From the $12 million fine, First Command was ordered to pay restitution
to thousands of customers who purchased a Systematic Investment Plan
after January 1, 1999 and who terminated the plan and paid an effective
sales charge greater than 5 percent. As of today, over $4.3 million has
been returned to this class of customers. The remainder of the $12
million dollar payment, after restitution payments have been completed,
is payable to the NASD Investor Education Foundation, to be used for
financial education needs of United States military personnel and their
families. In addition to making these payments, First Command was
required to hire an independent consultant to oversee the payment of
restitution and review its sales practices.
NASD would like to comment on the statement in the report that
"financial regulators did not identify the problems occurring with
sales to military members until they were brought to light by press
reports for various reasons." As the report notes, securities
regulators including NASD often rely on customer-initiated complaints
to undertake investigations and enforcement actions. In this case, NASD
began investigating potential misconduct by First Command and its
representatives in August of 2003, immediately after an article about
First Command appeared in Kiplinger's and before receiving any
complaints from military personnel or the Department of Defense about
investment products sold by First Command. NASD initiated this
investigation well before a series of articles was published in the New
York Times in July 2004 regarding sales of insurance products and
securities products to military personnel.
Summary of Military Financial Education Campaign:
First Command has made payments to the NASD Investor Education
Foundation, to be used for the financial education needs of members of
the military and their families. Established in 2003, the NASD Investor
Education Foundation supports innovative research and educational
projects that give investors the tools they need to better understand
the markets and the basic principles of saving and investing. To date,
the Foundation has granted more than $5 million to non-profit
organizations for educational programs and research projects targeting
underserved segments of the population.
The Foundation is using the funds it receives in connection with the
First Command settlement to support educational programs, materials and
research to help equip members of the military community with the
knowledge and skills necessary to make informed financial decisions. We
anticipate that the Foundation will receive approximately $7 million.
These funds will be used to mount a comprehensive financial education
program with the goal of improving the saving and investing knowledge
of military families. This will include a Web site devoted to financial
education issues for the military, a continuing investor education
program for base installation personal financial managers, financial
counselor certification for military spouses, and development of
materials such as a guide to the financial decisions surrounding
deployments. Beginning early next year, the Foundation will hold
investor forums and other educational events at three or more primary
military installations, at which specially prepared educational
materials will be distributed. As the year progresses, this will be
supplemented by events and activities at installations across the
country. Not only does the Foundation intend to educate active duty
military personnel, it intends to provide organizational and technical
assistance targeted to spouses and military family service
organizations so that financial education can be provided on an ongoing
basis to future personnel. Finally, all military installations will
receive materials to help them organize their own financial education
events and provide guidance for distributing investor education
information. Public service announcements regarding the importance of
saving and investing, on media outlets that serve military personnel in
the United States and overseas, will supplement this effort.
Conclusion:
NASD appreciates the diligence with which the GAO has researched and
prepared its report. We are confident that the recommendations made to
Congress and to financial regulators will help ensure that military
personnel receive the level of protection they deserve as investors.
NASD is committed to that goal and to providing them and all investors
with the tools necessary to make informed investment decisions.
Sincerely,
Signed by:
Robert R. Glauber:
Chairman and Chief Executive Officer:
[End of section]
Appendix VIII: Comments from the National Association of Insurance
Commissioners:
NAIC:
National Association Of Insurance Commissioners:
October 19, 2005:
Mr. Richard Hillman:
Managing Director:
Financial Markets and Community Investment:
U.S. Government Accountability Office:
Room 2A28:
441 G Street, N W:
Washington, DC 20548:
Dear Mr. Hillman:
Thank you for the opportunity to comment on the proposed report titled
"Financial Product Sales: Actions Needed to Better Protect Military
Members." State insurance regulators believe military personnel should
be afforded the highest level of consumer protection when purchasing
insurance. To this end, the NAIC would like to address the matters for
congressional consideration and recommendations.
The first matter for congressional consideration directs states to
review currently approved products that are being marketed primarily to
military members to ensure that all such product provisions are in
compliance with existing state laws. As the GAO report points,
thousands of junior military personnel have purchased a product that
combines life insurance with a savings fund promising high returns. In
recognition of this issue, the NAIC's Life Insurance & Annuities (A)
Committee has established the following proposed charge for 2006:
Review life insurance sold with a side fund to recommend a position on
the products being offered in the marketplace.
In addition, a number of states are actively examining the small number
of companies that have engaged in questionable marketing practices
involving these products.
Another matter for congressional consideration is for state insurance
regulators to have full access to persons and information necessary to
oversee the sales taking place on military installations. State
insurance departments can take corrective action sooner rather than
later if timely and complete information is available for review.
Coupled with this consideration is the congressional consideration that
the U.S. Department of Defense (DoD) and insurance regulators work
cooperatively to develop mechanisms to share information about
insurance activities. Since becoming aware of the sales issues to
military personnel, state insurance regulators have reached out to the
DoD. Diane Koken, the NAIC President, has made two personal visits with
the DoD and continues to foster a relationship of ongoing cooperation
with the DoD. More specifically, the NAIC is in the process of
accomplishing the following: (1) compiling a list of insurance
department contacts for the DoD to ensure the DoD has the proper
contact information for further state assistance; (2) updating the
NAIC's Complaint Database System (CDS) form to identify complaints that
are submitted by military personnel; and (3) providing the DoD with a
state-by-state premium volume summary for those companies that state
insurance regulators know are soliciting or have solicited insurance
products on military bases.
The NAIC also notices that the final recommendation of the report is
for the DoD and state insurance regulators to work cooperatively to
develop financial management training materials for military personnel.
To this end, the NAIC, in conjunction with the DoD, developed a
consumer brochure specifically addressing life insurance information
for military personnel. The NAIC also developed the following Web link
for military personnel [Hyperlink
http://www.naic.org/consumer_military_insurance.htm] and is working
with the DoD to update this Web link, as needed. Not only does this Web
link contain information on life insurance, this Web link also contains
information about other lines of insurance and how to electronically
file a complaint with a state insurance department. Moving forward, the
NAIC remains committed to working with the DoD to develop other
insurance consumer brochures, which the DoD believes are necessary to
fill any financial literacy needs of military personnel.
Finally, state insurance departments already have strong prohibitions.
against misleading and deceptive sales practices and will continue to
enforce these prohibitions when inappropriate activity is identified.
Again, we appreciate the opportunity to comment on the draft report and
provide an update on the activities of state insurance regulators.
Please do not hesitate to contact us if we can be of further
assistance.
Sincerely,
Signed by:
Catherine J. Weatherford:
Vice President and Chief Executive Officer:
Attachment:
[End of section]
Appendix IX: GAO Contact and Staff Acknowledgments:
GAO Contact:
Richard J. Hillman (202) 512-8678:
Staff Acknowledgments:
In addition to the individual above, Cody Goebel, Assistant Director;
Joseph Applebaum; Gwenetta Blackwell-Greer; Tania Calhoun; Rudy
Chatlos; Lawrence Cluff; Barry Kirby; Marc Molino; Josephine Perez;
David Pittman; and Amber Yancey-Carroll made key contributions to this
report.
(250166):
FOOTNOTES
[1] We also obtained information, including complaints and other
alleged problems, involving insurance product sales at six additional
military installations as part of a separate review. See GAO, Military
Personnel: DOD Needs Better Controls Over Supplemental Life Insurance
Solicitation Policies Involving Servicemembers, GAO-05-696 (Washington,
D.C.: June 29, 2005).
[2] Richard Buddin and D. Phuong Do, Assessing the Personal Financial
Problems of Junior Enlisted Personnel, RAND Corporation, 2002.
[3] The report's data on civilians were drawn from the 1996 Panel Study
of Income Dynamics, which was a nationally representative sample of
1,465 individuals. The survey is longitudinal and has been conducted
annually since 1968. To be comparable to the military junior enlisted
population, the authors excluded civilians who were full-time students
or over the age of 40. The report's data on military members came from
two surveys of military personnel. The first survey was a random sample
of 6,200 enlisted members with 10 or less years of service conduct in
1997. This survey explored various dimensions of the reenlistment
decision for junior enlisted personnel. The second survey was a 1999
random sample of enlisted and officer personnel in all service
branches. This survey included about 36,000 respondents but this report
analyzed the 8,000 respondents who were enlisted personnel with 10 or
less years of military service.
[4] GAO, Military Personnel: Longer Time between Moves Related to
Higher Satisfaction and Retention, GAO-01-841 (Washington, D.C.: Aug.
3, 2001).
[5] D.R. Segal and M.W. Segal, "America's Military Population,"
Population Bulletin, vol. 59, no. 4 (Dec. 2004).
[6] The increase in coverage and various death payments was included in
the Emergency Supplemental Appropriations Act for Defense, the Global
War on Terror, and Tsunami Relief, for the Fiscal Year Ending September
30, 2005, Pub. L. No. 109-13, sec. 1012 (May 11, 2005). This bill also
increased the death gratuity paid upon a service member's death from
$12,000 to $100,000 under certain circumstances. Some of the increases
were made retroactively to October 1, 2001.
[7] Although insurance is generally exclusively regulated by state
entities, some products offered by insurance companies are overseen by
other regulators. For example, variable life insurance may be
considered an investment vehicle due to the ability of the policy owner
to direct the cash values or accumulation funds into various investment
instruments. Unlike the other life insurance products, the variable
life insurance product may have a dual regulatory enforcement; the life
insurance portion regulated by the insurance regulator and the
investment portion (cash value) regulated by securities regulators.
[8] Loads that mutual funds impose at the time of purchase (other than
through reinvestment of dividends or capital gains) are called
"frontend loads." Some funds also offer classes of shares that impose
contingent "deferred sales loads", which an investor may pay at the
time the shares are sold. Such deferred sales loads decline and
eventually disappear depending on how long an investor holds the
shares.
[9] GAO, Military Personnel: More DOD Actions Needed to Address
Servicemembers' Personal Financial Management Issues, GAO-05-348
(Washington, D.C.: Apr. 26, 2005).
[10] GAO-05-696.
[11] Military Personnel Financial Services Protection Act, H.R. 458,
109th Congress (2005).
[12] Military Personnel Financial Services Protection Act, S. 418,
109th Congress (2005).
[13] Contractual plans are legal investments referred to and regulated
as "periodic payment plans" under Section 27 of the Investment Company
Act of 1940. These plans allow investors to accumulate shares of a
specified mutual fund indirectly by contributing a fixed amount of
money on a regular basis for a specified period usually ranging between
10 and 20 years. An investor in a contractual plan does not directly
own shares of a mutual fund. Instead, he or she owns an interest in the
plan trust. The plan trust invests the investor's regular payments,
after deducting applicable fees, in shares of a mutual fund. An
investor in a plan has a beneficial ownership interest in those shares.
For purposes of this report we refer to these plans as "contractual
plans."
[14] Companies interested in selling insurance products on military
installations overseas are required to apply to DOD each year for
permission through its Overseas Life Insurance Accreditation Program.
In order to gain authorization to conduct business in overseas
installations, companies are to demonstrate continuous successful
operation in the life insurance business for at least five years and
must be assigned an acceptable rating from a private organization that
assesses insurance company financial soundness.
[15] Information on current rates obtained from The New York Times
Business Section. The New York Times uses interest data provided by
http://www.bankrate.com.
[16] While in the service, a service member can purchase SGLI and
contribute to the TSP. If a service member leaves, he or she may elect
to purchase VGLI and can either leave any accumulated savings in TSP,
withdraw the money from TSP, or roll over the TSP balance into a
similar savings instrument, such as an individual retirement account.
In addition, we used the low risk TSP G Fund for this calculation
because it invests in interest bearing securities and thus was
comparable to the interest earning products offered by these insurance
companies.
[17] End of year balance is the money accumulated in the fund during
the policy year ending on the policy's anniversary date.
[18] Diana B. Henriques, "Basic Training Doesn't Guard Against
Insurance Pitch to G.I.'s," New York Times, July 20, 2004 and "Insurers
Rely on Congress to Keep Access to G.I.'s," New York Times, July 21,
2004.
[19] LIMRA International/Society of Actuaries, Individual Life
Insurance Persistency Study: Preliminary Results, (March 2005).
[20] Section 3(a)(8) of the 1933 Securities Act exempts from securities
registration any "insurance policy" or "annuity contract" issued by a
corporation subject to the supervision of an insurance commissioner,
bank commissioner, or similar state regulatory authority.
[21] Another important factor is the allocation of investment risk
between insurer and contract owner.
[22] Complaint, United States v. Academy Life Insurance Co., U.S. Dist.
Ct., E.D. Pa., Civil Action No. 02-9125 (Dec. 19, 2000).
[23] Settlement Agreement, United States v. Academy Life Insurance Co.,
U.S. Dist. Ct., E.D. Pa., Civil Action No. 02-9125 (Dec. 10, 2002).
[24] See http://www.commanderspage.dod.mil/dav/lsn/LSN/
BINARY_RESOURCE/BINARY_CONTENT/1827481.pdf.
[25] DOD, Commercial Life Insurance Sales Procedures in DOD, DOD Office
of the Inspector General Report No. 99-106 (Arlington, VA: Mar. 10,
1999).
[26] DOD, Final Report: Insurance Solicitation Practices on Department
of Defense Installations, Office of the Under Secretary of Defense for
Personnel and Readiness (Washington, D.C. May 15, 2000).
[27] Under the contractual payment plans commonly sold in the military
market, the investor is to pay 180 fixed monthly installments (15
years), which may be extended to 300 payments (25 years) at the
investor's option with no additional sales charge.
[28] Many mutual funds that are sold with sales charges or loads offer
discounts to investors who invest certain amounts of money. As such, if
an investor continues to invest in a conventional mutual fund over
time, eventually the sales charge percentage of that fund will decrease
as the total initial investments reach a certain amount, such as
$25,000 or $50,000.
[29] The study identified 98 companies offering S&P 500 index funds.
See Investment Company Institute, "Are S&P 500 Index Mutual Funds
Commodities?" Perspective Vol. 11 No. 3 (August 2005).
[30] SEC, Public Policy Implications of Investment Company Growth, H.R.
Rep. No. 2337, 89th Cong., 2d Sess. (1966).
[31] Pub. L No. 91-547 §16, codified at 15 USC §80a-27(d).
[32] S. 418, Sec. 3, and H.R. 458, Sec. 102.
[33] GAO, Insurance Regulation: Common Standards and Improved
Coordination Need to Strengthen Market Regulation, GAO-03-433
(Washington, D.C.: Sept. 30, 2003).
[34] NASD Rule 2310, Recommendations to Customers (Suitability), states
that in recommending to a customer the purchase, sale, or exchange of
any security, a broker-dealer is required to have "reasonable grounds
for believing that the recommendation is suitable for such customer
upon the basis of the facts, if any, disclosed by such customer as to
his other security holdings and as to his financial situation and
needs." For example, recommending a product that poses a high risk of
loss to an investor on a limited income could represent an unsuitable
recommendation.
[35] In an annuity contract, an insurer agrees to make a series of
payments for a specified period or for the life of the contract holder,
providing insurance against the possibility that the contract holder
will outlive his or her assets during the period covered under the
contract.
[36] To become IMSA-qualified, an insurance company must conduct a self
assessment of its ability to comply with IMSA's market conduct
standards, which is reviewed by a Qualified Independent Assessor
authorized to conduct an independent assessment of the company's
policies and procedures on behalf of IMSA. A company must undergo the
self and independent assessment every 3 years in order to retain its
IMSA qualification.
[37] S. 418, Sec. 9, and H.R. 458, Sec. 108.
[38] GAO-05-696.
[39] GAO-05-348.
[40] See Maryland Insurance Administration Market Conduct Examination
Report of Life and Health Business, Report No. 490-01 (Baltimore, MD:
Jan. 25, 2002).
[41] Tom Lauricella, "Some Military Investors Bear a Heavy Load" The
Wall Street Journal, C.1. (New York, N.Y.: Nov 27, 2002).
[42] Steven T. Goldberg, "Funds: A Marketer is Selling funds with Sky
High Fees to Military Personnel," Kiplinger's Personal Finance, Volume
57, No. 9, p. 53 (Sept. 2003).
[43] S. 418, Sec. 11, and H.R. 458, Sec. 110.
[44] S. 418, Sec. 10, and H.R. 458, Sec. 109.
[45] GAO, Credit Reporting Literacy: Consumers Understood the Basics
but Could Benefit from Targeted Educational Efforts, GAO-05-223
(Washington, D.C.: Mar. 16, 2005).
[46] GAO-05-348.
[47] S. 418, Sec. 8, and H.R. 458, Sec. 107.
[48] S. 418, Sec. 8(b)(4), and H.R. 458, Sec. 107(b)(4).
[49] When used in connection with an area of land, the term
"legislative jurisdiction" means the authority to legislate and to
exercise executive and judicial powers within that area. The federal
government holds land under varying degrees of legislative
jurisdiction, including "exclusive" legislative jurisdiction, where the
state's ability to enforce its laws and regulations is extremely
limited. The type of existing legislative jurisdiction over military
installations may vary depending on when and how specific tracts of
land were acquired.
[50] GAO 05-696.
[51] S. 418, Sec. 6(a), and H.R. 458, Sec. 105(a).
[52] NASAA is a voluntary association representing 67 state,
provincial, and territorial securities administrators in the 50 states,
the District of Columbia, Puerto Rico, the U.S. Virgin Islands, Canada,
and Mexico.
[53] See GAO-05-696.
[54] For projected return rates of below 7 percent, the amount earned
on the contractual fund plan would exceed that of the regular 5 percent
load fund sooner, but for returns of greater than 7 percent, the
contractual plan would require more than 15 years to exceed the 5
percent load fund's accumulated amount. Because TSP does not charge
sales charges, its accumulated amounts would always exceed those of the
other two investments by increasingly larger increments as the
projected return rates are increased. We used TSP C Fund for this
calculation because it invests in common stocks and was therefore
comparable to the contractual plan product.
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