Protecting grandpa from investing peril

Congress wants states to beef up oversight of firms that sell annuities to seniors. The plan: Cash grants to states that go along.

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By Jennifer Liberto, CNNMoney.com senior writer

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WASHINGTON (CNNMoney.com) -- Congress wants to help protect seniors who buy complex investment products that they don't understand or may do more harm than good.

A little-noticed proposal would set aside $8 million for states that bulk up oversight. It was buried last week in a 1,136-page Senate bill to reshape the financial system. A House bill contains a similar proposal.

States could get as much as $500,000 apiece to investigate and prosecute fraud against seniors, but only if they agree to strengthen their laws to match national consumer protection standards.

"You're dealing with situations that are very tough to enforce," said Sean Dilweg, the Wisconsin insurance commissioner. "It's so important to have strong standards."

The legislative language mostly targets annuities - contracts in which customers pay a lump sum upfront in exchange for monthly income over time.

As the financial crisis has wreaked havoc on nest eggs, more retirees have turned to annuities and other life insurance products as alternatives to stocks.

Annual sales of fixed annuities increased 50% in 2008 to $109.3 billion, according to the Insurance Information Institute. (In fixed annuities, customers give a lump sum and get income set at a fixed interest rate over a specific period of time.)

While many types of life insurance and annuities can be useful for seniors, they can also be complex. And the number of seniors getting ensnared in products they don't understand is on the rise, consumer watchdogs say.

"The policyholder has to become an expert to ever get the message," said Joseph Belth, an insurance professor emeritus at the Indiana University Kelley School of Business. "In the case of some annuities, the people selling them do not understand them, let alone the people buying them."

Confusion and sometimes fraud

Problems often arise when seniors don't understand what they have bought.

That happened to George Adam of Lake Placid, Fla.

Adam and his wife, Jeanne, cashed in $57,000 in an IRA fund and bought variable annuities tied to the mutual fund PBHG Funds. When the founders of that fund were charged with fraud, the fund tanked. And George and Jeanne Adam lost it all.

"I had no idea what an annuity was. I didn't know I had bought them. I didn't know they weren't guaranteed," said George Adam, 73. "And I didn't know the man who came to our door was actually an insurance salesman."

Some annuities come with high fees if the purchaser withdraws his underlying investment before a certain period of time has lapsed.

Dilweg, the Wisconsin regulator, recently revoked the license of a life insurance agent from Two Rivers, Wis. The agent had tied up most of an 88-year-old customer's nest egg - some $450,000 - in annuities that charged up to 25% of her investment if she withdrew money in the first 15 years.

In another recent case, a North Carolina man was charged with allegedly embezzling $2.6 million. Charles Mark Hall, 50, of Smithfield, N.C., is charged with, among other things, selling three annuities worth $168,000 to a 90-year-old woman and then convincing her to surrender the investment to him, according to the North Carolina Office of Insurance. His attorney declined to comment on his case but said he's working with investigators.

Stronger oversight

State and federal officials have already started looking into how they can strengthen oversight of annuities, but regulation is patchwork state by state.

Fixed and equity-indexed annuities are regulated by state insurance agencies. The Securities and Exchange Commission regulates variable annuities, which are considered securities. The SEC is trying to wrestle oversight of equity-indexed annuities away from the states, but that effort is stuck in court.

To crack down on bad actors, officials want to establish clear definitions of sales practices suitable for seniors.

The Senate push is being led by Sen. Herb Kohl, D-Wis., chairman of the Special Committee on Aging. Kohl wants to create a tough national standard and use the federal grants as a carrot to states that meet them.

But the American Council of Life Insurers, which represents 95% of annuities issuers, doesn't like the standard Kohl is advocating.

The lobbying group generally endorses the idea of providing consumers with more information but would prefer going about it in a different way.

"It seems like what he's attempting to do is going to set too high a bar for the states to cross," said Jack Dolan, spokesman for the insurance group.

Despite the push back, the proposed tougher oversight of annuities is poised to make a big leap forward because it's hitching a ride on high-profile regulatory reform legislation - a top priority for the Obama administration.

The House Financial Services Committee approved a version of the legislation earlier this month, and the Senate will start considering it later this week. To top of page

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