FINANCIAL SERVICES

Federal Savings Associations May Now Sell Insurance Directly

January 2004

By Susan B. Hollinger*
for New Hampshire Business Review

On July 11, 2003, the Office of Thrift Supervision (OTS) issued a memorandum notifying federal savings associations that the Securities and Exchange Commission (SEC) was issuing deficiency letters to broker dealers that have a networking contract with a service corporation of a savings association. The stated reason was that the SEC considers a service corporation to be a "broker" itself when it contracts with a broker dealer to offer nondeposit investment products and services (NDIPs) to a savings association's customers.

If the networking contract is with the savings association, the SEC excepts savings associations from broker dealer registration requirements. As a result, the OTS recommended in the Memorandum that savings associations should either replace the contract between the service corporation and the broker dealer with a contract between the savings association and the broker dealer, or register the service corporation as a broker dealer.

Many states, including New Hampshire and Massachusetts, view variable annuities as hybrid insurance and securities products and require licensing by the insurance department for those who sell or retain commissions for the sale of variable annuities. Thus, both the individuals selling the insurance product and receiving commissions and the entity receiving commissions for such sales must hold insurance licenses. Additionally, although these states would permit a savings association to conduct insurance sales directly, the OTS required insurance sales to be conducted by a subsidiary.

Until the time when the Memorandum was issued, savings associations used a service corporation for the sale of both NDIPs and insurance products because it was otherwise too complex to sort out the employment, compensation and corporate structure issues of selling NDIPs at the savings association level but insurance products at the subsidiary level.

The Memorandum left federal savings associations facing a predicament. Because of the cost and expense to register a service corporation as a broker dealer, many savings associations decided that it would be easier and more cost effective to choose the first OTS recommendation, namely replacing the existing networking contract with one between the savings association and the broker dealer. However, merely replacing the contracting party as the savings association presented its own set of problems.

Because most networking arrangements with broker dealers provide for the sale of variable annuities, savings institutions were faced with the predicament of how to structure the networking arrangement when there is no specific federal regulatory authority for the sale of insurance products directly by a savings association. Would they have to require the registered representatives to be employees of the savings institution only when equities were sold, but employees of the service corporation when insurance products were sold? Would the flow of commissions for various products need to go in separate corporate buckets? And how could variable annuities be sold when the SEC views them as NDIPs, but the states consider them insurance?

Thankfully, the OTS has relented. Although thrift regulators have not issued any public, written opinions clarifying whether a savings association can sell insurance, through conversations and correspondence with OTS personnel, the OTS is now taking the position that the sale of insurance by a savings association is within the "incidental" powers as set forth in the Home Owners' Loan Act, and is now allowing federal savings associations to sell insurance, without limitation as to lines of insurance, at the savings association level.

Networking contracts and the entire program, including policies and employees, can be moved up to the thrift level and thrifts can now apply to their state insurance regulator to obtain insurance licenses. Action should be taken immediately to bring a savings association into compliance with applicable state and federal law.

* Susan B. Hollinger is admitted in New Hampshire and Massachusetts.

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