Insurer Says Its Annuities Face Inquiry By Regulators
By JOSEPH B. TREASTER
The New York Times
January 31, 2004
Insurer Says Its Annuities Face Inquiry By Regulators In the first action against an insurance company in a sweeping investigation of variable annuities trading, federal and state regulators have prepared a case against Conseco, asserting that the insurer provided advantages to big investors that could increase profits but hurt small investors, the company acknowledged yesterday.
Through a spokesman, Conseco, the formerly highflying insurance and finance company that came out of bankruptcy protection in September, confirmed that it was confronting ''a potential enforcement action'' but that it thought it had ''violated no federal or state law.'' The spokesman, Jim Rosensteele, declined to elaborate.
In a Securities and Exchange Commission filing to inform shareholders of the investigative development, Conseco said the regulators were asserting that the Conseco Variable Insurance Company, a former subsidiary of Conseco that was sold in late 2002, had permitted some investors to make frequent trades in variable annuities in response to market-moving events while the majority of its customers were restricted or discouraged from doing so.
The practice, known as market timing, has resulted in hundreds of millions of dollars in fines and restitution payments for many mutual fund companies over the last several months.
Yesterday, federal and state regulators revealed that they had broadened the mutual fund investigation into the field of variable annuities, a combination of insurance and mutual funds that is the fastest-growing product in the insurance industry.
The regulators said they were investigating scores of insurance companies and brokerage companies that sold variable annuities.
Conseco is the first insurance company singled out for potential enforcement action that could lead to heavy fines and other penalties. Conseco was in the mid-ranks of variable annuities companies in the country, with estimated annual sales of more than $800 million.
Officials of the Securities and Exchange Commission and the New York State attorney general's office would not comment on Conseco. But federal and state officials said on Thursday that their investigations into the insurance industry were focusing on market timing, and officials said yesterday that evidence that a company permitted market timing would probably lead to charges of fraud.
In its filing with the S.E.C., Conseco said it had ''received telephonic notification'' that Eliot Spitzer, the New York attorney general, was preparing a case ''regarding alleged market timing'' by investors in variable annuities sold by its former subsidiary. The company said it was notified that similar action was being taken by the Securities and Exchange Commission in what is known as a Wells notice. People briefed on the investigation said the notification took place about two weeks ago.
Mr. Rosensteele, the company spokesman, said through an e-mail message sent by an aide that ''the filing speaks for itself.''
Stephen M. Cutler, the chief of enforcement at the S.E.C., said that one insurance company had been notified that a case was being prepared against it, but he would not name the company. Other officials at the commission and at the state attorney general's office declined to discuss the investigation, but people who have been briefed on it confirmed that a case had been prepared against Conseco.
Under S.E.C. procedures, investigators notify companies that a case has been prepared against them and they are given an opportunity to present arguments and documents in their defense. Then the case is taken to the commission's board for a final decision on filing formal charges.
''In the notice, we say, 'We are prepared to recommend an enforcement action against you and this is what we are recommending, this is what you are being charged with and this is your chance to speak up,''' one S.E.C. official said. ''This is your opportunity to produce exculpatory or explanatory documents before the commission votes to proceed with the enforcement action.''
Through a string of acquisitions, Conseco grew to become one of the country's biggest life and health insurance companies, catering to low- and middle-income customers. The National Association for Variable Annuities says that nearly 70 percent of the investors in variable annuities have holdings in the funds of $100,000 or less. Most of the investors are older Americans, saving for retirement.
Spokesmen for insurance industry trade groups declined to comment on the allegations against Conseco.
''I would really need to see the specifics of what is being charged as well as any response by the company,'' said Michael P. DeGeorge, the general counsel of the National Association for Variable Annuities.
Jack Dolan, a spokesman for the American Council of Life Insurers, said that ''as a matter of policy, we do not discuss issues involving any particular company.''
In an interview on Thursday, Mr. DeGeorge said that after the investigations into mutual funds, it was not surprising that federal and state investigators had begun scrutinizing the variable annuity business. ''We think the widening or broadening of the investigation is really a natural progression by the commission and others looking into this problem,'' he said.
Market timing is not strictly illegal but regulators say they regard it as a form of fraud that gives special advantages to select investors. Either as a matter of contract or general practice, they said, investors are restricted or discouraged from frequent trading in variable annuities, just as they are in most mutual funds. But insurance companies and brokerage houses sometimes make exceptions for big investors to attract or retain their business, which can run into the tens of millions of dollars.
The insurance companies and brokers do this because they receive fees based on the size of investments: the bigger the investment, the bigger the fee.
When big investors buy one day and sell the next to make a quick profit, they drain money from the fund, reducing the earnings of all the other participants. The frequent trading also increases transaction costs that are shared by all the members.
Another negative consequence of market timing is that it disrupts the management of a fund. Recognizing that market trading is going on, fund managers keep on hand more cash than they would otherwise so that they can pay profits on the short-term trades. As result, they have less money available to invest in stocks that they hope will enhance the overall performance of the fund.