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300 Day Hill Road Windsor, CT 06095 www.limra.com/compliance Issue 2011-2 Bimonthly
LIMRA Regulatory Review ADVANTAGE IN AREGULATORY WORLDBroker-Dealer
Investment Adviser
Insurance
Research
Whats Next in Broker-DealerCompensation Transparency?
United States
(This article is the second in a series
on compensation disclosures. The
first, titled An Emerging Trend:
Increased Producer Compensation
Transparency, can be found at:
http://www.limra.com/newsletters/
LRR/LRR_Newsletter_2010-6c.pdf.)
FINRA published a concept proposal
requesting comment last October
(see http://www.finra.org/web/
groups/industry/@ip/@reg/@notice/documents/notices/p122361.pdf).
This proposed rule would require
firms, at or prior to commencing a
business relationship with a retail
customer, to provide a written
statement that describes the types of
accounts and services they provide.
Firms would also be required to
disclose any conflicts associated
with such services. Although a new
standard of care or fiduciary standardfor broker-dealers is not yet in effect,
this new disclosure rule would figure
prominently in such an environment
and the disclosure would certainly
accomplish much of what might
be required under such a standard.
It is useful then to examine how
firms should react to this proposal
and begin the task of creating an
inventory of potential conflicts that
would be disclosed at the onset of any
client relationship.
All firms pay and receive
compensation this is not news.
They all provide, as would any sales
organization, incentives to managers,
producers, and third-party firms with
which they do business to grow sales,
increase revenue, attract more clients,
and provide good service. Clientsunderstand this at a basic level;
but, what clients understand less is
that firms may be paid in multiple
ways, or paid more for selling some
products over others, or paid under
complex formulas that even some of
the recipients dont fully understand
until all the variables are known. The
concern here is that some of these
practices present the real possibility
of conflicts of interest. In FINRAsview these conflicts, if known, might
change what the client ultimately
decides to buy or even from which
firm or representative they chose to
buy it. The problem is how to explain
the conflicts. They may or may not be
familiar constructs or concepts that
are easily described in terms clients
would understand.
This complimentary newsletter
addresses current regulatoryconcerns around the world and
provides broker-dealers, investment
advisers, and insurance companies
with tips and suggestions for
meeting regulatory obligations.
IN THIS ISSUE
United States
Whats Next in Broker-DealerCompensation Transparency?
FINRA Says to Report
Non-Securities Complaints Know Your Customer: How a
New Generation of SoftwareHelps Advisors to Identify theRight Solutions for Retirees
ERISA Compliance: AnOverview of New Challengesand Opportunities
Life Settlements: HowLong Should Investors WaitBefore Purchasing LifeInsurance Policies?
April 2011
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LIMRA SPOTLIGHT
2 www.limra.com/compliance 2011, LL Global, Inc.
SEMINAR
Social Media for Financial ServicesAugust 2426, 2011Cambridge, MAThis seminar will help your company take itssocial media eorts to the next level whilemeeting regulatory requirements. Presentationsand panel discussions by industry leadersand social media experts, plus specialbreakout sessions, will optimize your learningexperience. To learn more and register, pleasevisit us online. http://www.limra.com/Events/eventdetail.aspx?id=1074
NOTABLE
Help Producers to Leverage Social Mediaand Stay in ComplianceLIMRA and Socialware have teamed to
create Insights: Advisor Series, an always-current curriculum that helps producers growsales and protects your frm. Coursesalready available include Social Media 101,Compliance Basics, LinkedIn, Twitter, andFacebook. For more inormation, please contactMeggan Tuveson at [email protected].
Cost-Effectively Meet the NAICs Suitabilityin Annuity Transactions Model RegulationLIMRAs new AnnuityXT training program andCompliance Suitability Survey can help you
to: (1) ensure that producers complete basicsuitability and product-specifc annuity trainingbeore recommending an annuity product;(2) monitor sales; and (3) share fndings withdistribution partners. For more inormation orto see a demo o the new AnnuityXT trainingsystem, please contact Meggan Tuveson at860-285-7859 or [email protected].
The real challenge, then, is not what to disclose anyone can
compile a comprehensive, detailed legal document that is so lengthy
no one reads it, (today most of us call that a prospectus) but
how to do it. The objective is to explain it in sufficient detail so the
client understands the products, why they are being recommended,
and their impact on the client. The goal is to do so in a manner that
makes sense to consumers and gives them enough information to
compare firms and decide if the advice or recommendation is truly
impartial. This is an aggressive goal for a brief written document. Infact, FINRA suggests that firms consider new ways including, where
appropriate, web-based tools to provide easy ways for clients and
prospective clients to drill down and find the disclosure that is most
likely to interest them or which best explains how it may impact their
individual dealings with the firm or representative.
The good news here is the regulator is not saying they already have a
view of what the right way to do this might be, or that the myriad
ways compensation and revenue can flow, for very legitimate reasons,
are all necessarily bad. FINRA is not painting all revenue or com-
pensation as improper, but instead asks the firm to expose to clients
how the compensation may impact the firm or representative so thatclients are making decisions in full awareness of who benefits, and
how. FINRA is looking for firms to help them figure out the right
combination of how to capture investors attention up front; how to
provide the needed detail; and how to use brief but effective point-
of-sale disclosures to remind customers of the questions they should
ask their advisor or firm before they act on a recommendation. The
resulting document or website would begin a discussion with clients;
one that differs significantly different from any earlier discussions. So,
how can firms prepare for this new era of disclosure while also under-
standing what might be needed under a fiduciary standard of care?
A first step is to create an inventory or grid of the firms activities.Then, for each activity, identify the sources of revenue. Revenue
might be categorized by product or service, types of compensation,
commission, stock options, reward or recognition incentive plans,
benefit programs, and producer support programs that may be tied to
compensation or product sales, or volumes of sales of certain types of
assets or products.
Ask the following questions about how your firm provides solutions
to clients, and consider each element of compensation to determine
how this might impact what gets sold.
1. Does our compensation promote recommending one product
over another or one group of products or asset classes more
than another?
2. Do we limit the sale of some products either due to lack of a
selling agreement or for competitive reasons? Firms may not
offer all products of a certain class or type and that it or its
affiliates may be the sponsor or originator of certain products
or proprietary products. A firm may, in some cases, also act as a
distributor or placement or sales agent for a fee from the issuer or
sponsor of the product.
CONTACT USTo subscribe to LIMRA Regulatory Review or read
previous issues, please visit us online.
To suggest article topics or request article reprints:
Stephen [email protected]
http://www.linkedin.com/in/stephenselby
Follow LIMRA Compliance and Regulatory Services
on Twitter at http://twitter.com/limra_crs.
For more information about LIMRAs services:
LIMRA Compliance and Regulatory Services300 Day Hill Road, Windsor, CT 06095
Phone: 877-843-2641Email: [email protected] site: www.limra.com/compliance
mailto:[email protected]?subject=Insights:%20Advisor%20Seriesmailto:[email protected]?subject=Insights:%20Advisor%20Seriesmailto:[email protected]?subject=Insights:%20Advisor%20Seriesmailto:[email protected]?subject=AnnuityXThttp://www.limra.com/Compliance/LRR.aspxmailto:[email protected]://www.linkedin.com/in/stephenselbyhttp://twitter.com/LIMRA_CRSmailto:[email protected]://www.limra.com/compliancemailto:[email protected]?subject=Insights:%20Advisor%20Serieshttp://www.limra.com/compliancemailto:[email protected]://twitter.com/LIMRA_CRShttp://www.linkedin.com/in/stephenselbymailto:[email protected]://www.limra.com/Compliance/LRR.aspxmailto:[email protected]?subject=AnnuityXT -
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3. Are similar products available to the same client
through this producer, and are there products for
which we dont offer this incentive or compensation
to producers?
4. Is this compensation commonly paid by all firms,
and well understood by clients and prospects
(e.g., commissions on load mutual funds versus
marketing expense reimbursements tied to a
predetermined formula that can vary by produceror from year to year)?
5. Is our firm paid more by some providers than
others and does that impact the degree to which
those products are sold or promoted by the firm?
(e.g. shelf space, research, marketing support,
incentive meetings, expense reimbursements or that
the universe of research covered may be limited
or influenced by the issuers with which the firm
maintains relationship or the securities for which the
firm acts as a market maker or otherwise engages in
proprietary trading)6. Do we receive payments or other benefits for
referring clients to third parties (cash, revenue
sharing, commissions)?
7. Do we receive payments or other benefits for referring
clients to third parties (cash, revenue sharing,
commissions, equipment, research or non-research)?
8. In what capacity do we act on certain transactions
(broker, agent, advisor, market maker, in a
principal capacity)?
9. What fees are charged or offset on some products thatmight influence the recommendation of one product
over another (brokerage account fees, advisory fees,
ticket charges, transaction fees)?
Based on what you find in the above process, begin to
evaluate other issues that may be present. This will help
identify gaps, and where more robust disclosure might
be needed; or, in some cases even a re-evaluation of the
arrangement to reduce or eliminate possible conflicts.
1. Do our disclosures outline all the products we offer
and those we dont offer, and why?
2. Is there ongoing compensation that is lost (orincreased) by the recommendation of some products
over others (12b-1 fees, asset trails, advisory fees,
renewal commissions, and retained business
quality incentives)?
3. Do producers/advisory representatives earn credit
toward health or pension benefits on some products
and not others?
4. Is this compensation already clearly described in our
current disclosures?
5. Do our current disclosures have any gaps in what
they describe compared with all the possible
compensation, and do they clearly explain
possible conflicts?
6. For those identified gaps, ask how the arrangement
might be equalized across all products so that no
client is disadvantaged or no producer/representativeis unduly incented to recommend one product
over another.
This exercise will not only help you to prepare for what is
headed your way under a fiduciary regimen, but also will
be a valuable tool if this new proposed FINRA rule comes
into being. In addition, this process will give you an idea
of how future customers will perceive your firm within
the marketplace should the rule come into effect.
By Larry Niland, Senior Regulatory Consultant, LIMRA; and
former CCO of the John Hancock Financial Network. Pleasecontact Larry at [email protected] if you have any questions about
this article.
If you need to evaluate your firms compensation programs or
disclosures, LIMRA can help you identify opportunities or revise
compensation arrangements to reduce or eliminate possible conflicts.
For more information, contact Meggan Tufveson at 860-285-7859 or
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FINRA Says to Report Non-SecuritiesComplaints
Rule 4530 Effective July 1, 2011
On July 1, 2011, NASD Rule 3070, which requires elec-
tronic reporting to FINRA of certain events such as
customer complaints, will be replaced by FINRA Rule
4530. The new Rule has gathered recent criticism becausethe words should have are found in three different
sections. Protecting a firm from enforcement actions
is difficult when the rules use subjective words such as
should or reasonable. However, the attention given to
the should have clauses has overshadowed several other
changes which will have a significant impact on broker-
dealer operations and supervisory procedures. This rule
will be especially complex for firms whose representatives
hold outside business activities (OBAs).
One of those changes will require firms to report all
written complaints. Firms have been required to reportwritten complaints involving securities-related activities
for years; but now they will have to report any written
complaint received from a customer of the firm. In some
cases, the complaint will have to be reported even if the
complainant never opened an account. Not only will
complaints from customers concerning a fixed annuity
or investment advisory account have to be reported, but
complaints about a representatives accounting practice,
mortgage business, property & casualty business, etc.
Notice to Members 96-85 has been an important source
of guidance for reporting customer complaints; but asof July 1, 2011 some sections of that notice will no longer
be applicable: question #6 and the corresponding answer
will become obsolete. Question #6 asks if broker-dealers
are required to include in their quarterly statistical
reports . . . customer complaints regarding the sale of
insurance-related non-securities products (e.g., fixed
insurance products)? The FINRA answer was No . . .
members should not report complaints that relate to non-
securities activities (such as fixed insurance products).
Until now, firms have only been required to report non-
securities complaints when there was an allegation oftheft, certain misappropriations, or forgery, but that will
soon change. The first quarterly reporting requirement
under the new rule will be October 15, 2011.
FINRAs intention to expand the reporting requirement
for complaints was announced with Rule Filing
SR-FINRA-2010-034 which states on page 23 . . . if a
member has engaged, or has sought to engage, in secu-
rities activities with a person, then any written com-
plaint from that person is reportable under the proposed
rule, regardless of whether it relates to non-securities
products. On July 1, 2011 the requirement will change
from reporting only securities-related complaints, to
reporting any complaint. Fortunately, the final rule does
allow some reporting exemptions if the person was
solicited but did not become a customer.
The best source for information on the new Rule is found
in Regulatory Notice 11-06. In some cases the filing
requirement applies only when the complaint involvesa person who is or was a customer. In this situation a
customer is defined as a person with whom . . . a membe
has engaged in securities activities. In other cases the
requirement to file a complaint applies even to those who
were solicited by the firm but never became customers.
That definition includes a person with whom . . . a
member . . . has sought to engage in securities activities.
Supplementary Material .08 provides more details on
the differences. Complaints from those with whom the
member has engaged or sought to engage in securities
activities involving allegations of theft, misappropriationof funds or securities, or forgery must be reported within
30 days after the firm knows or should have known of the
complaint. Most other complaints must be filed quarterly.
Another important change is found at 4530(a)(1)(G).
Although similar to the wording in Rule 3070(a)(7)
and (8), the new Rule also applies to insurance and
other financial services and transactions. The specific
wording is, financial-related insurance civil litigation
or arbitration; and, relates to the provision of financial
services or relates to a financial transaction. The
requirement to report in this section does not includeproperty & casualty related matters. It does, however,
include fixed and indexed annuities among other
transactions. As with the old Rule, the filing is normally
required when a payment of $15,000 or more has been
determined. But a new twist has been added; the calcula-
tion must include attorneys fees and interest if that is part
of the payment. This will complicate negotiations for
claims that are near the $15,000 minimum.
Action is required. The definition of a reportable
complaint has changed and firms will need to train
compliance staff, supervisors, and reps to ensure that
they understand the new requirements. Procedures will
need to be developed in order to collect and timely report
non-securities related complaints. It will be especially
important that registered representatives understand their
obligation to report non-securities-related complaints to
their compliance department. The firm is responsible for
reporting complaints either within 30 days or after the
end of a quarter. The 30-day requirement applies even to
a person who never opened an account at the firm and
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the clock starts ticking when the firm knows or should
have known of the complaint.
One suggestion would be to update the annual
questionnaire. It is a common practice for firms to
require registered representatives to submit an annual
certification of outside business activity questionnaire.
The annual questionnaire could include more questions
about complaints. Questions designed to capture the reps
understanding of the new rules would be especially useful.Requiring representatives to certify that they understand
that even non-securities-related complaints must be
promptly reported to compliance would help protect
firms from the should have known clauses. Promptly
means in a time frame sufficient for compliance to receive
the information, investigate if necessary, and submit the
report in a timely manner. Requiring all complaints to be
forwarded promptly will give the compliance department
time to determine if the complaint needs to be filed at all,
within 30 days, or at the end of the quarter. The require-
ment to file certain events within 10 days will no longerapply once Rule 3070 expires.
Changes to branch office inspection procedures could
also be considered. The inspection would provide a good
opportunity to explore the level of understanding of the
new complaint requirements and to ask some probing
questions. But how deep the firm should dig into the
representatives OBAs is a complicated question.
Those responsible for submitting the electronic report
will also need some training. The name of the reporting
application will change from Disclosure Events andComplaints to Rule 4530 Application. The drop-down
menus will also change. A list of the new menus can be
found in a footnote to Regulatory Notice 11-10. The new
menus are more descriptive than the current ones and it
should be easier to identify the appropriate filing category.
When developing the procedures, firms will have a
number of issues to consider. Will the firm have access to
complaints containing confidential client information?
For example, the AICPA Code of Conduct prohibits a
member from disclosing any confidential client infor-
mation without the specific consent of the client.Under what conditions would the firm investigate the
complaint and what are the record retention requirements?
Rule 4530(d) requires reporting customer complaints in
such detail as FINRA shall specify. There is no mention of
investigation, response, or record retention in Rule 4530.
NASD Rule 3110(d) and (e) still regulate the requirements
of the complaint file. Those Rules will be replaced by
FINRA Rule 4513 at some point in the future. Section
(b) of the approved Rule reads in part, For purposes
of this Rule, customer complaint means any grievance
by a customer . . . in connection with the solicitation
or execution of any transaction or the disposition of
securities or funds of that customer.
Here is an example of the need for training. Any
complaint received from a customer must be reported.
If the complaint is from a prospective customer it must
be reported only if the complaint involves securities-
related activities or allegations of theft, misappropriation,or forgery. Records for the complaint file will only be
required if the complaint is securities-related and from
customers the definition of which has not changed.
A final complication in complying with 4530(d) is that
the report is due after the end of the quarter in which
customer complaints are received by the member. A non-
securities-related complaint from a customer received by
an accounting firm involving an accountant/registered
rep will likely be deemed to have been received by the
member when the accountant/registered rep becomes
aware of the complaint.
In order to comply with Rule 4530 firms will need to
develop new procedures and implement additional
training to collect and report non-securities-related
complaints, litigation, arbitrations, and claims. Many
decisions will need to be made before the July 1st
deadline; and, as is often the case with rules in this
industry, the procedures will necessarily evolve over time.
By Victor A. Shier, LIMRA Regulatory Services Consultant
Know Your Customer: How a NewGeneration of Software Helps Advisors toIdentify the Right Solutions for Retirees
Supports compliance with FINRA rules that go intoeffect October 2011
The need to know your customer is critical to every
advisor-client relationship, and is the foundation for any
recommendation or strategy that an advisor proposes.This need to understand the essential facts concerning
every customer is the key to delivering the right solutions
to clients, and is mandated under new FINRA rules which
will take effect on October 7, 2011.
Although the new FINRA rules are based in part on
former NASD and NYSE provisions, they expand on these
prior rules in important ways. The new rules underscore
the need to use reasonable diligence in gathering the
essential facts concerning a customer, and require that this
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undertaking occur at the beginning of a client-advisor
relationship. This can be difficult if a new (or existing
client) is about to retire. Typically, most clients approach
retirement with an accumulation mindset for years
they have been saving and investing to build up their
retirement nest egg. They are frequently unprepared
to address the financial risks they will need to manage,
or to evaluate the alternatives for ensuring that they
have a retirement income that meets their needs andlifestyle goals. And, before an advisor can recommend
an investment strategy, the new FINRA Suitability Rule
2111 requires that he or she understand the customers
age, financial situation and needs, investments, tax
status, investment objectives, investment experience,
investment time horizon, liquidity needs, risk tolerance,
and any other information the customer may disclose.
In most cases, this all changes when a client retires, and
the advisor as well as the firm they represent are bound
by new regulations, and the strictures of ethical conduct,
to understand and document the changing investment
profile of each customer.
If the customer does not yet have a clearly defined picture
of their goals for retirement, an understanding of how
long retirement is likely to last, or how their expenses or
tax situation may change, creating an investment profile
for that client will be particularly challenging. In advisor
focus groups conducted by LIMRA, advisors express
frustration over the inability of clients to articulate their
goals for retirement (or in the case of spouses, to agree
on goals), and the time involved in educating clients
regarding the risks of outliving assets, managing health-care costs, keeping pace with inflation, and optimizing
Social Security and Medicare benefits. Pre-retirees over
age 55 hold over $16 trillion dollars in assets, and advisors
are witnessing a significant redeployment of retirement
savings as in excess of $1 billion dollars moves from
employer-sponsored defined contribution plans to IRA
rollover accounts every business day. With that much
retirement money in motion, it is essential that advisors
and their firms understand the new FINRA rules and
apply them correctly.
What if there was a way for existing or prospectiveclients, about to retire, to frame their thinking about
lifestyle goals, their preferences for retirement residence,
and the timing of retirement? What if clients could
educate themselves about the new financial risks and
challenges that retirement will bring, and rank them
in order of priority? What if clients could do all this
while conveying to an advisor how they plan to pay
for basic and discretionary retirement expenses, and
indicating their level of confidence in achieving their
goals, and which financial management strategies they
would like to consider? If that were possible, it would
certainly make it easier for advisors to conclude that
their recommendations were based (as new FINRA Rule
2111 requires) on an investor profile developed through
reasonable due diligence. The new rule recognizes that
not every factor regarding a customers investment profile
will be relevant to every recommendation, but because the
listed factors that comprise an investor profile are oftencrucial to recommending strategies to soon-to-be-retired
and other customers, it would be prudent for advisors
and their firms to document, with specificity, what they
believe is relevant. Certainly the when, where, and how
attitudes that a customer has toward retirement would
seem highly relevant to any recommendation an advisor
might make.
To help clients and their advisors make the transition to
retirement together, LIMRA, in partnership with Impact
Technology Group, Inc. has developed an engaging and
educational software application that creates a SummaryProfile which is completed before any recommendations
are made. While it is very informative for the client,
and very useful for the advisor, the application also
provides documentation of goals and concerns, and of
strategies the client is interested in learning more about.
Its colorful graphics and intuitive functionality make it
easy-to-use, and it can be completed in about 20 minutes.
Unlike planning tools that require the input of financial
data, and assumptions about long-term rates of return
and inflation, the new software helps clients prepare
for their meeting with an advisor so that the solutionswhich are ultimately proposed are the right ones for
theirretirement. This is a new generation of software
application for financial services it doesnt provide
the answers, but it makes sure that the clients, and their
advisors, are asking all the right questions.
For information regarding new FINRA Know-Your-
Customer and Suitability Rules, see Regulatory Notice
11-02, which can be viewed on www.limra.com/
retirement.
By Paul S. Henry, LIMRA Managing Director of Retirement Clients
and Products, and formerly a Registered Principal with MML
Investor Services, Inc., a MassMutual subsidiary.
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solutions to support plan sponsors, plan participants,
and IRAs.
Proposed Expansion of the Definition of FiduciaryUnder ERISA and the Code
The DOL has the authority to make rules affecting
ERISA and certain aspects of the Code. In October 2010,
it issued a proposal to redefine the term investment
advice, which is the most common way for an adviserto trigger fiduciary status, and expand the activities
that may give rise to prohibited transactions. The
proposed standard is much easier to meet, and registered
investment advisers (RIAs) are singled out and have
unique status. For example, if individualized to the
needs of the client, even one-time advice may now be
fiduciary advice. The revised definition would also make
recommendations concerning investment managers a
fiduciary act.
While changes to ERISA will no doubt present challenges,
most firms have already begun to identify and remediatecompliance gaps as part of their 408(b)(2) preparedness
strategies (see below). It will be important to anticipate
and evaluate the effect of the proposed expansion of
fiduciary status even though not final. The impact on IRA
business, however, may not be as clear given the fact that
many firms have not invested the same resources toward
IRA-related compliance initiatives.
The DOL has both rulemaking and enforcement
authority over ERISA, but enforcement of the prohibited
transactions under the Code (applicable to IRAs) lies
solely with Treasury. To date, Treasury has not madeexamination of IRA service providers a priority; however,
the creation of the Consumer Financial Protection
Bureau under Dodd-Frank is expected to change that.
Firms should therefore not only begin preparing for
the proposed changes but also should examine their
compliance with existing rules to ensure that prohibited
transactions are detected and prevented under the status
quo (investment advice in brokerage accounts with
variable commissions and 12bs, failing to offset 12bs
against fees in advisory accounts, etc.).
Plan-Level Fee Disclosure Under ERISA 408(b)(2)
While the expansion of fiduciary status remains a
proposal at this time, the fee disclosure regulation has
been finalized and will become effective January 1, 2012.
The regulation requires service providers to provide
written disclosures setting forth: (1) all services to be
provided to the plan and/or its participants; (2) any and
all direct and/or indirect compensation received by the
service provider (and affiliates); and (3) a statement
ERISA Compliance: An Overview of NewChallenges and OpportunitiesSweeping reforms introduced this year by the DOL will
pose significant challenges for insurance companies,
broker-dealers (BDs), agents, and financial advisers that
provide services to qualified retirement plans, including
individual retirement plans (IRAs). The risks will be
particularly acute for those considered to be providingfiduciary services, as it is a prohibited transaction under
the Employee Retirement Income Security Act (ERISA)
and the Internal Revenue Code (Code) to use the
authority that makes one a fiduciary to cause him/herself
(or an affiliate) to receive additional compensation.
Prohibited transactions, therefore, may arise where an
adviser provides investment advice to a plan sponsor, plan
participant, or account holder/beneficiary of an IRA that
results in additional receipt of commissions, 12b-1 fees,
revenue sharing payments, or investment management
fees for affiliated products/funds. The new regulationswill require firms to disclose all indirect and direct
compensation earned from qualified plans, which will
among other things be used to populate newly required
detail on participant statements, and the Department of
Labor (DOL) recently proposed expanding the nature and
scope of activities that would give rise to fiduciary status
under ERISA and the Code.
In addition to new and changing regulatory requirements,
Phyllis Borzi, Assistant Secretary of Labor, has vowed to
implement a strong, vigorous, comprehensive enforce-
ment policy. Indeed, the DOL has already increased itsenforcement staff significantly, and examination of ERISA
plan service providers jumped markedly in 2009 and
2010. The agency is also sharing information and
actively cooperating with the Securities and Exchange
Commission (SEC) in examinations designed to detect
and prevent prohibited conflicts of interest among
retirement plan service providers.
The convergence of new regulations, increasing
enforcement, and ongoing ERISA litigation, could lead
to significant exposure for firms that have not helped
their advisers prepare for and adapt to these challenges.Particularly at risk are those that distribute proprietary
or affiliated funds through agents and advisers. Proactive
firms that develop and deploy thoughtful responses will
not only mitigate fiduciary risk but also will be well-
positioned to retain and attract advisers seeking to stay
competitive in the qualified plan and IRA marketplace.
This article provides an overview of the changes to come
and describes how firms can mitigate fiduciary risk by
developing competitive and compliant non-fiduciary
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acknowledging any of the services that are reasonably
expected to give rise to fiduciary status. This disclosure
alone presents a number of challenges to insurance-
affiliated firms.
For example, ERISA requires plan sponsors to manage
the plans investments prudently. If they do not possess
the requisite investment-related expertise, they are
required to hire it. Many plan sponsors, therefore,
look to their advisers for assistance with the selectionand monitoring of the plans designated investment
alternatives (DIAs). If the adviser provides individualized
investment advice, then a prohibited transaction may
occur if he/she (or his/her affiliate) receives unlevel
compensation (commissions, 12bs, revenue sharing, etc.)
or if the DIAs include proprietary or affiliate sub-advised
funds. The written disclosure will operate to provide a
roadmap for plan fiduciaries, regulators, and would-be
plaintiffs. Affected firms should deploy adequate resources
to educate their advisers of this risk (ERISA imposes
personal liability on fiduciaries) and arm them withthe necessary tools to service their clients in a
compliant manner.
Competitive forces are also at play, as advisers who
may have provided more holistic support in the past
(e.g., plan- and/or participant-level investment advice,
model portfolio allocations) may now find themselves
constrained by home office policies and disclosures
generated by supervising firms, and will be forced to
defend or redefine their value proposition in light of any
perceived or actual reduction in services. Again, advisers
will be looking to their home office for the requiredresources and support.
Participant-Level Fee Disclosure Under ERISA404(a)(5)
The DOL issued its above-referenced Plan Fee Disclosure
Regulation as part of a three-part initiative aimed at
facilitating the exchange of information among service
providers and plan sponsors, plan sponsors and the DOL
(via Schedule C of Form 5500) and plan participants. In
October 2010, it published its final Participant Disclosure
Regulation under ERISA 404(a)(5) requiring plansponsors to provide each participant, or beneficiary, with
two categories of information:
(1) Plan-related information, including general plan
information, administrative expense information, and
individual expense information; and
(2) Investment-related information including
performance data, benchmarking information,
fee and expense information, Internet access to
investment-related information, and a glossary
to assist participants with investment-related
terminology.
Both categories of disclosures must be presented to the
plan participant prior to the participants first direction
of investments, and annually thereafter. Further, thenew rule requires that this information be provided in a
comparative format such as a chart or similar comparative
format, and the information must be provided in plain
language the average participant can understand. (See
the Model Comparative Chart presented in the appendix
to Fiduciary Requirements for Disclosure in Participant-
Directed Individual Account Plans; Final Rule).
While nothing affirmative is required on the part of plan
service providers under the Participant Disclosure
Regulation (service providers are required to disclose
sufficient information under 408(b)(2) to allow plan
sponsors to meet their requirements under 404(a)(5)),
recent surveys indicate that the majority of plan partici-
pants currently believe that their plans are free or that
the plan sponsor pays most or all of the plan expenses.
Consequently, advisers will need to be prepared to defend
their value to participants who will now see the fees paid
from their investments to the broker-dealer, adviser, or
both. Firms should begin to support their advisers in this
regard and provide them with materials to assist plan
sponsors track and manage participant inquiries
concerning services and fees.
Mitigating Risk and Adding Value Through Non-Fiduciary Support
As discussed, given the challenges presented by fiduciary
status, firms should begin evaluating the support provided
to advisers for non-fiduciary services. For example, firms
should consider developing more robust investment edu-
cation programs that their advisers can implement as part
of a retirement readiness approach for participants by
using tools such as gap analysis; this process of tracking
participant success measurements is a way to demonstratethe value of an advisers non-fiduciary support. If he/she
can demonstrate an increase in participation and contri-
butions year over year, plan sponsors will be better able to
verify and document the value of the advisers services.
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Another way that supervising firms can assist agents and
advisers in adding value through non-fiduciary services is
by educating advisers and plan sponsors on their respon-
sibilities arising out of new DOL regulations. For example,
plan sponsors may not have the time or inclination to
stay abreast of the new requirements to assess the com-
pleteness and reasonableness of disclosures presented by
the plans other service providers (recordkeepers, TPAs,
investment advisers, etc.). By assisting the plan fiduciariesin establishing and maintaining procedures to evaluate
their service arrangements, agents and advisers can not
only add additional value but also can insert themselves
in that process and thereby help ensure that there is an
ongoing need for their services. Many advisers report
recent successes with prospecting new plans by offering
disclosure management services to plan sponsors. As such,
firms that are the first to build and to market their plan
sponsor education materials for their advisers will be at
a strategic advantage over other firms who lack adviser
resources in this area.
Plan advisers, given the proper training and support
materials, may also benefit from offering to assist
sponsors to manage the inquiries that will likely come
from participants once the new disclosures are reported
on their statements. Advisers, who are often the most
knowledgeable on concepts such as share classes, expense
ratios, etc., can serve as the first line of defense for
sponsors. Many routine inquiries can be resolved by
demonstrating the prudence of the sponsors selection
and monitoring processes and that the plan would not
exist but for the support provided by and the fees paidto the plans service providers. At a minimum, plan
sponsors will value the advisers foresight, preparedness,
and willingness to run interference on their behalf by
providing information and explanations designed to
resolve informal and/or routine participant inquiries.
Firms should also consider providing training and
materials to help their advisers educate plan sponsors on
procedures to track and manage participant inquiries.
Plan participants that do not receive adequate, timely,
or complete responses to their questions may turn to
the DOL for assistance. The DOL Enforcement Manualprovides that [c]omplaints may be specific or non-
specific, written or oral . . . [and] when appropriate, a par-
ticipant complaint may be transferred as an investigative
lead to the enforcement unit. Plan sponsors often rely
on their adviser to ensure that the plan is maintained in
a compliant manner. Indeed, most plan sponsors do not
have the time or the inclination to stay abreast of their
requirements and have failed to establish procedures to
mitigate the likelihood of participant complaints. A visit
from the DOLs enforcement division will, at a minimum,
operate as a distraction from the sponsors business and
will not reflect well on the plan adviser. Moreover, service
provider examinations often arise from plan audits
triggered by participant complaints. By educating andassisting plan sponsors in establishing procedures for
logging, resolving, and/or escalating participant inquiries,
forward-looking advisers and their firms can mitigate the
risk that a participant inquiry or request for information
will lead to a formal DOL complaint.
Lastly, given the increase in plan audits (from both the
DOL and IRS), firms should provide their advisers with
the tools needed to aid plan sponsors in developing an
exam-ready approach to compliance. For example,
many firms have created web-based systems for their
advisers that allow for the collecting and storing operativedocuments and information. If these files are maintained
in real time, plan fiduciaries can respond more accurately
and timely to requests from examiners. The fact that the
documents are complete and easily accessible will, in
and of itself, demonstrate a high degree of prudence on
the part of the plan sponsors and help to streamline the
examination process.
Although only a sampling of non-fiduciary services were
described above, there are many ways that firms can assist
their advisers by providing non-fiduciary, value-added
tools. Firms that are the first to move and implementthese resources will possess a compliance and competitive
advantage and can use these resources for adviser
recruiting and retention.
By Jason C. Roberts, Esq., AIFA, Founder and CEO
Pension Resource Institute, LLC. The firm works with insurance
companies, broker-dealers, registered investment advisers,
investment managers, recordkeepers, and third-party administrators
to develop and deploy sustainable and profitable solutions in the
qualified plan marketplace. For more information, visit
www.pension-resources.com.
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Life Settlements: How Long ShouldInvestors Wait Before Purchasing LifeInsurance Policies?In the United States, a market has developed for
institutional investors to purchase life insurance policies
that insure the lives of U.S. residents residing in various
states. Many investors correctly understand that stranger-
originated life insurance (STOLI)1 is prohibited by most
U.S. states; and, accordingly, seek to ensure that they do
not purchase any life insurance policies that were issued
in violation of a states STOLI prohibition. However, some
investors believe that if they purchase STOLI policies,
an insurer that issued such a policy cannot contest the
policys validity upon the passage of two years from the
date the policy was originally issued. Unfortunately,
depending on a number of factors, those investors
could be wrong.
Because insurance in the United States is primarilyregulated on a state-by-state basis, determining whether
(and when) an issuing insurer may contest the validity
of a life insurance policy requires a review of (i) the laws
of the state in which the sale of the policy originally
occurred; and (ii) the laws of the state where the owner
resides at the time the policy is settled (i.e., sold by the
life insurance policys owner to a third-party provider).
State insurance statutes and regulations, as well as relevant
administrative and judicial decisions, all of which vary
from state to state, would need to be reviewed to make
any such determination.
The following provides a brief overview of the issues
that will need to be reviewed before investing in a policy
(e.g., contestable periods, STOLI, insurable interest, and
life settlement waiting periods), as well as a review of the
current situation in New York.
The Contestable Period
The insurance laws of most states provide that the validity
of an individual life insurance policy is not contestable
by the issuing insurer after the policy has been in force
during the life of the insured for a specified period fromits date of issue. Generally, the time period during which
a life insurer may contest the validity of the policy (i.e.,
the contestable period) is two years. The prohibition
against an insurer contesting the validity of a life
insurance policy after the expiration of the contestable
period is based on the notion that it would be unfair
to allow the policyowner to pay premiums indefinitely
while assuming that benefits are available, only to have
the policy declared void because of a defect existing when
the policy was issued.2 This prohibition forces the insurer
to investigate the validity of the policy at a time when
evidence that could support the policyowners position is
likely to still be available.
In some states, the expiration of the contestable period
may serve as an absolute bar to an insurers challenge
to the validity of a life insurance policy. In other states,
an insurer may challenge the validity of a life insurance
policy if, for example, there was no insurable interestin the insured life at the time the policy was purchased
from the insurer, even after the contestable period has
expired.3 Because an insurable interest is required to
create a validly existing life insurance policy, it is reasoned
that if no such insurable interest existed at the time the
policy was issued, the policy is void ab initio (i.e., void
from its inception). Moreover, if the contestable period
requires that the policy be in force during the life of
the insured for a period of two years, and there was no
insurable interest at the time the policy was originally
purchased, then it cannot be said that the policy was everin force. Accordingly, in such states, the expiration of the
contestable period should not operate to create a validly
existing policy where one never existed.
STOLI and Insurable Interest
Because an issuing insurer might be able to contest the
validity of a life insurance policy after the expiration
of the contestable period based on a lack of insurable
interest at the policys inception, the investors should
understand the relationship between STOLI policies and
insurable interest.Although some states do not have an explicit STOLI
prohibition, the insurance laws of all states prohibit the
procurement of life insurance policies by those not
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1The National Conference of Insurance Legislators Life Settlements ModelAct (the NCOIL Model Act) defines Stranger-Originated Life Insurance asa practice or plan to initiate a life insurance policy for the benefit of a thirdparty investor who, at the time of policy origination, has no insurable interestin the insured.
The NCOIL Model Act does not have the force of law; it merely servesas a model for life settlement statutes that have been enacted in variousU.S. states. In addition to the NCOIL Model Act, some U.S. states haveenacted life settlement statutes that are based on the National Association ofInsurance Commissioners Viatical Settlements Model Act (the NAIC ModelAct). Unlike the NCOIL Model Act, the NAIC Model Act does not containa definition of STOLI. Since 2007, approximately 28 states have enactedstatutes that are based on the NCOIL Model Act, the NAIC Model Act,or both.2See New England Mut. Life Ins. Co. v. Caruso, 73 N.Y.2d 74 (1989).3In some states, a life insurer is also permitted to contest the validity of alife insurance policy after the expiration of the contestable period if (i) thepolicy was purchased with the intent to murder the insured, or (ii) the policysmedical examination was taken by an imposter.
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having an insurable interest in the life of the insured at
the time the policy is originally purchased from the life
insurance company.
The definition of insurable interest with respect to life
insurance varies slightly from state to state, but generally
is defined as an interest in the continuation of the life of
the person insured. An individual always has an insurable
interest in his or her own life. In addition, an insurable
interest generally exists where there is (i) a substantialinterest engendered by love and affection (in the case
of persons closely related by blood or by law); or, (ii) a
substantial economic interest in the continued life, health,
or bodily safety of the individual insured. Such insurable
interests are distinguished from an interest that would
arise only by, or would be enhanced in value by, the death,
disablement, or injury of the insured (in the case of
persons not closely related by blood or law).4
In general, investors do not have an insurable interest
in the lives of the individuals insured under the policies
they purchase as investments. In fact, in such a situation,
investors have an interest that would arise upon the
death of the individual insured. Although an individual
is generally permitted to purchase a life insurance policy
insuring his or her own life and then immediately transfer
or assign the policy to a person that does not have an
insurable interest in the life of the insured, several recent
court cases have determined that where an individual pur-
chases a life insurance policy on his or her own life, with
the then present intent to sell or otherwise transfer the
policy to an identified third party, and there is a precon-
ceived agreement or understanding with such identifiedthird-party regarding such sale or transfer, the third party
is, in essence, the real purchaser of the policy. In such a
case, the validity of the policy could be challenged by the
issuing insurer based upon the third partys lack of an
insurable interest in the life of the insured.5
The Two-Year and Five-Year Waiting Periods
Adding confusion to a potential investors understanding
of the two-year period following the issuance of a life
insurance policy are the NCOIL and NAIC Model Acts
so-called two-year and five-year waiting periods forentering into life settlement contracts.
As a means of preventing STOLI, both the NCOIL Model
Act and the NAIC Model Act contain provisions that
prohibit any person from entering into a life settlement
contract for a certain period of time following the issu-
ance of the policy. Specifically, the NCOIL Model Act
prohibits any person from entering into a life settlement
contract at any time prior to, or at the time of, the appli-
cation for, or issuance of, a policy, or during a two-year
period commencing with the date of issuance of the
policy . . . . Similarly, the NAIC Model Act prohibits any
person from entering into a life settlement contract6 at
any time prior to the application or issuance of a policy
which is the subject of [a] viatical settlement contract or
within a five-year period commencing with the date of
issuance of the insurance policy . . . .7
Although neither the NCOIL Model Act nor the NAIC
Model Act explicitly provide for an insurer to invalidatea life insurance policy that is settled before the expiration
of the statutory period prohibiting settlement of a policy,
neither model Act explicitly prohibits an insurer from
doing so. In fact, the NCOIL Model Act explicitly provides
that [n]othing in [the Section providing the two-year
ban] shall prohibit an insurer from exercising its right to
contest the validity of any policy.
In determining which states law applies to any waiting
period for entering into a life settlement contract, both
the NCOIL Model Act and the NAIC Model Act provide
that the residency of the owner of the policy at the
time that the policy is settled is the determining factor.
With respect to state statutes that provide for waiting
periods before entering into life settlement contracts,
approximately 17 states (and the Commonwealth of
Puerto Rico) have enacted a two-year waiting period, two
states have enacted a four-year waiting period, and nine
states have enacted a five-year waiting period.
The Situation in New York
The issue of whether an insurer may contest the validity
of a life insurance policy after the expiration of the con-testable period remains unsettled in New York. In a recent
federal case in the Southern District of New York,8 the
district court determined that under certain conditions, a
life insurer may be permitted to invalidate a life insurance
policy after the expiration of the contestable period,
stating [t]hough a high bar, the incontestability clause
is not sacrosanct. In support of its determination, the
_____
4See, e.g., N.Y. Ins. Law 3205(a) (McKinney 2006).5See First Penn-Pac. Life Ins. Co. v. Evans, 313 F. Appx 633 (2009); SunLife Assurance Co. of Canada v. Paulson, Civil No. 07-3877(DSD/JJG),2008 U.S. Dist. LEXIS 99633 (D. Minn. Dec. 3, 2008).6The NAIC Model Act refers to a life settlement contract as a viaticalsettlement contract.7Both the NCOIL Model Act and the NAIC Model Act also provideexceptions to their respective bans for certain situations that tend to show thatthe insurance policy was settled within the prohibited period for a legitimate(non-STOLI) purpose.8Settlement Funding, LLC v. AXA Equitable Life Ins. Co., No. 09 CV 8685(HB) (S.D.N.Y. Sept. 29, 2010).
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district court cited a February 6, 2002 Opinion of the New
York Insurance Departments Office of General Counsel,
which concluded that whether or not an individual life
insurance policy is contestable after being in force during
the life of the insured for a period of two years from its
date of issue depends on the facts. The district court
also stated that the need to monitor and quell what
appears to be an expanding market for STOLI policies
tips the scales in favor of reviewing otherwise incon-testable life insurance policies where, as here, a substantial
factual record points to an improperly procured policy.
The district court then allowed a jury to determine, as a
factual issue, whether the insurer was barred from con-
testing the validity of the policy based on the expiration
of the contestable period. Although the jury in this case
thereafter determined that the insurer was so barred, the
insurer is now seeking to have the district court determine
that the policies are invalid as a matter of law.9
In addition, although many investors believe that the
situation in New York was clarified by the November 17,2010 decision of the New York Court of Appeals in
Kramer v. Phoenix Life Insurance Co.,10 because of the
extremely limited scope of the question that was before
the court of appeals, as well as the fact that the case was
decided based on the law that was in effect in New York
in 2005 (which has since been supplemented by a STOLI
prohibition and a two-year waiting period before settling
a life insurance policy), the Kramer decision may be of
limited importance.
The Kramer case involved more than $56 million dollars
in life insurance coverage on the life of Arthur Kramer,a named partner in a New York law firm. According to
the decision, in 2003, Steven Lockwood, the principal of
Lockwood Pension Services, Inc. (Lockwood Pension),
approached Mr. Kramer about participating in a STOLI
transaction. In 2005, the transaction was commenced
when several life insurance policies on Mr. Kramers life
were purchased by two trusts established by Mr. Kramer.
Although both trusts were established by Mr. Kramer and
named his adult children as the trusts beneficiaries, it
was alleged that both trust agreements were prepared by
counsel for Lockwood Pension, neither Mr. Kramer norhis children ever paid premiums on the policies, and the
Kramer children sold their interests in the trusts after the
policies were issued.
After Mr. Kramers death, his widow, Alice Kramer,
instituted a federal court action in New York alleging that
the policies violated New Yorks insurable interest statute
and should therefore be paid to her, as representative
of Mr. Kramers estate (and not to the investors). In
response, the insurers sought a declaratory judgment that
the policies were void and that they were not required to
pay the policies proceeds to anyone at all (i.e., neither to
Alice Kramer nor to the investors).
The federal district court, citing New England Mutual
Life Insurance Co. v. Caruso, determined that the insurers
could not void the policies, as they had been issued more
than two years earlier (and so were incontestable). The
district courts order was then appealed to the SecondCircuit, which granted a petition to have the following
certified question answered by the court of appeals:
Does New York Insurance Law 3205(b)(1) and(b)(2) prohibit an insured from procuring a policy onhis own life and immediately transferring the policy toa person without an insurable interest in the insuredslife, if the insured did not ever intend to provideinsurance protection for a person with an insurableinterest in the insureds life?
The court of appeals answered the question in the
negative and held that New York law permits a personto procure an insurance policy on his or her own life
and immediately transfer it to one without an insurable
interest in that life, even where the policy was obtained for
just such a purpose.
However, the decision expressly did not apply recently
enacted legislation in New York (with an effective date of
May 18, 2010) that, among other things, prohibits anyone
from entering into a valid life settlement contract for
two years following the issuance of a policy (with certain
limited exceptions). In addition, the new legislation
also prohibits STOLI (which is defined in New York,
in relevant part, as any act, practice or arrangement,
at or prior to policy issuance, to initiate or facilitate
the issuance of a policy for the intended benefit of a
person who, at the time of policy origination, has no
insurable interest in the life of the insured under the
laws of this state). The STOLI prohibition became
effective on November 19, 2009. Because the events that
were reviewed by the court of appeals occurred prior to
dates of enactment of New Yorks statutes requiring a
two-year waiting period to elapse before entering into a
life settlement contract and prohibiting STOLI, the newstatutes were not applied to this case.
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9The investors argument that it should be granted summary judgment basedon principles of estoppel (i.e., that it relied on the insurers representationsconcerning the validity of the policy) was rejected by the District Court, whichconcluded that this issue should also be decided by the jury. Accordingly,although an insurers representation that a particular policy is in forcemay be helpful to an investor, it does not prevent an insurer from seeking toinvalidate the policy.1015 N.Y.3d 539 (N.Y. 2010).
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Moreover, although the insurers urged the court of
appeals to expand the scope of the certified question and
consider whether the district court properly dismissed
their claims based upon the expiration of the contestable
period, the court of appeals declined to expand the scope
of the certified question. Accordingly, the court of appeals
did not address whether the expiration of the contestable
period should serve to prohibit the insurers from con-
testing the validity of the policies in connection with aSTOLI transaction.
Although it appears that the death benefit in the Kramer
case will likely be paid to the investors, future New York
cases involving the same facts as this New York case, but
involving life insurance policies purchased and/or settled
after enactment of the New Yorks new life settlement
statutes, would be expected to yield different results.
Conclusions
Investors should never assume that it is safe to purchase a
life insurance policy simply because more than two yearshave passed since the policy was issued. Only by reviewing
applicable state laws can investors determine whether an
issuing insurer is permitted to contest the validity of a life
insurance policy. Specifically:
Investors should carefully review the laws of the states
in which the life insurance policies were originally
purchased to determine whether the laws of those
states provide for contestable periods,11 the length of
such contestable periods, and whether any exceptions
exist that would permit the insurer to contest the
validity of a life insurance policy after the expiration ofa contestable period (such as the lack of an insurable
interest at the inception of the policy).
In those states in which there is no contestable period,
the contestable period has not expired, or there is an
exception to the contestable period based on a lack
of insurable interest at the inception of the policy,
investors should be aware of the risk of the issuing
insurers potential to challenge the validity of the
policy based upon a lack of insurable interest at the
policys inception.
In those states in which the validity of the life insurance
policy can no longer be contested by the issuing insur-
ance company (e.g., because of the expiration of the
contestable period in a state that does not have an
insurable interest exception thereto), investors should
be aware of the risk that the benefits payable under
the policy might be required to be paid to the estate of
the deceased insured rather than to the policys benefi-
ciary (i.e., the investor) if, for example, the states lawprovides that policy proceeds obtained in violation of
a states insurable interest requirement must be paid to
the estate of the deceased insured.
Investors should be aware that an insurers representa-
tions concerning the validity of a policy (e.g., that that
policy is in force as of a certain date) does not prevent
an insurer from seeking to invalidate the policy.
Finally, investors should review the laws of the state
where the owner of the policy resides at the time
the policy is settled to determine whether there is a
statutory waiting period for settling a policy, the lengthof any such waiting period, and whether there are any
exceptions that might be applicable.
By Frederic M. Garsson, Associate, Baker & McKenzie LLP.
Mr. Garsson can be reached at 212-626-4701 or
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11In those few U.S. states where there is no contestable period, insurersmight be able to challenge the validity of the insurance policy at any time.
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