Financial Product Sales: Actions Needed to Protect Military
Members (17-NOV-05, GAO-06-245T).
In 2004, a series of media articles alleged that financial firms
were marketing expensive and potentially unnecessary insurance or
other financial products to members of the military. GAO's report
for this committee examined (1) features and marketing of certain
insurance and securities products being sold to military members
and (2) how financial regulators and the Department of Defense
(DOD) were overseeing the sales of insurance and securities
products to military members. GAO also examined issues relating
to DOD's oversight of insurance sales for a report issued in June
2005.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-06-245T
ACCNO: A41619
TITLE: Financial Product Sales: Actions Needed to Protect
Military Members
DATE: 11/17/2005
SUBJECT: Insurance
Insurance regulation
Insurance companies
Military personnel
Marketing
Securities regulation
Product evaluation
Securities
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GAO-06-245T
United States Government Accountability Office
GAO Testimony
Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate
For Release on Delivery Expected at 10 a.m. EST Thursday, November 17,
2005
FINANCIAL PRODUCT SALES
Actions Needed to Protect Military Members
Statement of Richard J. Hillman, Managing Director Financial Markets and
Community Investment
GAO-06-245T
November 17, 2005
FINANCIAL PRODUCT SALES
Actions Needed to Protect Military Members
What GAO Found
A limited number of firms accused of using deceptive sales practices are
targeting costly financial products to military members with features that
reduce their benefits to military purchasers. Although some service
members benefited from a product that combines insurance with a savings
component, the additional coverage was more expensive than the low-cost
government insurance almost all service members already receive. One
feature reducing these products' benefits was that if the service member
ever stopped making payments and did not request a refund, the accumulated
savings is used to continue the life insurance coverage. With military
members often leaving the service within a few years, most stopped their
payments and likely failed to amass any savings from their purchase.
Various regulatory and other actions have been taken against the insurance
companies that sell these products in the past and new investigations are
underway in 14 states over whether these companies have failed to clearly
identify the products as insurance as required by law or whether the
products' features comply with all state insurance requirements. A small
number of broker-dealers were also marketing a securities product-the
mutual fund contractual plan-that has largely disappeared from the
civilian marketplace. Although potentially providing returns equivalent to
other products if steady payments are made over a long period, these
contractual plans proved more expensive to most military purchasers than
other widely available alternative products because many military members
stopped making payments in the first few years. In addition, the largest
brokerdealer selling contractual plans has already been sanctioned by
regulators for using misleading marketing materials and examinations into
the practices of other firms marketing this product are also underway.
A lack of routine complaint sharing by DOD prevented financial regulators
from identifying inappropriate sales to military service members earlier.
Although insurance regulators in some states review sales activities
periodically, most rely on complaints to indicate that potentially
problematic sales are occurring, particularly since no appropriateness or
suitability standards exist for insurance. Securities regulators' efforts
were also hampered by the lack of complaint sharing from DOD personnel.
Because sharing with financial regulators can be complicated by privacy
regulations and potential legal restrictions, DOD personnel at individual
installations generally resolved matters involving product sales with
companies directly. However, in light of the problems identified in our
June 2005 report and the report issued for this committee, DOD has efforts
underway to revise its solicitation policies regarding such sales, and has
reviewed ways in which it can legally share additional information with
financial regulators. However, DOD has not yet issued these new policies
or coordinated with military installation personnel or with regulators on
appropriate ways that additional sharing could occur.
United States Government Accountability Office
Mr. Chairman and Members of the Subcommittee:
I am pleased to be here to discuss GAO's work on the sales of financial
products to members of the U.S. military. 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 broker-dealer
firms marketing a mutual fund product with high upfront sales charges that
was rarely being offered to civilians. These media reports raised concerns
within Congress and elsewhere over whether the men and women in the armed
services were as adequately protected from inappropriate financial product
sales as their civilian counterparts.
Today, I will summarize the results from the report being released today
that we prepared at this committee's request, which is entitled Financial
Product Sales: Actions Needed to Better Protect Military Members.1
Specifically, I will discuss (1) the insurance and securities products
that were being sold primarily to military members and how these products
were being marketed, and (2) the ability of financial regulators and the
Department of Defense (DOD) to oversee the sales of insurance and
securities products to military members. Where applicable, I will also
present results from a related report entitled Military Personnel: DOD
Needs Better Controls over Supplemental Life Insurance Solicitation
Policies Involving Servicemembers.2
In summary:
A limited number of firms accused of using deceptive sales practices are
targeting costly financial products to military members with features that
reduce their benefits to military purchasers. About six insurance
companies are marketing products that combine high-cost insurance with a
savings component. 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 may
have had little need for more coverage beyond that already provided
through the low-cost government insurance offered to service members. In
addition, these products also appeared to be a poor
1GAO-06-23 (Washington, D.C.: Nov. 2, 2005). 2See GAO-05-696 (Washington,
D.C.: June 29, 2005).
investment choice for service members because they include provisions that
allow the money accumulated in the savings fund 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 cancel their policy and request
refunds, and as a result, few likely amassed any savings from their
purchase. Since the 1990s, state regulators, law enforcement authorities,
and DOD have taken various actions against the few insurance companies
that sell these products to military members and current investigations
are continuing in as many as 14 states. Among the allegations being
investigated is whether these companies are violating state laws by
failing to clearly identify the products as insurance. In addition,
several states are also reviewing whether the products' features comply
with all state insurance requirements. Similarly, a small number of
broker-dealers were marketing a securities product-the mutual fund
contractual plan-that has largely disappeared from the civilian
marketplace. Although potentially providing returns equivalent to other
products if steady payments are made over a long period of time, these
contractual plans proved more expensive to most military purchasers than
other widely available alternative products because many military members
stopped making payments in the first few years. Securities regulators are
also concerned over the practices used to market these products and the
largest broker-dealer selling contractual plans recently agreed to pay a
$12 million penalty to settle Securities and Exchange Commission (SEC) and
NASD allegations that it used misleading marketing materials. In addition,
these regulators are currently conducting examinations into practices of
the other firms that also marketed these products to military members.3
A lack of routine complaint sharing between financial regulators and DOD
was the primary reason that regulators did not generally identify the
problematic sales of financial products to military service members until
such accounts appeared in the media. 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
3NASD, formerly known as the National Association of Securities Dealers,
oversees the broker-dealer firms and their registered sales
representatives that market securities.
products. Although conducting periodic examinations of broker-dealers
sales practices, securities regulators' ability to identify problems
involving the sale of contractual plans was also hampered by the lack of
complaint sharing from DOD personnel and the absence of standardized
information on the extent to which contractual plan purchasers were
successfully making their payments. Because sharing with financial
regulators can be complicated by privacy regulations and potential legal
restrictions, DOD personnel at individual installations generally resolved
matters involving product sales with the service member and the companies
directly. However, in light of the problems identified in our June 2005
report and the report we issued for this committee, DOD has efforts
underway to revise its solicitation policies regarding such sales and has
reviewed ways in which it can legally share additional information with
financial regulators. However, DOD has not yet issued these new policies
or coordinated with its installation personnel or with regulators on
appropriate ways that additional sharing can occur. State insurance and
securities regulators also expressed concerns over whether their
jurisdiction over sales of financial products on military installations
was sufficiently clear.
Given the concerns over potentially inappropriate financial product sales
to military members, the need for definitive actions to better protect
service members appears overdue. The report we issued to this committee
recommends actions by Congress that are consistent with many of the
provisions that seek to improve protections for military members in the
bills that passed the House of Representatives and are under consideration
in the U.S. Senate.4 Because the features of the products being sold to
military members provided limited benefits to many military purchasers, we
believe that Congress should act to have all state insurance regulators
conduct reviews to ensure that only legal products are being sold to
military members and to have regulators work cooperatively with DOD to
develop standards that could help ensure that companies only market
products appropriate for the military members' needs and circumstances.
Similarly, given the wide availability of less expensive alternatives,
Congress should act to amend the Investment Company Act to ban the sale of
contractual plans. Because financial regulators' ability to adequately
oversee sales to military members was hampered by a lack of information
sharing about military members' complaints and concerns, we also
4See Military Personnel Financial Services Protection Act, H.R. 458, 109th
Congress (2005) and Military Personnel Financial Services Protection Act,
S. 418, 109th Congress (2005).
Costly Financial Products With Features Inappropriate for Military Members
Raise Sales Practice Concerns
recommend that Congress direct DOD to work with insurance and securities
regulators to overcome barriers to sharing information and to clarify that
state regulators have jurisdiction on military installations. In the
report prepared for this committee, we also recommend that DOD issue its
revised solicitation policies that will require military personnel to
share complaints with financial regulators. To improve oversight by state
insurance regulators, SEC, and NASD, we recommend that these organizations
designate specific members of their staff to receive complaints and
conduct outreach to proactively learn of problems involving military
members. In the event that contractual plans continue to be sold, we also
recommended that SEC and NASD improve the information they have to assess
the sales of contractual plans. DOD, SEC, NASD, and the National
Association of Insurance Commissioners (NAIC) provided comments on our
current report and indicated that they intend to take steps to consider
and implement our recommendations.
A limited number of insurance companies and broker-dealers are under
investigation for deceptive sales practices to target military members
with financial products that have features that reduce their benefit to
service members. Although most service members already receive
considerable low-cost life insurance as part of their government benefits,
state insurance regulators we contacted said that at least six insurance
companies have been selling a hybrid insurance product that combines life
insurance coverage with a side savings fund to thousands of service
members at installations across the United States and around the world.
For example, four of these companies were licensed to sell insurance in at
least 40 states, and the other two licensed in at least 35 states and five
of them had received DOD approval to conduct business at U.S. military
installations overseas. 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.
These products provide additional death benefits but are significantly
more expensive than other life insurance coverage available to service
members. For example, service members purchasing these products make
payments of about $100 per month for additional death benefits generally
ranging from $25,000 to $50,000. In contrast, all service members are
currently able to purchase $400,000 of life insurance through
Servicemembers' Group Life Insurance (SGLI) for $26 per month.5
Although the insurance products these six companies were selling also
included a savings component that recently promised to earn interest
between 6.5 and 8.1 percent, these products also included features that
reduced the likelihood that service members purchasing them would
accumulate large amounts of savings. As we reported, military members move
frequently and many leave the service after a few years, which which may
reduce their ability or willingness to continue making payments to fulfill
a long-term financial commitment. However, the products being marketed by
these insurance companies require a long series of payments to result in
significant benefits to their purchasers. For example, most of the
payments made in the earliest years-ranging from 1 to 7 years- would be
used to pay the premiums for life insurance coverage. In subsequent years,
more of the service members' payment would be allocated to the savings
component.6 In addition, these products also included features that
allowed the companies to use the money accumulated in a service member's
savings fund to automatically pay any unpaid insurance premiums. Although
this would extend the period of
5Previously, service members were automatically covered for the maximum
amount of $250,000 of insurance on their first day of active duty status,
unless they declined or reduced their coverage. Included in the Emergency
Supplemental Appropriations Act of 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), were provisions that increased this
amount to $400,000 effective September 1, 2005. This act also increased
the death gratuity paid upon a service member's death from $12,000 to
$100,000, under certain circumstances.
6For example, for a $100 monthly payment for the product sold by three of
the companies 100 percent of the first year's payments would be allocated
to the insurance premium. Between the second and the seventh years, 75
percent of the purchaser's total payment would be allocated to the life
insurance premium and 25 percent would allocated to the savings fund.
After 7 years, all of the total payment would be allocated to the savings.
Three other companies sold products that allocated 75 percent of the total
payment to the life insurance premium during the first year, followed by
25 percent in subsequent years.
time that these service members would be covered under the insurance
policy, data we obtained from several of these companies indicated that 40
percent or more of the service members that purchased these products
stopped making payments within the first 3 years. With regulators
indicating that most purchasers failed to request refunds of their saving
fund balance, few likely accumulated any savings as a result of their
purchase.
According to our analysis, the amount of time that it takes for a service
member's savings fund on these combined insurance and savings products to
become totally depleted through the automatic payment provision varied.
Figure 1 shows the impact on a service member who purchases the product
providing $30,000 of insurance coverage that requires full payment of the
total life insurance premimium during the first 7 years. As the figure
shows, the money in the savings fund of a service member who makes the
required $100 monthly payments for 4 years and then stops paying would be
totally depleted to pay the subsequent insurance premiums in just over 1
year. This occurs because of the large premiums due in the early years on
this type of policy, and because the accumulated value of the savings fund
for this product was modest. For the other type of insurance and savings
product typically being sold to military members, which involves lower but
continuous premium payments over the life of the policy, service members
who halt their payments after 4 years would have accumulated sufficient
savings 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 and invest the remainder 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.7
7While 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
Veterans' Group Life Insurance (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.
Figure 1: Total Approximate Future Values of Insurance Products' Savings
Fund and TSP with Payments Ceasing after Year 4
Dollars (in thousands)
The companies that market primarily to military members have been subject
to actions by state insurance regulators, the Department of Justice (DOJ),
DOD, and others. In the report we prepared for this committee, we
identified at least 17 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 have been accused of
inappropriate sales practices and agreed to settlements as part of
lawsuits or administration actions involving fines, refunds, and other
actions. For example, in December 2002, DOJ announced a settlement against
an insurance company that had marketed a combined insurance and saving
product primarily to military members in which the company paid a penalty
and agreed to no longer sell insurance in the United States. According to
the DOJ complaint, this company had allegedly defrauded
10 8
6
4
2
0 1 2 3 4 5 6 7 8 9 1011121314151617181920 Policy year
7-year premium product Continuous premium product SGLI with TSP
Source: GAO analysis.
Insurance Companies Accused of Inappropriate Sales Practices to Military
Members
military service members who purchased life insurance policies from the
company by having its agents pose as independent and objective counselors
representing a nonprofit fraternal organization that offered, as one of
its benefits, the ability to purchase the company's life insurance.
The insurance companies that marketed primarily to service members have
also been accused of violating DOD's own solicitation policies for many
years. For example, a 1999 DOD Inspector General report and a
DOD-commissioned report issued in 2000 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's 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. More recently, 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 group 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. As of August 11, 2005, this
web site listed 21 agents from some of the 6 companies that market
primarily to military members that are permanently barred-or have had
their solicitation privileges temporarily suspended-at 8 different
military installations.
Our own work also found that problems involving sales of insurance
products to military members appeared to be widespread. We reported in
June 2005 that DOD only recently began systematically collecting and
disseminating information on violations of DOD's solicitation policy by
sellers of financial products.8 However, as part of that report, we also
surveyed DOD personal financial training program managers and found that
nearly 37 percent believed that insurance company representatives had made
misleading sales presentations at their installations during 2004, with 12
percent believing that such presentations were occurring routinely. At the
two bases visited as part of work for this report, we also found evidence
that problematic sales to service members were occurring.
8GAO-05-696.
For example, our review of statements taken from 41 service members that
military investigators interviewed at one Army base indicated that more
than 70 percent of the service members said that the insurance sales
personnel had described the product being sold as a savings or investment
product rather than as insurance, which violates state insurance laws.
Additionally, many of these service members also described conduct that
appeared to represent instances in which insurance company sales personnel
had violated one or more of the restrictions in DOD's solicitation policy,
such as making these sales presentations during group training sessions.
In addition to these past actions, insurance regulators in as many as 14
states are also conducting examinations of these six insurance companies,
as well as others that market to military members. Among the issues that
regulators are investigating are whether representatives of these
companies have not been clearly identifying these products as insurance,
as state laws require, but instead marketing them as investments.
Regulators and other organizations are also examining whether the sellers
of these products are misrepresenting information on the forms used to
initiate pay allotments to deduct the payments for the products directly
from the service members' pay.
In addition, insurance regulators in some states are currently reviewing
whether these combined insurance and savings products that are being sold
to military members comply with all applicable state insurance laws and
regulations. For example, regulators in Washington state rescinded
approval to sell the products that had previously been approved for sales
by some of these companies because the savings component, which the
companies had been labeling as an annuity riders, was determined to not
meet that state's annuity regulations.9 Regulators in Virginia also
recently ordered three companies that marketed primarily to military
members to cease sales of combined insurance and savings products because
of concerns over whether these products adequately complied with that
state's insurance law. However, although these products may be marketed in
as many as 46 states, currently only 14 states are involved in such
reviews of the legality of these products. As a result, in the report we
prepared for this committee, we recommend that Congress act to have
9In 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.
insurance regulators in all states conduct reviews to ensure that the
products being marketed to military members adequately comply with state
insurance laws.
Companies also Selling Service Members a Mutual Fund Product with Features
that Reduce Its Benefit to Most Military Members
Large numbers of service members, including officers, were also purchasing
a unique securities product, known as a contractual plan, with features
that reduce its benefit to military members. Under the terms of the
contractual plans sold to military service members, they would be expected
to make monthly payments of a set amount for long periods, such as 15
years, that would be invested in the mutual funds offered by some of the
largest mutual fund companies. Under the terms of the contractual plan,
the broker-dealer selling the product deducts a sales charge (called a
load) of up to 50 percent from each of the first year's monthly payments
with generally no further sales load deductions thereafter. In contrast,
conventional mutual funds typically deduct loads that average 5 percent
from each contribution made into the fund. According to regulators, about
five broker-dealers accounted for the bulk of contractual plan sales to
military members. According to the marketing materials of the
broker-dealer that was the largest seller of contractual plans, this firm
had nearly 300,000 military customers, with an estimated one-third of all
commissioned officers and 40 percent of active duty generals or admirals
as clients. This firm also 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.
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.10 As illustrated
in Figure 2, if all 180 monthly payments are made under a contractual
plan, the effective sales load on the total investment decreases to 3.33
percent
10Many 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.
by year 15. However, if a purchaser of one of these plans stops making
regular investments earlier, the effective sales charge can be much
higher. For example, halting payments after 3 years results in an
effective sales load of 17 percent of the amount invested.
Figure 2: Mutual Fund Sales Load as a Percentage of Investment by Year
Percentage
50
40
30
20
10
0 1 2 3 4 5 6 7 8 9101112131415
Plan year
Traditional plan load
Contractual plan load
Source: GAO analysis.
At one time, contractual plans were the only way for small investors to
invest in mutual funds as in the past many mutual funds required large
initial investments, which 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.11 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
currently 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 over the
telephone, the Internet, or by mail.
Although contractual plans can provide benefits to those holding them for
long periods, many service members were not making the expected payments
and thus ended up paying more than had they invested in other
alternatively available products. Given military members' frequent moves
and with many leaving the service after a few years, regulators found that
most 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 broker-dealer that was
the largest marketer of contractual plans had completed the full 15 years
required under the contract-with many service members ceasing their
payments after about 3 years and thus effectively having paid sales loads
of 17 percent on their investment. Regulators found that customers of the
other broker-dealers marketing these plans were similarly or even less
successfully making all of the payments expected under the plan-for
example, at one firm only 10 percent of customers had made payments for a
full 15 years.
Contractual plans have been associated with sales practice abuses for
decades. Concerns about excessive sales charges and other abuses involving
these products during the 1930s provided the impetus for provisions in the
Investment Company Act of 1940 that limited the amounts that purchasers of
contractual plans could be charged. Additional
11The 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).
concerns involving contractual plans during the 1950s and 1960s also led
Congress to amend the Act in 1970 to further limit the maximum sales
charges and to provide a period in which purchasers could obtain refunds
of their investment. Firms marketing contractual plans have again been
accused of inappropriate sales practices. In December 2004, SEC and NASD
sanctioned the largest broker-dealer marketing these plans to service
members after alleging that the firm's marketing materials were
misleading. 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 noncontractual 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. This firm agreed to pay a total of about $12 million and has
voluntarily discontinued sales of contractual plan products. About $8
million of the total money paid by this firm is to be used to fund
financial education efforts for military members that are being developed
and administered by NASD. Regulatory examinations of the other four
smaller broker-dealers that continue to sell contractual plans are
continuing.
Given the longstanding history of sales-practice abuses associated with
the contractual plans and the availability of viable alternative
investments, we believe that Congress should act to ban the further sale
of contractual plans. The bills currently under consideration in the
Congress include language that would amend the Investment Company Act of
1940 to render sales of such plans illegal, thereby removing from the
market a product that appears to have little need to continue to exist.12
12S. 418, Sec. 3, and H.R. 458, Sec. 102.
Lack of DOD Complaint Sharing Hampered Regulators' Ability to Identify
Problems Involving Sales to Military Members
Additional actions by Congress, DOD, and regulators also appear warranted
to improve the effectiveness of insurance and securities regulators in
overseeing sales of financial products to military members. As we
reported, the ability of insurance and securities regulators to identify
problems involving sales to military members was hampered because DOD
personnel were not generally sharing service member concerns and
complaints. In addition to conducting routine examinations, insurance and
securities regulators use complaints from financial firms' customers as an
indicator that problems involving particular products, or the practices of
particular firms, exist. For example, state insurance regulators conduct
various types of reviews of the insurance companies they oversee,
including reviews focusing on insurance companies' financial soundness.
Regulators in some states also review some aspects of insurance product
sales as part of market conduct examinations that may involve reviews of a
range of company practices, including sales, underwriting, and claims
processing and payment. 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.
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, under most state insurance laws, insurance
regulators do not have the authority to evaluate whether the product sold
to a military member was appropriate or suitable given the customer's
needs. State regulators and others have previously attempted to establish
suitability standards for insurance products, but these efforts have had
limited success. For example, a NAIC working group originally formed to
develop suitability standards to apply to all insurance sales instead
concluded its efforts by developing standards that applied only to the
sale of annuity products to seniors age 65 and over.13
To reduce the likelihood that service members will be marketed products
inappropriate to their needs, in the report we prepared for this
committee, we recommend that Congress act to have insurance regulators
work
13Other 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.
cooperatively with DOD to develop suitability or appropriateness standards
that would apply to the sale of financial products to military members.
The bills being considered in the U.S. Senate include provisions to have
these parties work together to develop such standards.14 Such 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 and income levels. Having such standards
could also provide protection for service members that are located in
overseas installations not directly overseen by state regulators.
Securities Regulators Also Hampered by Lack of Complaints Involving
Military Members
Similarly, the ability of SEC and NASD to identify problems involving
sales by broker-dealers to military members was also hampered by the lack
of complaints from DOD and for other reasons. For example, previous SEC
and NASD examinations of the largest marketer of contractual plans had not
identified any significant problems. However, staff from these
organizations 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.
The 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, SEC examiners had obtained data
from the largest broker-dealer 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.
However, after press reports appeared, NASD and SEC examiners reviewing
this firm's operations found that the firm maintained various sets of data
on its customers' activity. However, these various sets did not always
include all customers' information, which made regulators' efforts to
definitively determine the extent to which this firm's customers were
continuing to make payments and successfully completing their plans more
difficult. By further analyzing the data, the regulators determined that,
by excluding any customer whose account remained open but had not made any
payments in the last year, the actual extent to which this broker-dealer's
customers were successfully completing their contractual plans was only 43
percent. As a result, the report we prepared for this committee recommends
that, if contractual plans continue to be sold, SEC and NASD should
consider ways (such as through revised examination procedures or
recordkeeping rules) to ensure that they obtain
14S. 418, Sec. 9, and H.R. 458, Sec. 108.
better information on the extent to which broker-dealer customers are
successfully making their payments.
DOD Acting to Improve Sharing with Financial Regulators but Not All
Efforts Complete
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. A primary way
that DOD attempts to protect service members from inappropriate sales is
through its directive on commercial solicitation on military
installations.15 DOD staff within the Office of the Under Secretary of
Defense for Personnel and Readiness are revising this directive and, in
April 2005, sought public comments on a revised version that incorporates
new requirements. For example, the revised directive would expressly
prohibit insurance products from being sold as investments. The draft of
the revised solicitation directive includes provisions that would also
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. In our June 2005 report, we
recommended that DOD create a database of all violations of its
solicitation policy. DOD has collected and posted some of this information
to a web site available to its personnel and others. The bills under
consideration in the Senate would further require DOD to promptly notify
insurance and securities regulators of those individuals or companies
whose solicitation privileges have been suspended, limited, or revoked by
DOD installations.16 In our June 2005 report, we also identified various
improvements that DOD has agreed to make to its oversight of insurance
purchasers by military members, including the regulations governing the
pay allotment process. We summarize these findings and DOD's proposed
improvements in appendix I of this statement.
Although DOD personnel had not routinely shared service member complaints
with financial regulators in the past, DOD officials have told us that
they intend to require their personnel to report more of this 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
15DOD Directive 1344.7, Personal Commercial Solicitation on DOD
Installations (Feb. 13, 1986).
16S. 418, Sec. 11, and H.R. 458, Sec. 110.
that was published for comment also lacked any provisions relating to such
information. In addition, when we issued our June 2005 report on DOD's
insurance solicitation oversight, DOD was reluctant to provide information
to regulators beyond indicating that DOD installations had suspended or
revoked a given firm's or individual's solicitation privileges or that the
violations involved the eligibility of the agent to hold a State license
or meet other regulatory requirements.17 However, staff in the office that
oversees the policy directive told us more recently that 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. DOD has
not, as of yet, issued this new directive. To ensure that financial
regulators have critical information that they need to identify
problematic products and sales practices, the report we prepared for this
committee recommends that DOD issue a revised DOD solicitation policy
directive that would require that information on service member complaints
related to financial product sales be provided to relevant state and
federal financial regulators.
DOD and financial regulators have also worked together to increase
education for military members. For example, NAIC and DOD personnel have
worked to together to develop a brochure that can be distributed to
service members that describes insurance products and lists the state
regulatory organizations to contact if they have concerns. In addition,
NASD was cooperated with DOD personnel as part of developing the education
campaign that is being planned using the money from the broker-dealer
contractual plan settlement.
However, DOD has not acted to fully address potential barriers to
increased sharing with financial regulators. For example, securities
regulatory staff told us that while they were conducting their
investigations of contractual plan sales, personnel at some DOD
installations were reluctant to share any information involving specific
service members for various reasons. According to these regulators, the
17In response to our June 2005 report (GAO-05-696), DOD also concurred
with several other recommendations we made, including agreeing to clarify
the policy in the revised solicitation directive relating to the "cooling
off" period before processing allotments for insurance, improving its
database of insurance allotments, and reminding all installations of the
policies related to initiating or changing allotments. Our findings on
these issues are discussed in appendix 1.
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 DOD has
researched these legal issues and now 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
military installation personnel and financial regulatory staff understand
how additional sharing could appropriately occur
To ensure that financial regulators have critical information that they
need to identify problematic products and sales practices, the report we
prepared for this committee recommends that Congress direct DOD to develop
mechanisms to overcome any barriers and coordinate with its installation
personnel and with financial regulators on ways to share additional
information about problematic financial firm practices and service member
concerns. Our report further recommends that insurance regulators, SEC,
and NASD designate specific staff that would receive complaints from DOD
and conduct outreach with military installations to proactively learn of
issues or concerns involving product sales.
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."18 For example, a Texas insurance
department official told us that he had trouble getting access to
complaints information at a military installation because installation
personnel questioned his authority to
18When 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.
request such information. 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.19 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. 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.
As a result, the report that we prepared for this committee also
recommends that Congress consider acting to clarify the jurisdiction of
state regulators over sales of financial products 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 offers and sales are generally applicable to any
such activities 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 activities.20
Mr. Chairman, this concludes my prepared statement and I would be happy to
respond to questions you or other members of the Committee many have.
GAO Contacts and For further information regarding this testimony, please
contact Richard J. Acknowledgements Hillman (202) 512-8678. In addition,
others making key contributions to
19GAO 05-696.
20S. 418, Sec. 6(a), and H.R. 458, Sec. 105(a).
this statement included Cody Goebel, Assistant Director; Jack Edwards,
Gwenetta Blackwell-Greer; Tania Calhoun; Barry Kirby; and Josephine Perez.
Appendix I: Additional Actions Needed to Improve Oversight of Pay
Allotments for Insurance for Military Members
As a result of a report we issued in June 2005, the Department of Defense
(DOD) has agreed with our recommendations to improve aspects of its
oversight of insurance purchases by military members. 1 At the request of
the chairs of the House Committee on Government Reform and House Committee
on Armed Services as well as various other members of the House of
Representatives, we reviewed DOD's procedures to oversee the sale of
insurance products to military members, including the procedures used to
process pay deduction allotments to pay for insurance products.
Based on the work we conducted, we determined that DOD was not able to
monitor the extent to which service members were purchasing supplement
insurance because of problems with its personnel pay databases. Pay
information for service members is maintained by the Defense Finance and
Accounting Service (DFAS) in separate databases for the different military
services. However, we were not able, even with DFAS assistance, to use
information from these databases to reliably determine the extent to which
service members had purchased additional insurance. For example, the codes
in the databases used to identify an insurance company are not the same
for all services. Further, DOD and service regulations permit the use of
at least seven different allotment forms, but not all of these forms
explicityly identify which allotments are for supplemental life insurance.
A major cause of these database-related problems is DOD's systems
supporting service members' pay, which we had previously found
unreliable.2 While a significant system enhancement project is under way
to improve the administration of military pay, DOD is likely to continue
operating with existing system constraints for several years. The
continued use of forms that do not require information and coding specific
to supplemental life insurance could cause allotment data to continue to
be unreliable for oversight purposes.
The absence of accurate data on the extent to which service members are
purchasing supplemental life insurance limits the ability of DOD policy
officials and installation solicitation coordinators to oversee such sales
1GAO 05-696.
2See GAO, DOD Systems Modernization: Management of Integrated Military
Human Capital Program Needs Additional Improvement, GAO-05-189
(Washington, D.C.: Feb. 11, 2005), and GAO, Military Pay Army National
Guard Personnel Mobilized to Active Duty Experienced Significant Pay
Problems, GAO-04-89 (Washington, D.C.: Nov. 13, 2003).
and ensure that all relevant DOD policies are being followed. For example,
the lack of accurate data prevents DOD personnel from readily identifying
whether service members at a particular installation have submitted an
unusually large number of new allotments for supplemental life insurance
during a short period, which could indicate that a mass solicitation to
recruits or trainees has occurred in violation of DOD's personal
commercial solicitation policy directive.3
As a result, our June 2005 report recommended that DOD determine what
current and future modifications should be made to the regulations, forms,
and procedures used to initiate and electronically capture supplemental
life insurance allotments so that more useable data are available to the
DOD, service, and installation offices responsible for overseeing
supplemental life insurance solicitation. In its comments on a draft of
our report, DOD concurred with this recommendation and stated that the
department will consider our proposed changes for a future enhancement of
their pay system and will review the regulations and forms to determine
what further modification should be made.
Based on our work, we also found that weaknesses in DOD's regulations and
forms prevented it from determining the extent to which its personnel
adhere to allotment regulations. For junior enlisted service members (pay
grades E-l to E-3), the DOD directive on personal commercial solicitation
requires that at least 7 days elapse before the allotment is to be
processed to allow these members to receive counseling about the purchase
of the supplemental life insurance. However, contrary to the regulation,
we found that some DOD financial personnel were accepting allotment forms
to start supplemental life insurance without verifying that a cooling-off
period had elapsed.4 Currently, the allotment forms that service members
use to start supplemental life insurance do not require certification that
the required cooling-off period and, possibly, counseling have occurred.
The absence of this information from allotment forms prevents finance
personnel from readily determining whether the 7 days have elapsed before
they certify the allotment. In addition, ambiguities in the language of
the solicitation policy directive may have also led to improper allotment
processing. For example, the directive was not clear as to whether the
3DOD Directive 1344.7.
4This cooling off period can be waived. For example, the directive states
that the purchaser's commanding officer may grant a waiver of this
requirement for good cause, such as the purchaser's imminent permanent
change of station.
counseling is required or optional during the cooling-off period. In
addition, the directive and the standard allotment forms do not contain
procedures for documenting whether the counseling took place.
To ensure better compliance with the directive, our June 2005 report
recommended that DOD clarify the requirements relating to the cooling-off
period in its upcoming revision to the solicitation policy directive, and
thereby eliminate the ambiguities about its requirements. In its comments
on a draft of our report, DOD concurred with this recommendation and
stated that it had identified an additional ambiguity in the current
revised directive regarding who is responsible for monitoring and
enforcing the cooling-off period for supplemental life insurance
purchases. It indicates that the proposed revision to the directive will
address these issues.
We also found DOD personnel were not consistently complying with
regulations relating to ensuring that allotments were appropriately
authorized. According to DOD's Financial Management Regulation,
establishment of, discontinuance of, or changes to existing allotments for
supplemental life insurance are to be based on a written request by a
service member or someone with a special power of attorney on behalf of
the service member.5 However, DOD personnel and insurance agents indicated
that some offices accepted allotment forms personally submitted by
insurance agents or through the mail with only the signature on the form
serving as proof that the service member initiated the allotment. For
example, finance office personnel at Naval Station Great Lakes said that
about half of all insurance allotment forms submitted to and processed by
their office came from insurance agents. In addition, we reported that a
life insurance agent was alleged to have submitted allotment forms at Fort
Bragg for service members who later said they had not wanted the policies
for which they were paying. Finance personnel said they accepted allotment
forms in this manner to ensure that polices start promptly, but starting
allotments without service members' awareness can negatively affect
members' finances and their unit's morale and readiness.
5DOD, Financial Management Regulation 7000.14-R, Vol. 7A, Chapter 41, sec.
410801. This regulation allows most financial allotments to be established
though MyPay, DOD's automated payroll program. MyPay allows service
members to start, stop, or change allotments with financial institutions
when the funds are directed to be sent to a savings or checking account.
MyPay is not intended to be used for allotments to purchase supplemental
life insurance. Use of MyPay to establish a supplemental insurance
allotment makes it impossible for installation officials to monitor or
enforce the proper use of insurance allotments and other parts of the
on-installation personal commercial solicitation requirements.
To ensure that allotments are properly authorized, our June 2005 report
recommended that DOD issue a message to all finance offices and DFAS
offices that process allotments for supplemental life insurance to remind
personnel that DOD's Financial Management Regulation indicates that only
service members or their designated representatives with special power of
attorney for the prescribed purpose are authorized to start, stop, or
modify financial allotments. In its comments on a draft of our report, DOD
concurred with this recommendation and stated that it will issue such a
statement.
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