Background

Members of the U.S. military serve in different branches in locations across  the country and around the world. The various branches within DOD  include the Department of the Air Force, the Department of the Army, and  Department of the Navy, which also incorporates forces of the Marine  Corps. DOD also oversees the members of the Coast Guard along with the  Department of Transportation. As of 2004, approximately 1.4 million active  duty military personnel served in the various branches in more than 6,000  locations. In addition, 2 million retirees receive pay and benefits from the  department. DOD is also the largest employer and trainer of young adults in  the United States, recruiting about 200,000 individuals into active duty in  2004—the majority of them recent high school graduates. As shown in  figure 1, the pay of typical junior enlisted staff—grades E-1 through E-3— ranges between $1,143 and $1,641 per month.
Entry-level military personnel are generally young and have limited  education and incomes. A 2002 private research organization report that  examined the financial situation of military members noted that the  military hires primarily young, untrained, entry-level employees.   Comparing data from various surveys done of large numbers of civilians  and military members, this report found that less than 5 percent of junior  enlisted personnel held bachelor’s degrees compared to 27 percent of the  civilians. In terms of income, this report found that 87 percent of junior  enlisted personnel had total monthly family incomes of $3,000 or less.  However, a DOD commission that reviews military compensation has  found that military members are paid at the 70th percentile or higher of  comparably educated civilians. In addition, military members receive  housing and subsistence benefits, with about half living in on-base housing  and many having access to military facilities that provide meals.
Various aspects of the military life can increase the challenges that service  members face in managing their finances. According to the private  research report, factors that appeared to increase the financial distress  among military members were the family separations resulting from  changes in duty stations and deployments away from home. According to  our report on military relocations, DOD reported that about one-third of all  military members make Permanent Change of Station (PCS) moves every  year. The average length of time spent at each location can also be brief,  with 20 percent of such relocations lasting less than 1 year and about 50  percent lasting 2 years or less. Leaving or retiring from the service also  represents the last major transition in a service member’s career, with data  indicating that most enlisted personnel leave after their initial duty  commitment.
As with their civilian counterparts, military service members may be  offered various types of financial products, including life insurance. Types  of life insurance commonly sold include term, whole, universal, and  variable life insurance products. Many companies offer term life insurance,  which generally provides basic death benefits for a specified time period,  such as 10 or 20 years.  At the end of this term, the insured can usually  renew the coverage at a higher premium rate for another set term period.  The coverage on a term policy may also end if the insured person ceases  making the required periodic premium payments. Under a whole life policy,  an insured person can make level premium payments, which will provide  the specified amount of death benefits. Because the premium generally  stays the same throughout the time that the policy is in force, premiums for  whole life insurance are generally higher initially than for comparable  amounts of term life coverage. Whole life insurance policies can build cash  value, which can be borrowed upon, though this will reduce death benefits  until the loan is repaid in full. Some whole life policies are known as  “modified whole life insurance” in which the policyowner pays a lower than  normal premium for a specified initial period, such as 5 years, after which  time the premium increases to a higher amount that is payable for the life  of the policy. Universal life products may also provide permanent  insurance—like a whole life policy—but may also offer their purchasers  more flexibility. Under such policies, the holder can vary the amount of the  premium to build up the cash value of the policy by increasing the amount  of the payment, or can pay less into the policy at other times, when money  is needed for other purposes. Similarly, under a variable life policy, a cash  value accumulates that can be used to invest in various instruments, such  as common stocks, bonds, or mutual fund investments. However, with a  variable life policy, the policyholder (and not the company) assumes the  investment risk tied to the product. If these investments perform well, the  death benefits paid on the policy can increase; conversely, if the  investments perform poorly, the purchaser may have to increase their  premiums to keep the policy in force.
The federal government offers service members life insurance as part of  their total benefits package. Each member is eligible for inexpensive  coverage under Servicemembers’ Group Life Insurance (SGLI), which  provides group term life insurance. Until September 1, 2005, service  members were automatically covered for the maximum amount of $250,000  of insurance on their first day of active duty status, unless they decline or  reduce their coverage, but Congress has now increased this amount to  $400,000. Service members leaving the military can also opt to continue  coverage through the government-sponsored coverage provided to  veterans. Although many life insurance policies exclude coverage for  deaths resulting from acts of war, these government-sponsored policies do  not contain this exclusion.
State government entities are the primary regulators of insurance  companies and agents in the United States. When first establishing  operations, an insurance company must obtain a charter or license in order  to write business in a state. This state becomes its state of domicile.  Insurers may obtain approval to market products in multiple states, and  therefore the sales by insurers can be overseen by multiple state regulators,  though financial solvency of each company is primarily overseen by the  regulator in the company’s state of domicile. Some insurance companies  market their products using their own proprietary sales force. Some  companies may also use agents employed by independent firms who may  be marketing the products of multiple companies to their customers. The  state insurance regulators oversee the insurance companies and agents  that do business in their jurisdictions in several ways, including reviewing  and approving products for sale and examining the operations of  companies to ensure their financial soundness or proper market conduct  behavior.
Although each state has its own insurance regulator and laws, the National  Association of Insurance Commissioners (NAIC) provides a national forum  for addressing and resolving major insurance issues and for allowing  regulators to develop consistent policies on the regulation of insurance  when consistency is deemed appropriate. This association consists of the  heads of each state insurance department, the District of Columbia, and  four U.S. territories. It serves as a clearinghouse for exchanging  information and provides a structure for interstate cooperation for  examinations of multistate insurers. NAIC staff also coordinate the  development of model insurance laws and regulations for consideration by  states. Its staff also review state insurance departments’ regulatory  activities as part of its national financial accreditation program.
To meet their financial investment needs, military members may also be  offered various securities products. These can include stocks issued by  public companies that are traded in various markets, or debt securities,  such as bonds that provide interest income to their holders. A common  securities product that many investors purchase is a mutual fund. Mutual  funds are investment companies that pool the money of many investors,  and then invest them in other assets, such as stocks or bonds. By holding  the shares of the mutual fund, investors can benefit from owning a broad  portfolio of diversified securities managed by professional money  managers, whose services they might otherwise be unable to obtain or  afford. Investors are charged mutual fund fees, which cover the day-to-day  costs of running a fund. Mutual funds are sold through a variety of  distribution channels. For instance, investors can buy them directly by  telephone or mail, or they can be sold by sales forces, such as the account  representatives of third party broker-dealers. Some mutual funds assess  sales charges (also called “loads”), which are generally paid at the time of  purchase to compensate these sales personnel.
Securities—and the firms that market them—are overseen by various  regulators. At the federal level, the Securities and Exchange Commission  (SEC) oversees securities issued by public companies. The firms that  market securities to investors, known as broker-dealers, must also register  and subject themselves to SEC oversight. This includes complying with  various requirements for regulatory reporting, financial soundness, and  sales practice regulations designed to protect investors. In addition to  oversight by SEC, broker-dealers also are overseen by private entities  known as self-regulatory organizations. The New York Stock Exchange and  NASD (formerly called the National Association of Securities Dealers) are  two examples of such organizations. State regulators also oversee  securities activities.
Congressional concerns over the adequacy of military member’s financial  literacy and the processes in place to address financial product sales have  prompted recent reviews and legislative actions. In response to a  Congressional committee’s request to review military members’ financial  condition, we recently reviewed and reported on the financial condition of  active duty service members and their families. We also reported on DOD’s  efforts to evaluate programs to assist deployed and non-deployed service  members in managing their personal finances and the extent to which  junior enlisted members received required personal financial management  training. As part of this study, we found that the financial conditions of  deployed and non-deployed service members and their families are similar,  but deployed service members and their families may face additional  financial problems related to pay. We also found that DOD lacks an  oversight framework for evaluating the effectiveness of its personal  financial management training programs across services, and that some  junior enlisted service members were not receiving personal financial  management training required by service regulations. In addition, we  reviewed and reported on the extent of violations of DOD’s policies  governing the solicitation of supplemental life insurance to active duty  service members and DOD personnel’s compliance with procedures for  establishing payroll deductions (commonly referred to as allotments) for  supplemental life insurance purchases. The findings of this review are  discussed later in this report.
In response to concerns over the sale of questionable financial products to  military members, the House of Representatives passed legislation in 2004  and 2005 requiring additional protections for service members. In  February 2005, a similar bill was introduced in the U.S. Senate. Both bills  contain various congressional findings, including the finding that military  members are being offered high-cost securities and life insurance products  by some financial services companies engaging in abusive and misleading  sales practices. According to the bills, Congress finds that the regulation of  these products and their sale on military bases has been clearly inadequate  and requires congressional legislation to address these issues. These bills  have been referred to the Senate Committee on Banking, Housing, and  Urban Affairs for further consideration.

	Sales of Costly Insurance Products to Service Members Raise Sales Practice Concerns

A limited number of insurance companies that appear to target junior  enlisted military members nationwide and around the world have sold  certain costly, problematic insurance products, sometimes using  inappropriate sales practices. These insurance products combine life  insurance coverage with a side savings fund. The insurance products  typically provide small amounts of death benefits and are considerably  more costly than coverage offered to service members by the government  or other private firms. Although they combine insurance with a savings  component promising high returns, many military personnel did not benefit  because any savings accumulated on these products can be used to extend  the insurance coverage if service members ever stop making payments and  fail to request a refund of their savings. A number of financial regulators  are also investigating the claims that these companies have been using  inappropriate sales practices when soliciting military members, including  examining allegations that agents have been inappropriately marketing the  insurance products as “investments.” Some of these companies have also  been subject to past disciplinary actions by insurance regulators and for  violations of DOD regulations governing commercial solicitation on  military installations.

		Small Number of Firms Are Targeting Junior Military Personnel with Expensive Insurance Products with Adverse Provisions

According to state insurance regulators we contacted, at least six  insurance companies were marketing products combining insurance and  savings funds with provisions that reduce the likelihood that military  purchasers would accumulate any lasting savings with such products.  These state insurance regulators are currently reviewing the operations of  these companies. Several of these companies share common ownership,  with three owned by the same firm and two others having key executives  from the same family. These companies operate extensively throughout the  United States, with four licensed to sell insurance in at least 40 states, and  the other two licensed in at least 35 states. In addition, as of July 2005, DOD  approved five of these companies 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.

			Products Couple High-Cost Insurance with a Savings Component Promising High Rates of Return

The insurance companies that target military service members are  primarily marketing a hybrid product that combines a high-cost insurance  policy with a savings component. According to insurance regulators we  contacted, and company marketing materials that we examined, the  insurance component generally consists of either a term or modified whole  life policy that would provide death benefits generally ranging from $25,000  to $50,000 for premiums of approximately $100 per month in the first year  with different variations in the premium amounts for subsequent years,  depending on the product. In addition to the insurance component, part of  the total monthly payment is allocated to a savings fund. Based on our  review of these products, most (or all) of the service member’s payments in  the first year are applied to the insurance component of the product. In  subsequent years, more money is allocated to the savings fund to varying  degrees, depending on the specific product.
The companies marketing these products advertised that they paid  relatively high rates of return on these savings funds. At the time we  conducted our work, all of the companies were promising to pay 6.5  percent interest, or higher, on the savings fund portions of their products  with a minimum of no less than 4 percent interest guaranteed. In contrast,  as of August 30, 2005, the average national interest rate paid for a money  market account was 2.16 percent. Company officials also told us that in  the past they had paid much higher interest rates. For example, one  company’s marketing materials for their product stated that over the past  25 years they had paid an average rate of 11.4 percent on the savings fund.  Further, another company’s marketing material stated that their saving  fund interest rate for the past 10 years averaged over 10 percent.
The six companies that were marketing primarily to military members were  selling two primary variations of these combined insurance and saving  products. Three of the companies sold a product that provided 20 years of  term life insurance. However, the premium payments for this product were  structured so that purchasers would pay for the entire 20 years of life  insurance coverage within the first 7 years. As a result, most of the service  member’s monthly payment for the first 7 years was allocated to the life  insurance premium, not the savings fund. After the seventh year, all  subsequent payments are to be deposited into the savings fund. In addition,  this product also promised the full return of the total premiums paid for the  insurance at the end of the 20th year, although state insurance regulators  told us they were not aware of any policies that had reached this 20-year  point and received this refund. Figure 2 provides an example of how the  payments would be allocated for a service member purchasing this “7-year  premium” term insurance product, assuming a monthly payment of $100  and a savings portion crediting the guaranteed 4 percent simple interest  paid annually.
Three other companies marketing primarily to military members sold other  variations of the combined insurance and savings product. Generally, these  products combined a modified whole life insurance policy with a savings  fund. Under the basic terms of these products, most of the service  members’ first year’s payments would be applied to the life insurance  premium and the remainder allocated to the savings fund. From the second  year on, the allocation proportions reverse where most of the money is  applied to the savings fund. Premium payments on these products could  continue for the life of the purchaser, although the face value of the death  benefit would be reduced to half its initial amount after a certain period or  when the policyholder reached a certain age, depending on the product.  Figure 3 provides an example of how the payments could be allocated for a  service member purchasing this type of product with a $100 total monthly  payment and 4 percent simple interest credited on the savings fund.
These insurance products also cost significantly more than other life  insurance coverage available to service members. Prior to September 2005,  all service members could purchase $250,000 of term life insurance through  SGLI for $16.25 per month. Since September 1, 2005, the total coverage has  increased to $400,000 for $26 per month. According to the Department of  Veterans Affairs, which administers the SGLI program, 98 percent of all  service members opt to receive this coverage. After leaving the service,  service members can convert their SGLI coverage to a Veterans’ Group Life  Insurance (VGLI) policy which now also provides up to $400,000 of low- cost term life insurance for veterans, with rates dependent upon age. For  example, veterans between the ages of 40 and 44 years of age can purchase  $50,000 of life insurance for less than $10 per month. In addition to  government-sponsored coverage, service members can also purchase  similar coverage, including covering combat deaths, from other insurance  companies. For example, according to officials of one company that sells  insurance and other financial products to military personnel directly, they  could provide a 20-year-old service member an additional $250,000 of life  insurance to supplement SGLI for $15 to $20 per month.
In addition to being many times more expensive than other products  already available to military members, companies have been selling  insurance products to service members who generally do not appear to  need additional life insurance, according to state regulators we contacted.  These regulators also said the companies that targeted military members  typically marketed their products to junior enlisted service members, who  often have no dependents. During our review, we obtained data from the  Defense Finance and Accounting Service (DFAS), which maintains military  personnel pay records, indicating that most service members that appeared  to have purchased life insurance products from some of these insurance  companies had no dependents. For example, according to DFAS data on  Marine Corps service members, over 6,500 pay deduction allotments to  send premium payments to banks used by three of these insurance  companies, starting between July 2004 and June 2005, indicated that  approximately two-thirds were unmarried service members with no other  dependents. Data available from other Services on allotments sent to these  insurance companies during the same period also indicated that most of  the service members had no dependents. Regulatory officials we contacted  noted that the amount of coverage available to these members from SGLI  would likely be adequate for their insurance needs, and thus no additional  insurance coverage would be necessary.
Officials with one of the companies that targeted military members told us  that the insurance they sell has benefited some service members. For  example, their company has paid $37 million in death claims for service  members in the last 5 years, including $1.5 million to survivors of service  members killed in the recent conflict in Iraq.

			Certain Product Provisions Prevented Many Service Members from Receiving Favorable Investment Returns

The insurance products with combined insurance and savings components  being sold by several companies to service members had provisions that  reduced their benefits to purchasers that could not--or did not--pay into the  product for a long-term period. According to regulators we contacted and  our review of selected policies, the products being sold by at least six  companies had an automatic premium payment provision, which allows  the companies to use money accumulated in the service member’s savings  fund to automatically pay any unpaid insurance premiums. The provision  extends the period of time that the service member is covered under the  life insurance policy if the service member does not proactively contact the  insurance company to cancel the insurance policy and request a refund of  the savings fund. After the automatic premium payment provision is  triggered and the savings fund becomes depleted, the policy then  terminates, or lapses. Regulators we contacted were critical of the impact  that this provision can have on purchasers of these products. For example,  an official at one state regulatory agency described this provision as  allowing the company to “parasitize” the savings fund for its own benefit. In  contrast, representatives of one company told us that this provision allows  the service member to receive extended life insurance coverage.
Many military members that purchased these products only made their  payments for a short period of time. State insurance regulators we  contacted believed that most service members that purchased these  products from these companies stopped making payments within the first  few years, and that the lapse rates were significantly higher than industry  norms. During our review, we received data on the percentage of policies  that lapsed or terminated during the first year on products offered by four  insurance companies that substantiated lapse rates above industry  averages. For instance, information we obtained from one company that  targets the military market segment indicated that approximately 40  percent of products purchased had lapsed or terminated within the first  year. Data provided to us from three other firms indicated that the majority  of policies had lapsed after being held between two and three years.
The characteristics of the military population that these companies were  marketing to increases the likelihood that service members will stop  making payments and not receive any savings they have accumulated in  these products. Regulatory officials we spoke with said that one of the  reasons so many service members discontinue making payments is that  they leave the service and thus the automatic deductions of their premium  payments to these companies also stop. Company officials we spoke with  told us that service members ceasing payments can request and receive  refunds of the amounts accumulated in their savings accounts. However,  according to regulators we contacted, companies do not always receive  such requests from service members at the time payments cease.  According to these regulators, many service members may not have  received refunds of any accumulated savings given that such funds are  automatically depleted to pay for the insurance policy for an extended  period until such amounts were exhausted. As a result, many of the service  members who simply stop paying into the product likely did not receive  any of the money they had paid into the savings portion of the product. As  such, they obtained some extended life insurance coverage after their  payments ceased that, as shown previously, was more expensive than  insurance they already receive and that they would not likely have  purchased except for the promised savings provision.
According to our analysis, the amount of time that it takes for a service  member’s savings fund on the products these six companies were selling  with a monthly payment of $100 to become totally depleted through the  automatic payment provision varied. Figure 4 shows the impact on a  service member that purchases the 20-year term life product with the 7- year premium period with $30,000 of insurance coverage, makes $100  monthly payments for 4 years totaling $4,800, and then stops making  payments. As the figure shows, the money in this service member’s savings  fund would be totally depleted to pay the subsequent insurance premiums  in just over 1 year. This occurs because the policy requires that the entire  20 years of coverage be paid for in the first 7 years, which results in the  monthly premium being larger than comparable policies. In addition,  because almost all of the service member’s payments during the first few  years are allocated to the insurance policy, the accumulated value of the  savings fund is modest. For the modified whole life product previously  discussed, which required lower premium payments and larger savings  accumulation after the first year, the savings fund of service members that  ceased making their payments after 4 years would be sufficient 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—totaling $92 for 4 years—and invest the remaining $4,708 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.
In addition to the high costs associated with the insurance portion of these  combination products, other provisions diminished the value of the savings  component as well. According to regulators we contacted, withdrawal  penalties and unique methods of interest crediting significantly reduced the  advertised rate of return for these products. Typically, service members  withdrawing all or part of the accumulated money in the savings fund any  time after purchase within the first 10 years would be assessed early  withdrawal penalties. For example, one of the companies assessed an early  withdrawal fee of 10 percent in the first year, with this fee declining by 1  percent each subsequent year until reaching zero in the 10th year. Several  companies credit the amount accumulated on the basis of either the year- end balance or the average balance--whichever is less. For sufficiently  large withdrawals, a service member would not receive any interest at the  end of that policy year on the money withdrawn from the fund. Under this  methodology, amounts withdrawn during the year earn no interest, thereby  reducing (in some instances significantly) the advertised rate of return.

		Allegations of Improper Sales Practices often Associated with Companies Targeting Military Members

Insurance companies that market primarily to military members have been  frequently accused of using inappropriate sales practices by regulators,  DOD, and others. As part of our review, we identified at least 15 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 were accused of misrepresenting the products as investments  or identifying themselves as representatives of independent benefit or  fraternal organizations. (Appendix II lists these actions.) For example, in  December 1998, two of the insurance companies that target military  members settled a lawsuit filed by DOJ in Washington state that alleged  that their agents had misrepresented their insurance policies as investment  plans. As part of the settlement the companies had to offer refunds to  approximately 215 service members in certain states who purchased life  insurance polices between 1994 and 1997. In an agreement with the  Attorney General's Office in the state in which one of the companies was  domiciled, each of the companies also made $1 million donations to a  university in that state. More recently, after the Georgia Insurance and  Safety Fire Commissioner initiated investigations to review allegations of  improper insurance sales practices at military installations in that state,  two insurance companies have agreed to make refunds of about $2.4  million to soldiers who had purchased insurance products.
After a series of articles in The New York Times raised concerns over sales  of financial products to military members, state regulators in as many as 14  states began new investigations into the practices of companies that target  service members. According to regulators in these states, various sales  practice concerns are being examined. As of September 2005, the  investigations by these states generally had not been concluded. In addition  to efforts by insurance regulators, law enforcement organizations and  securities regulators are also reviewing the activities of some of the  insurance companies that target military members.
One of the issues that is again a focus of regulators and others in their new  investigations, is whether the companies and their agents were  inappropriately marketing these products--not as insurance--but primarily  as investment products. State insurance laws generally require any product  with an insurance component to be clearly identified and marketed as  insurance. However, regulators in various states raised concerns that the  companies targeting service members were deemphasizing the insurance  aspects of the product. Some state officials told us that the companies  would have considerable incentive to obscure the insurance aspects of the  product because 98 percent of service members already obtain a  substantial amount of life insurance through the government-offered SGLI  program. Insurance regulators we contacted told us that when marketing  to military members these companies typically emphasize the investment  provision of the products even though most, if not all, of the payments in  the first year are used to pay the insurance premiums.  Furthermore, most  of this amount is then used by the companies to pay sales commissions to  the selling agents.
The marketing materials for the companies that we examined also  emphasized the savings component of the products. For example, a script  from a sales presentation of one company mentions the insurance coverage  third, after describing other product benefits. It also highlighted that the  cost of the insurance was “free” if the service member completes the  product terms. Insurance regulators with whom we spoke mentioned that  such a sales presentation is designed to overcome objections from service  members that they did not need any additional life insurance. In addition,  examiners in one state reported in 2002 that one of the companies’  materials referred to the premium payments for the insurance product  being sold to service members as “considerations” or “contributions,”  which were terms that they said were typically used when selling  investment products. Our review of information provided by legal offices at  Fort Benning, Georgia, and Great Lakes Naval Training Center, Illinois, also  indicated issues related to insurance products being marketed and sold  primarily as investment products.
The design of the products themselves may have also been misleading.  Despite emphasizing the investment returns and high rates of promised  interest earnings that were possible with these products, regulators in one  state told us that the companies may have assumed that their actual  policyholders would not generally attain these returns. As part of a class  action case previously filed against one of these companies, presented as  evidence were a series of internal company memorandums dating from  around the time the company was proposing to begin selling a combined  insurance and saving fund product. In one of these documents, a company  official states the assumption that product purchasers would not earn the  initially-promised 11 percent interest, or any amount even close to that,  because the product’s savings fund “is inextricably coupled with a rather  expensive traditional life insurance policy,” and has restrictive interest  crediting and withdrawal provisions.
According to a deposition taken of a former company official, the company  also assumed that many purchasers would not hold the product for very  long. For example, this official stated that the company assumed that as  many as 45 percent of purchasers would stop paying into the product  within 1 year and another 25 to 30 percent would stop paying by years 2  and 3. In contrast, data from a service that tracks the rates at which  insurance policyholders stop paying on their policies—called lapse rates— indicates that the lapse rate in the first year on term life policies requiring  monthly premium payments averaged less than 15 percent.
Other federal regulators are also investigating the extent to which the  companies that market primarily to military members were marketing  insurance as investment products. According to SEC officials with whom  we spoke, insurance products marketed as investments may need to be  registered as securities. Currently, insurance policies and annuity contracts  issued by an entity subject to supervision by state insurance or banking  regulators are exempt from securities registration. Under existing case  law, one factor that is important in determining whether an insurance  product is entitled to this exemption is the manner in which the product is  marketed. Under a safe harbor created by SEC Rule 151, one condition  for annuity contracts to avoid being subject to the federal securities laws is  to not be marketed primarily as an investments. As of September 2005, SEC  staff told us their inquiries into some of these companies’ operations were  continuing. In addition, DOJ officials also confirmed that they are  investigating some insurance companies that market primarily to military  members.
Officials with several of the companies that market primarily to military  members told us that they clearly inform service members that the product  they are offering is insurance. For example, officials at one of the  companies showed us documents that they said are to be initialed and  signed in multiple places by purchasers of their product that indicate that  the product is insurance. An investigation by DOD personnel into sales at  one naval facility indicated that many members knew they were buying  insurance as well. However, an investigator of one of the states that  previously sanctioned one of these companies told us that they had  received information indicating that the company’s sales agents may have  found ways to present the products without the service members realizing  they were buying insurance. Such allegations illustrate the difficulties that  regulators face in determining whether inappropriate sales practices were  being used.

			Irregularities on Pay Allotment Forms Used for Deducting Premium Payments Being Investigated

Insurance regulators and other investigators are also investigating whether  some of the companies have been misrepresenting the nature of the  products in the forms used to initiate deductions for the premiums from  service members’ pay.  According to DOD staff responsible for personnel  pay systems, service members can have various types of allotments  deducted from their pay, including deductions to be sent to savings  accounts or to pay for insurance they purchase. However, for insurance  allotments for junior enlisted members (those at rank E-3 and below), a 7- day “cooling off period” is required to pass before the allotment can be  processed. Although these companies were selling insurance products,  state regulatory officials we contacted were concerned that, in some cases,  the companies were mislabeling the government pay deduction forms to  reinforce the appearance that these purchases were investments and not  insurance. For example, we reviewed pay allotment documents that  appeared to indicate the service member purchasing this product was  initiating a pay deduction that would be sent to a savings account in the  member’s name at a bank. In addition, the service member would also be  asked to complete a form that authorized the recipient bank to withdraw  the premiums due on the insurance product from the service member’s  account at that bank. However, state insurance regulators told us that the  service members did not actually have accounts at these banks; rather, the  money was deposited in a single account belonging to the insurance  company. After we contacted officials at some of the banks to which these  insurance companies were having service member payments routed, bank  officials confirmed to us that the service members did not have accounts at  the bank, but rather, contributions were sent to accounts belonging to the  insurance companies. Thus, routing the payments to a bank with the  allotment appearing as a bank allotment on the service member’s pay  statement, rather than an insurance allotment, could reinforce the  impression that the service member had purchased an investment product  rather than insurance. Insurance regulators in one state also told us that  they found instances in which insurance agents were assisting service  members to access online military pay systems to add allotments for  insurance premiums.
Our own review found additional evidence of possible irregularities  involving pay allotment forms and other activities by agents selling these  combined insurance and saving products. During a review of documents  used to initiate allotments from service members’ pay at two military  installations we visited, we also found several examples of allotment  deduction forms that seemed as though the service member involved had a  savings account at a bank used by the insurance company.
We also noted several other potentially irregular activities. In some  instances, insurance agents mailed allotment forms to the finance office  that processes pay transactions for service members stationed at one of  these bases using bank envelopes that had a bank’s address as its return  address. The use of bank envelopes could help convince base personnel  that these were savings rather than insurance allotments, and thus not  subject to any required “cooling off period.” In another example of  insurance company agents attempting to make the service member  allotments used to pay for these insurance products appear to be savings  allotments, we saw multiple instances of the use of an allotment form  bearing the signature of the same bank official as the initiator of the  allotment. After we contacted this bank official, he told us that he had once  signed such a form but that the repeated use of the form with his signature  was being done by the insurance agents without his knowledge. The results  of these reviews and indications of potential fraud were referred to our  special investigators, who are conducting further reviews and have  initiated contacts with other law-enforcement organizations, DOD  investigative agencies, and state regulatory departments.
Our review of allotment forms raised questions about whether agents  marketing products targeting military members were encouraging service  members to reduce tax withholdings and other savings contributions, thus  providing a source of income to invest in the insurance products.  Specifically, we found several examples of forms canceling service  members’ TSP contributions and altering the number of exemptions  claimed on service members’ W-4 forms (reducing the amount of tax  withheld from their pay) that were submitted along with insurance  allotment forms. Forgoing investment in TSP (which is generally  recognized as being one of the lowest-cost ways to invest for retirement  available anywhere) to purchase expensive insurance would not generally  be in the service member’s best interest financially. By reducing the  member’s withholdings and TSP contributions, the agents in these cases  may have been attempting to overcome service member objections about  affording the additional payment for the insurance product. In addition,  reducing a service member’s withholdings could potentially result in  additional taxes due at year’s end.

			Concerns Exist over Whether Insurance Company Personnel Represent Themselves as Members of Other Organizations

Another sales practice issue that insurance regulators we contacted have  been concerned about is whether some individuals that are selling  insurance were not clearly representing themselves as insurance agents  when marketing to military service members. In the past, DOD has found  that insurance agents who have marketed to service members frequently  identify themselves as counselors from benefits associations. Such entities  provide counseling on obtaining government benefits or other services and  may also offer their members discounts on other products, such as auto  services. By representing themselves as benefits counselors, insurance  agents may more readily gain access to service members.
However, regulators and others have documented prior instances in which  insurance agents marketing to military members misrepresented  themselves as benefits association employees. For example, in December  2002, DOJ announced a settlement against an insurance company that  targeted military members whose agents had misrepresented themselves  solely as employees of a benefits association. According to the DOJ  complaint, this company had allegedly defrauded military service members  who purchased life insurance policies from the company by having its  agents pose as independent and objective counselors representing a non- profit fraternal organization that offered as one of its benefits the ability to  purchase the company’s life insurance. However, the company’s agents  allegedly failed to disclose to the service members that they only were  compensated through commissions from the insurance company, and that  the company was making undisclosed payments to the benefits association  for every policy sold. Under the terms of the settlement, the company  agreed to, among other things, increase the face amount of all in force  coverage by 6.5 percent, pay $2.7 million to all service members who  canceled their policies during a specific period, and to never again sell  another insurance policy or reapply for DOD permission to conduct  business on U.S. military installations. According to a state insurance  department investigation that was finalized in January 2002, agents from an  insurance company that is currently being investigated by other states  portrayed themselves as benefit association representatives without  disclosing that they were insurance agents. As a result these agents were  allowed to conduct military training during which they would solicit  insurance to groups of service members. According to the report, the  service members believed that the benefit association was part of the  military establishment.

			Regulators Are Reviewing Whether Some Insurance Product Sales Comply With State and Federal Laws

Another aspect of the operations of the companies that market primarily to  military members that state insurance regulators were examining was  whether the products comply with applicable state laws and regulations.  For example, regulators in several states have been examining whether the  saving funds that some of the companies had labeled as annuities may not  actually qualify as such under their laws. After concerns arose about the  sale of these combined insurance and savings products, insurance  regulators in Washington state rescinded approval to sell the products that  had previously been approved for sales by one of the companies that  targeted the military in June 1997 and for three additional companies in  October 2004. In taking these actions, the state’s insurance department  noted that it had determined that the savings fund provision of these  products the companies were marketing were not properly structured to  meet the requirements of this state’s regulations pertaining to annuities.

			Insurance Companies Targeting Military Members Also Frequently Accused of Violating DOD Solicitation Policies

In addition to raising concerns among financial regulators, the companies  that target military members also have been accused of violating DOD’s  own solicitation policies. For example, 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 captive 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. Last updated on August 11,  2005, this web site lists 21 agents from some of the 6 companies that are  permanently barred--or have had their solicitation privileges temporarily  suspended--at 8 different military installations.
Concerns over such violations are longstanding. For example, in March  1999, the DOD Inspector General also 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 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. Similarly, a May 2000 report  commissioned by the Office of the Under Secretary of Defense for  Personnel and Readiness also reviewed insurance solicitation practices on  DOD installations and identified many of the same concerns and  recommendations as those the DOD Inspector General had identified. As  result of these two reports, DOD officials began efforts to revise its  directive governing commercial solicitation on military installations.

	A Unique Securities Product with High Sales Charges Sold to Military Members Has Also Raised Sales Practice Concerns

A few broker-dealers have marketed a unique securities product, often  referred to as a contractual plan, to military service members that has  proven to be more costly than other commonly available products. These  contractual plans were primarily being sold by one large firm and several  smaller firms that generally marketed only to service members. These  products involve making periodic investments into a mutual fund under  contractual agreements with much of the first year’s investments going to  pay a sales load that compensates the selling broker-dealer. Purchasers that  make all required payments for the entire term of the contractual mutual  fund plan would pay charges slightly less than the amount charged by other  load funds. However, regulators found that most military purchasers were  not making all required payments, resulting in them paying higher sales  charges than would have been paid on other commonly available mutual  funds. Regulators indicated that contractual plans are rarely sold to  civilians and the products have been associated with sales practice abuses  for decades. Regulators recently sanctioned the largest seller of these plans  for inaccuracies in its marketing materials. Investigations into the activities  of other broker-dealers selling contractual plans are also underway.

		Most Contractual Plans Were Sold in the Military Market by One Firm

Although being sold to large numbers of service members, contractual  mutual fund plans were being marketed by only a few broker-dealers. SEC  and NASD staff told us that their investigations have identified only about  five broker-dealer firms that were marketing these plans. According to  regulators, one of the broker-dealers accounted for over 90 percent of the  $11 billion invested in contractual plans as of year-end 2003. Unlike the  insurance companies that targeted junior service members, this broker- dealer generally marketed its products to more experienced military  members, including commissioned officers and senior noncommissioned  officers.
According to its marketing materials, this firm had nearly 300,000 military  customers, and indicated that one-third of all commissioned officers and 40  percent of active duty generals or admirals were clients.  The firm 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. From January  1999 through March 2004, the firm received approximately $175 million in  front-end load revenue from the sale of contractual plans. Officials with the  firm announced in December 2004 that they would be voluntarily  discontinuing sales of contractual plans after being sanctioned by SEC and  NASD.
The other four firms that continue to sell contractual plans were smaller  broker-dealers. Of these, regulators told us that three also principally  targeted military service members although, unlike the largest broker- dealer, these three firms generally sold contractual plans to junior enlisted  personnel. According to regulators, the fourth broker-dealer appeared to be  marketing to civilians. However, given the availability of other alternative  low-cost mutual fund products in the marketplace that allow investors to  make relatively small contributions on a regular basis, regulators indicated  that they rarely see contractual plans being sold to civilians by other firms.

		Contractual Payment Plans Feature High Up-Front Sales Charges that Are Not Typical of Other Securities Products Available

Under the terms of the contractual plans being sold to military service  members, the purchaser enters into a contract to make periodic  investments for a set term (such as 10 to 15 years). These payments are  invested into funds offered by some of the largest mutual fund companies.
Under the contractual plan, the firm deducts a sales load of up to 50  percent from each of the first year’s monthly payments but generally no  further sales loads are applied thereafter. In contrast, a conventional  mutual fund with a sales load will deduct a certain percentage—currently  averaging about 5 percent—from each contribution made into the fund.  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. As illustrated in  Figure 5, if all 180 monthly payments are made under a contractual plan,  the effective sales load on the total investment decreases to 3.33 percent by  year 15.
At one time, contractual plans were the only way for small investors to  invest in mutual funds. Regulators told us that in the past, many mutual  funds required large initial investments that 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. 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 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 through toll- free numbers, the Internet, or by mail.
According to industry participants, contractual plans provide their  purchasers with the incentive to invest for the long term. Officials from the  most active broker-dealer that marketed contractual plans told us that the  larger upfront sales load encourages the investor to maintain a long-term  investment plan because of the financial penalty that results from halting  their payments too early. They also said that the contractual nature of the  product helps purchasers make regular investments. In addition, these  officials explained that the clients they serve are not high-income  individuals with considerable accumulated wealth available for investment.  As a result, they said that other broker-dealers do not provide financial  services to these individuals. The officials from this firm said that their  sales representatives spend many hours explaining the products and  preparing and updating financial plans for their military clients. As a result,  the higher up-front sales charge compensates their staff for the amount of  time spent with clients. Officials from this firm told us that clients who  purchased contractual plans and received financial plans from their firm  generally benefited as the result of an improved financial condition overall.

		Many Service Members Failed to Benefit from Contractual Plans

However, according to data obtained from securities regulators, many  service members did not benefit from purchasing contractual plans.  Although such plans can prove beneficial to an investor that makes all of  the required periodic payments, regulators found that many 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 largest broker-dealer had completed  the full 15 years required under the contract. Instead, 35 percent of these  clients that bought during this period had terminated their plans early.  Another 22 percent had not cancelled their plans but were not making  regular payments. According to securities regulatory staff, most of the  clients that stopped making payments into this broker-dealer’s contractual  plans ceased doing so after about 3 years.
SEC staff told us that the customers of the other broker-dealers that were  marketing contractual plans to military members had the same or even  lower success rates of contracts completion. For example, they said that  only about 43 percent of the clients of one of these broker dealers had  made all required payments for a full 15-year period and, at another firm,  just 10 percent of the customers had successfully completed a plan.
Because of the manner in which sales charges are assessed, terminating a  contractual plan or halting payments early can greatly reduce the benefits  to an investor. If the investor does not continue paying into the plan, the  effective sales load can be much higher than industry norms. For example,  as shown previously in Figure 5, an investor terminating after 3 years pays  an effective sales load of 17 percent of the amount invested, which is more  than three times the current average sales load in the mutual fund industry.  As result, many of the service members that purchased contractual plans  from these firms likely paid much higher sales charges than they would  have under other alternative investments. Even if an investor makes all  required payments under a contractual plan, we found that the amount  accumulated on a contractual plan investment earning a 7 percent annual  return is lower than that of a conventional mutual fund with a 5 percent  sales load earning the same projected return until at least year 16 (this  analysis is shown in appendix III).

		Long Associated with Sales Practice Abuses, Firms Marketing Contractual Plans Again Raising Regulatory Concerns

Contractual plans have long been associated with sales practice concerns  and recently regulators have taken action against the largest seller of these  products. According to an SEC study, contractual plans to sell mutual fund  securities were first introduced to the public in 1930. However, concerns  over the sale of these products, including excessive sales charges, arose  and, as a result, the subsequently-enacted Investment Company Act of 1940  included a provision that limited the sales load that could be charged on  contractual plans. After the passage of the Act, sales of contractual plans  declined, with most of the companies selling such plans halting their  marketing of such products.
However, during the 1950s and 1960s sales of contractual plans  significantly increased. With researchers finding that many contractual  plan purchasers were not continuing to invest in their plans, SEC  recommended that the Investment Company Act of 1940 be amended to  prohibit future sales of contractual plans. Although Congress chose not to  ban contractual plans, it amended the Act in 1970 to increase protections  for contractual plan investors. Specifically, Section 27 was revised to allow  investors who cancel their plans within the first 18 months of purchase to  obtain refunds on that portion of the sales charges which exceeds 15  percent of the gross payments made. In addition, investors terminating  their plan within the first 45 days could receive their full investment back  with no sales charge deductions. Even with such limitations, sales charges  associated with contractual plans can still be much higher than those of  other mutual fund products and industry norms.
However, regulators again found inappropriate sales practices associated  with contractual plans even after this provision was changed. For example,  in the early 1990s, federal and state securities regulators took action  against a broker-dealer, First Investors Corporation, for improper  marketing of contractual plan investments, including its alleged failure to  notify investors that they could invest in the same funds without having to  pay the high sales charge required under the contractual plan. During this  period, other low-cost mutual fund products emerged in the marketplace,  allowing investors to make relatively small monthly payments into a mutual  fund product with low fees. The contractual plan product generally  disappeared from the civilian marketplace but continued to be sold in the  military market by a few firms, with one emerging as the dominant player  in this niche market.
Recently, securities regulators have taken actions against a firm marketing  contractual plans to military service members. In December 2004, SEC and  NASD sanctioned the broker-dealer firm that was the dominant seller of  such plans to service members. According to settlements reached with  these regulators, the firm’s marketing materials were alleged to have been  misleading and to have inappropriately disparaged other viable investment  options available to their clients. 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 non-contractual 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. The SEC and NASD settlements also alleged that  the firm mischaracterized the contractual plan’s high up-front sales load as  the only way to ensure that purchasers remain long-term investors and  presented comparisons of contractual plans using a holding periods of  more than 14 years despite having data within the firm that showed that  many of its customers were not successfully completing their plans. As a  result, securities regulators found that the firm’s service member clients  paid higher than normal sales charges because they frequently did not  continue making enough payments into such plans to reduce the effective  sales charges to a level comparable to typical mutual fund sales charges in  the industry.
The regulators also took action against the firm for inappropriate handling  of customer complaints. As part of its investigation into this firm’s  practices, NASD sanctioned the firm for the actions of one of its  supervisors who made improper statements to a service member who had  previously expressed dissatisfaction with the broker-dealer. The regulatory  settlement provides a summary of a call made to this customer in which the  firm’s supervisor appeared to threaten the service member with adverse  consequences from his military superiors, including possible cancellation  of his previously approved temporary duty orders.
In settling with SEC and NASD, the broker-dealer agreed to pay a total of  about $12 million, including restitution to compensate customers who paid  an effective sales charge of more than five percent on investments made  since January 1999. As of October 6, 2005, $4.3 million has been paid to  investors. The remaining money is to be used to fund an educational  program for service members that NASD will administer (this program is  described later in this report). As previously stated, this broker-dealer  announced that it has voluntarily discontinued sales of contractual plan  products. SEC and NASD continue to investigate the other smaller broker- dealer firms that are marketing contractual plan products to military  members and others. In addition, SEC staff also began conducting reviews  of sales to military members in overseas locations and at installations in the  United States. Two bills before the U.S. Senate (one of which passed the  House of Representatives) would amend Section 27 of the Investment  Company Act of 1940 to ban further sales of contractual plans.

	Lack of Complaint Sharing Prevented Earlier Identification of Improper Sales to Military Members

A lack of routine complaint sharing between financial regulators and DOD  was the primary reason that regulators did not identify problematic sales of  financial products to military service members before such issues were  raised in press accounts, although other limitations among regulators’  practices also contributed. Insurance companies are generally required to  submit products for regulatory approval before marketing them but the  review processes in most states may not have addressed the  appropriateness of their features for service members. 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 products. Although some states had taken action, other state  insurance regulators were not generally aware of problems involving  military members until recent press reports, in part because DOD  personnel were not usually sharing complaints or information about other  inappropriate practices regarding the companies that targeted service  members. However, we found evidence that concerns over inappropriate  sales to service members exist widely at various military installations.  Similarly, securities regulators also did not identify recent problems  involving contractual plan sales to service members until such press  accounts appeared. These regulators’ ability to detect problems was also  hampered by the lack of information on the extent to which broker-dealer  customers purchasing contractual plans were successfully making their  payments. In light of the problems surrounding sales of financial products  to military members, DOD has efforts underway to revise its policies  regarding such sales and has reviewed ways in which it could share  additional information. However, DOD has not coordinated these efforts  with military installation personnel or with regulators.

		Without Complaints, Regular Insurance Regulatory Processes Did Not Identify Problems

The product approval processes followed by many insurance regulators did  not allow them to identify the products being marketed to military  members as potentially problematic. One of the ways that state insurance  regulators ensure that the products being sold in their states comply with  insurance laws and regulations is through product approval requirements.    Although insurance regulators in most states require insurance companies  to submit products for approval before marketing them, state insurance  officials in the states we contacted explained that the processes for  approving products varied. In several of these states, insurance companies  must submit products to the state regulators for reviews that are intended  to assess whether the provisions and terms of the products comply with  existing insurance regulations in those states. Companies sometimes  submit additions to existing products, called riders, which change terms or  provide additional features to their policies. However, according to some  regulators in the states we contacted, the entire product may not be  reexamined by their reviewers when such riders are submitted. In at least 2  states we contacted, different components of products sold to military  members were filed and approved separately but then marketed and sold  as a single product. For example, the savings fund of the insurance product  being sold by four of the companies that target military members was  submitted as a rider to a previously approved policy. However, regulators  found that it was being sold as an integral part of the entire product, not as  an optional feature to a life insurance policy. In at least one state we  contacted, many insurance products are not reviewed but can be sold  immediately upon filing notification with their department of the  company’s intent to market the products.
Additionally, insurance product approval processes may not necessarily  reveal how a product is to be marketed or the target market for the  product. According to officials in the state insurance departments we  contacted, none of these states required insurance companies to provide  descriptions of the target market for a particular product during the form  filing process. As part of the investigations that state insurance regulators  are conducting of the companies that target military members, some of the  regulators are also reexamining the products these companies sell to  ensure that they meet existing state requirements. For example, insurance  regulators in Virginia issued an order in September 2005 to three  companies to cease and desist from selling such products. However, the  extent to which this review is occurring in other states is not clear.

			Insurance Regulatory Examinations Generally Focus on Financial Soundness

State insurance regulators may conduct various types of reviews of the  insurance companies they oversee. Many of the routine reviews that these  regulators conduct focus on insurance companies’ financial soundness.  During such examinations, the regulators assess the quality of insurance  companies’ assets and whether their income is sufficient to meet present  and future financial obligations to their policyholders.
Some state insurance regulators also review some aspects of insurance  product sales as part of market conduct examinations. Designed to help  protect consumers from unfair practices, market conduct reviews are done  for a wide range of company practices, including sales, underwriting, and  claims processing and payment. For example, a regulator may review a  sample of sales by a particular company to ensure that its agents have not  misrepresented products or otherwise violated the requirements of their  particular state. 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.

			Many States Lack Appropriateness or Suitability Standards

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, when an insurance regulator receives a  complaint or other information indicating that potentially problematic  sales have occurred, they can review the marketing practices of any  insurance companies involved to assess whether any misrepresentations or  other fraudulent activities occurred. However, under most state insurance  laws, insurance regulators do not have the authority to evaluate whether  the product sold was appropriate or suitable given the customer’s needs. In  contrast, broker-dealers selling securities products are required to assess  the financial circumstances of their customers to ensure that any products  they recommend to these customers are suitable. Specifically, broker- dealers are required to consider such factors as their customer’s income  level, investment objectives, risk tolerance, and other relevant  information.
State regulators and others have tried to establish suitability standards for  insurance products, but these efforts have generally not been successful.  For example, in 2001, NAIC formed a working group to collect and analyze  data, prioritize key issues for examination, and assess interstate  cooperation in developing guidelines for market conduct standards. These  market conduct standards would be intended to protect consumers from  abuses in the insurance market, including those related to the availability  and affordability of insurance. Using such standards, state insurance  regulators would review the underwriting and marketing practices of  insurance companies and their agents.
However, after being unable to come to consensus on suitability standards  that would apply to all insurance sales, the NAIC working group narrowed  its approach. Instead, the group drafted a model law that provided  standards for annuity products sold to seniors age 65 and over. This draft  model legislation would require that before insurance agents recommend  the purchase or exchange of an annuity, they must take into account the  purchaser’s financial situation (including other investments or insurance  policies owned) and reasonably believe that the recommendation is  suitable for the purchaser. As of July 2005, NAIC reported that only nine  states had fully or partially adopted this model law, 10 others already had  similar or related legislation, and 35 states or territories had yet to take any  action.
Other 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. After becoming IMSA qualified, a  company’s salesforce would be expected to assess a potential buyer’s need  for insurance before recommending its purchase. A representative of IMSA  told us that insurance companies and agents following IMSA’s guidelines  for conducting a needs-based selling analysis would review a customer’s  insurable needs and financial objectives to determine the appropriate life  insurance product, if any, to be offered. In many cases, junior service  members with no dependents may not need additional life insurance  beyond that available through the low-cost, government-offered SGLI.  However, none of the six companies that were primarily marketing to  military members with the combined insurance and savings product were  IMSA qualified.
Legislation has been proposed that would require insurance regulators and  DOD to work together to study ways to improve the quality of--and  practices used to sell--life insurance products sold on military installations.  For example, one option offered by these bills would be to only allow those  companies that have met best practice procedures (such as those  developed by IMSA) to sell insurance on military installations. These bills  also propose that standards that would apply to the sale of products to  military members could be developed.

			Concerns and Complaints Existed at Military Installations

Although concerns or complaints involving insurance sales existed on DOD  installations, insurance regulators we contacted mentioned that they  generally have not historically received complaints from DOD officials  about potentially problematic sales of products to service members. The  actual extent to which service members have concerns or complaints  involving insurance product sales is not known because, as we reported in  June 2005, DOD only recently began systematically collecting information  on violations of  DOD’s solicitation policy by sellers of financial products.   However, the DOD reports described earlier in this report, and work we  conducted for this report and several other reports we recently issued,  appears to indicate that concerns over inappropriate practices related to  product sales among military members was widespread. For example, for  our April 2005 report on the financial condition of military members, we  surveyed 175 U.S. installation-level managers of DOD’s personal financial  management program, which provides service members with financial  literacy training, financial counseling, and other assistance to avoid or  mitigate the adverse effects associated with personal financial problems.   We reported in June 2005 that about 25 percent of the managers surveyed  believed that insurance company representatives occasionally made  misleading sales presentations at their installations during 2004, and 12  percent believed that such presentations were made routinely.
At the two bases visited as part of work for this report, we also found  evidence that service members had concerns or complaints about the  marketing practices used by sales personnel from some of the companies  that targeted military members. After complaints were raised by some  service members at these bases, military personnel conducted  investigations of the matters. For example, at Fort Benning, Georgia,  statements were taken from several service members that were solicited  insurance products between 2001 and 2004. Of the 41 statements in the  investigative files that we were able to review, more than 70 percent  indicated that the sales personnel had described the product as a savings or  investment product. Additionally, almost all of these service members  indicated that the insurance company sales personnel had taken actions  that violated one or more of the restrictions in DOD’s solicitation policy,  such as making these sales presentations during group training sessions.
At Great Lakes Naval Training Center, base legal advisers told us they do  not receive many complaints because service members were often being  solicited shortly before they transferred to other installations. However,  legal staff at Great Lakes Naval Training Center showed us documentation  related to 5 complaints pertaining to insurance products from service  members between January and June 2005. In addition, they also indicated  that they have also seen complaints arising from other military installations  after leaving Great Lakes Naval Training Center. We also spoke with  finance office personnel at this base who had become concerned about the  sale of insurance to service members occurring there. As a result, these  personnel had retained copies of some of the pay deduction allotment  forms submitted for processing between June and September 2004.  Numbering over 100, the copies represented forms that had been used to  initiate pay deductions for products purchased by base service members  from three different insurance companies, according to military pay  personnel. We attempted to contact a random selection of these service  members. We were able to speak with three of the service members and a  spouse representing a service member who had purchased these products,  and all indicated that the insurance product they had purchased had been  generally represented as an investment.
However, state insurance regulators we contacted generally were not  aware of the potentially problematic sales to military members because  they generally were not receiving information about concerns or  complaints from military personnel. These state insurance regulators and  NAIC officials told us that they had received few complaints involving  military members. For example, as part of our June 2005 report, we  surveyed insurance regulators in 50 U.S. states and 4 territories and  received 48 responses. Of these, regulators in only 8 states indicated that  they had received life insurance related complaints from service members  or on their behalf between October 2003 and December 2004.
According to the director of the DOD office that oversees commercial  solicitations on military installations, information about service member  concerns or complaints involving financial product sales are not generally  shared with state regulators for several reasons. In some cases, service  members expressing reservations about purchasing one of these products  might have received advice from other members or from superior officers  to cancel, rather than complain to a regulator. In other cases, DOD officials  told us that base personnel will work directly with the selling company to  resolve a matter rather than involving a financial regulator. For example, a  service member with concerns about a purchase of a financial product  could consult with the installations’ legal advisers from the judge advocate  general staff. However, DOD officials stated that interactions between  service members and these staff are covered by attorney-client privilege  and thus are more difficult to share with external parties, such as financial  regulators. Attorneys representing two state insurance departments  believed that DOD attorneys should be forwarding such complaints  because this would be in the best interest of the service members. They  emphasized that complaints related to financial products should be  forwarded to the financial regulators that can take action on behalf of the  service members. They emphasized that failure to notify regulators that  there are service members with concerns about financial product sales  deprives regulators of important information necessary for their oversight  processes to function properly.
In some cases in which military installations have reported concerns or  complaints, regulators have been able to take action against insurance  companies that conduct business with military service members. For  example, regulators in Maryland were notified in the 1990s about potential  improprieties involving sales of insurance products to junior enlisted  personnel by a concerned official at one military training base in their state.  In an examination report issued in January 2002, insurance regulators  found that companies (including some of those that are currently being  investigated by other states) marketing combined insurance and savings  products to military personnel in Aberdeen Proving Grounds and other  locations had violated various state laws and regulations and had misled  some service members about the nature of the products, including  misrepresenting insurance products as investments.As noted previously,  regulators in Washington state also became aware of problematic sales at  military installations in their state in the 1990s. This state eventually took  action to rescind approval of certain insurance products where the side  savings fund did not meet the state’s requirements for an annuity, a  premium deposit fund, or a universal life product. In addition, regulators in  Virginia have also ordered that some companies that target military  members to cease selling certain products in their state However,  regulators in the other states that are currently conducting investigations of  the companies targeting military members were not generally aware of  such sales until recent press reports because DOD personnel were not  generally sharing information about any service member complaints or  concerns they received.

		Lacking Complaints and Data on Actual Customer Experiences with Contractual Plans, Securities Regulators Were also Unable to Identify Problems Involving Sales to Service Members

Lacking information on complaints and data on the extent to which broker- dealer customers were successfully completing contractual mutual fund  plans, securities regulators, similar to insurance regulators, also did not  identify problems involving military members until press reports appeared.  Although SEC and NASD, which has primary regulatory responsibility over  the broker-dealers that were marketing contractual plans to service  members, took enforcement actions against the firm that was the largest  marketer of these products in late 2004, both regulators had conducted  earlier examinations of this firm and did not identify any significant  problems. SEC and NASD staff 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. However, NASD staff told us that after a DOD  online periodical reported in 2003 that securities regulators were reviewing  contractual plan sales, DOD staff received several inquiries from service  members who had concerns about the products they had purchased. To the  securities regulator staff, this provided evidence that concerns or  complaints from military members were not being directed to the  regulators--either by the service members themselves, or by the DOD  personnel aware of such concerns.
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, in response to an article in The  Wall Street Journal in 2002 that raised questions about the appropriateness  of the sales of such plans to military members, SEC staff reviewed the operations of the largest seller of contractual plans. According to SEC  staff, their review did not raise any major concerns because they found no  evidence that military members were complaining about their purchases  from this firm. In addition, the firm provided the SEC staff with documents  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. The SEC staff told us that their  examiners accepted these statistics as valid because they were also able to  obtain data from one of the major mutual fund companies whose funds  represented the majority of those in which this broker-dealer’s customers  had invested. The data showed that most of this broker-dealer’s customers  still had open plans with the company.
After an article that raised concerns about contractual plan sales to military  members appeared in Kiplingers, a personal financial magazine, in 2003,  NASD staff also initiated an examination of this broker-dealer. According  to NASD staff, although they had concerns over the sales of the contractual  plan product, obtaining data on the extent to which the firm’s customers  were continuing to make payments and successfully completing their plans  was difficult, particularly since no specific requirement mandates that  broker-dealers maintain records or standardized data. According to NASD  staff, this firm maintained various sets of data on its contractual plan  customers and becoming familiar with the differences in the information  and determining what would be most useful for their reviews proved to be  difficult and time consuming. They also noted that their existing  examination procedures did not address issues such as persistency rates  that were found to be relevant to examining contractual plans.
However, these regulators were able to identify concerns after they  required the firm to provide comprehensive data on all customers that  purchased such products. According to SEC and NASD staff, they were  able to determine how successful this firm’s customers were being with  their contractual plans only after they required the firm to provide specific  data on all customers that purchased contractual plans covering a full 15- year period. After obtaining this data, regulators determined that the actual  proportion of customers making all required payments for the 15-year term  of the plans was only 43 percent. This percentage was about half of the  persistency or success rate shown in documents that the firm had  previously provided to the regulators during their prior examinations,  because the previously supplied data had excluded any customer whose  account remained open but had not made any payments in the last year.  However, in the view of regulators, investors that were no longer making  payments into their plans should be taken into consideration when  determining the overall extent to which a firm’s customers were  successfully completing their plans.

		DOD also Taking Actions to Address Problematic Sales to Military Members, but Remains Reluctant to Fully Share Information with Financial Regulators

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. The primary way  that DOD attempts to protect service members from inappropriate sales is  through its directive on commercial solicitation on military installations.  This directive, DOD Directive 1344.7, is administered by the Office of the  Under Secretary of Defense for Personnel and Readiness. The directive  currently places various requirements and restrictions on financial firms  seeking to market products on military installations in the United States  and overseas. For example, it prohibits sales from occurring as part of  group meetings and instead requires financial institution personnel to make  an advance appointment and meet with service members individually. In  addition, sales personnel that are former military members are also  prohibited from using their military identification to gain access to an  installation. In the event that a company, its agents, or representatives  violate DOD’s solicitation policy, installation commanders can permanently  withdraw the company’s or individuals’ solicitation privileges through a  ban or can temporarily suspend those privileges for a specified period.
Following the DOD reports that detailed issues and concerns associated  with insurance sales to military members, staff within the Office of the  Undersecretary for Defense for Personnel and Readiness began efforts to  revise DOD’s solicitation directive. In April 2005, DOD sought public  comments on a revised directive that incorporates new requirements. For  example, the revised directive expressly prohibits insurance products from  being sold as investments. In addition, it also includes a new evaluation  form that is intended to be completed by each service member that has  been solicited. The form would allow service members to indicate, with yes  or no answers, whether the individual soliciting them violated certain  aspects of DOD’s policy, such as contacting them during duty hours. The  evaluation form also has questions relating to salespersons’ conduct during  any solicitation, such as whether they pressured the service member into  making a purchase, failed to provide adequate information, or implied that  they were endorsed by the military.
In addition to revising its solicitation directive, DOD personnel have also  taken enforcement actions against several insurance agents for improper  solicitations at several military installations. For instance, at Fort Benning,  an insurance company and its agents that operate in the military market  segment were banned from conducting sales on the base. Additionally,  several military personnel in supervisory positions were also disciplined  for allowing improper insurance solicitations to occur and not properly  enforcing existing solicitation policies.

			DOD Lacks Requirements to Comprehensively Share Violations and Complaints with Financial Regulators

Although DOD has taken some steps to better protect its service members  from inappropriate financial products, DOD does not currently require its  personnel to share all relevant information with financial regulators,  including complaints from service members. DOD’s current policy  regarding financial product solicitation only requires installation  commanders to notify the appropriate regulatory authorities if they  determine that an agent or company does not possess a valid license or has  failed to meet other state or federal regulatory requirements. However, the  draft of the revised solicitation directive includes provisions that would  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. The legislation being considered in Congress  would also require DOD to maintain a list of names, addresses, and other  appropriate information of any individuals selling financial products that  have been barred, banned, or limited from conducting business on any or  all military installations or with service members.
DOD has already begun collecting and publishing information on actions  taken by individual installations for violations of the solicitation policy. As  noted previously, DOD has already consolidated this information from its  installations and posted it on a web site. Under the legislation before  Congress, DOD would also be required to promptly notify insurance and  securities regulators of those individuals included or removed from this  list. DOD officials have indicated that financial regulators can access the  information about the actions taken against individuals or companies that  have violated DOD solicitation policies from the web site and that, if these  additional requirements become law, they will provide the information on  their listing to financial regulators as it changes.
Although DOD is planning to share more information with financial  regulators, DOD officials remained reluctant to share all information on  violations of DOD policies that do not result in bans or suspensions. We  recommended in our June 2005 report that DOD implement a department- wide searchable database to capture all violations of its own solicitation  policy and provide this information to financial regulators. However, DOD  officials told us that violations of some DOD policies, such as when sales  personnel solicit without an appointment or solicit groups of service  members, would probably not represent violations of financial regulations  and therefore would be of little concern to such regulators. DOD officials  also said that being required to report every time even minor violations  occur, such as when a retired military member uses military identification  to obtain base access for a solicitation visit, would be burdensome to their  personnel.
However, financial regulators’ staff told us that receiving information  related to violations of DOD’s commercial solicitation policies also would  be very helpful in determining whether further action, such as revocation  of licenses, was warranted. For example, officials from one state insurance  department told us that insurance agents have the obligation to be  trustworthy and that if such individuals are violating any DOD regulations,  this information could help them determine whether the conduct of the  agents also violate their state’s requirements.
Although DOD personnel had not routinely shared service member  complaints with financial regulators in the past, DOD officials have also  told us that they intend to require their personnel to report more of that  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 that was published for comment also lacked any provisions relating to  such information. However, staff in the office that oversees the policy  directive told us that, as part of addressing the comments they have  received, 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.
Financial regulators indicated that receiving such information from DOD  would greatly improve their ability to recognize and act on potentially  problematic financial product sales involving service members. Insurance  and securities regulator staff told us that promptly receiving concerns or  complaints raised by service members would allow their normal regulatory  oversight processes to function properly, which rely on complaints as an  important indicator of potential problems involving insurance company or  broker-dealer practices.
Congress also may be increasing the amount of information that both  regulators and DOD have about potentially problematic practices by  insurance sellers. Both of the bills currently under consideration in  Congress would prohibit insurers from using agents that sell life insurance  on military installations unless the insurer has a system to report to the  state insurance regulators in its state of domicile and in the state of  residence of an agent any disciplinary actions known to have been taken by  any government entity and any significant disciplinary action taken by  the  insurer itself against an agent with regard to the agent’s sales on military  installations. Furthermore, the bills would require that state insurance  regulators develop a system for receiving such information and the ability  to disseminate it to all states and to DOD.
However, some barriers appear to make sharing between DOD and  financial regulators more difficult. As part of conducting their  investigations of contractual plan sales, securities regulator staff told us  that personnel at some DOD installations were reluctant to share any  information involving specific service members for various reasons.  According to these regulators, the 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  they have researched these issues with their legal staff and 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 its own military installation personnel and financial  regulatory staff understand how additional sharing could appropriately  occur. In addition, to improve financial regulators’ ability to obtain  information from DOD, officials from NASD told us that the financial  regulators could create liaisons on their staff to receive complaints and be  the primary person responsible for seeking information from the military as  part of examinations.

			Inadequate Financial Literacy and Lack of Jurisdictional Clarity Are also Concerns

Although increased financial literacy could also help protect military  service members from inappropriate financial product sales, concerns  exist over the adequacy of such efforts to date. In a report on the extent to  which consumers understand and review their credit reports, we noted that  individuals’ ability to understand credit matters differed across various  demographic characteristics. For example, we found that college-educated  individuals with high incomes and credit experience exhibited more  expertise than those without such characteristics. Similarly, many  military members also tend to lack advanced education or high incomes.     As our April 2005 report on the financial condition of military members  noted, almost 40 percent of service members reported having some trouble  managing their financial affairs and studies by private consultants have  found that the overall financial literacy among service members is not  high.
DOD is attempting to increase financial literacy among military members.  As noted previously, DOD has developed personal financial management  programs to provide service members with financial literacy training,  financial counseling, and other assistance to avoid or mitigate the adverse  effects associated with personal financial problems. However, as we  reported in April 2005, not all service members were receiving the training  required as part of these programs. As a result, our report recommended  that DOD implement a monitoring plan to ensure that all junior enlisted  members receive the required personal financial management training.
Similarly, financial regulators have also begun working with DOD to  increase financial literacy and awareness among service members, but  these efforts have not been completed. For example, approximately $7  million of the settlement that SEC and NASD reached with the largest  broker-dealer selling contractual plans to military members will be used to  fund financial education efforts among service members. Using the  proceeds of the settlement, NASD staff told us that the staff of the NASD  Investor Education Foundation plan to conduct research to determine  current levels of service members’ investment knowledge and use this to  plan and develop its military education efforts. Among the efforts currently  being designed are a military-specific online resource center to provide  unbiased information on saving and investing. In addition, they plan to  develop training to support the military’s current personal financial  management program by establishing a coordinated and uniform financial  education program. They also plan to conduct a public outreach campaign  to promote saving and investing to members of the military and their  families. These efforts are anticipated to be publicly launched in late 2005  with many national and local activities taking place in 2006.
To help convey information to service members about insurance regulatory  organizations outside the military that can receive and help resolve their  complaints, NAIC and DOD staff have also been working together on  materials to help educate service members. As of October 2005, their  efforts have produced a consumer brochure for military members that  contains information to help service members better understand factors to  consider when purchasing life insurance and regulatory entities that  service members can contact should they have complaints concerning  insurance sales. According to NAIC officials, they are also working on  information to be presented on a NAIC Web site.
Congress has also recognized the need for additional information to better  protect military service members from inappropriate product sales. For  example, both versions of the bill currently under consideration in  Congress would require that, for any sales taking place on a military  installation, insurance representatives disclose that subsidized life  insurance may be available from the government to the service member  and that the government has not sanctioned, recommended, or encouraged  the sale of the product being offered. In addition, this legislation also  would require that service members be provided with information about  where to complain regarding any problems involving an insurance sale on a  military installation. Specifically, both bills would generally require that, for  any sales taking place on federal land or facilities located outside the  United States, insurance sellers provide a disclosure that lists the address  and phone number where consumer complaints are received by the  applicable state insurance regulator.
Although DOD currently has a program to provide financial literacy  training to junior personnel, not all levels of the services receive such  information. Currently, the personal financial management training that the  various branches offer to service members are provided only to junior  enlisted members. However, an officer in one branch of the service also  told us that she and other more senior members of the military are also  solicited by financial firms and thus having such training, including  addressing proper procedures for directing concerns or complaints,  offered to more than just junior personnel would be helpful.
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.” For example, regulators from Maryland conducting work on  a market conduct examination mentioned that they had asked an agent  from the Federal Bureau of Investigation to accompany them when visiting  the military installation in case installation personnel questioned the  insurance regulators’ authority to conduct an investigation on the  installations. Further, according to a Texas insurance department official,  he had trouble getting access to complaints information at a military  installation because installation personnel question his authority to request  such information. In addition, Georgia officials told us that a military  installation in their state had an “exclusive federal jurisdiction” designation  that could potentially present a jurisdictional issue. However, regulators in  Virginia noted that they have been able to conduct examinations after  seeking and obtaining written permission from base commanders. 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. 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.
While securities regulators also generally believed they had jurisdiction  over sales on military installations, they too indicated that greater clarity  would be beneficial. 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. 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 sales is generally applicable to any such activity 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 sales.

	Conclusions

Large numbers of military service members are being targeted by a few  firms offering products that provide limited benefits unless held for long  periods, which most military purchasers were failing to do. Thousands of  service members across the United States and around the world are  purchasing products from insurance companies that combine insurance  and savings. 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  little need for any more coverage than that already provided by the low- cost government insurance service members receive. Instead, they were  likely attracted to these products for their investment features. However,  by being tied to expensive life insurance, these products appeared to be a  poor investment choice for service members because they include  provisions that allow the accumulated savings 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 request refunds, and as a result,  few likely amassed any savings from their purchase. The few companies  that sell these products also have been accused of using inappropriate sales  practices in the past, have been sanctioned, and are again being  investigated by numerous federal and state regulatory and law enforcement  authorities.
With concerns over potentially inappropriate insurance sales to military  members being longstanding, the need to take definitive actions to better  protect service members appears overdue. The legislation that passed the  House of Representatives and is being considered in the U.S. Senate  includes various provisions that, based on our work, would appear to  improve the protections for military members. Some of the provisions of  these bills are of particular importance. Currently, both would direct  insurance regulators and DOD to work together to develop measures to  address sales to military members. Given that many service members were  obtaining only limited benefits from purchasing these combined insurance  and savings products, we believe that congressional action that results in  state regulators undertaking reviews to ensure that only products that  comply with state insurance regulations, an area in which regulators in  some states now have developed concerns, is warranted to provide  protections to military personnel in all U.S. jurisdictions. In addition,  having insurance regulators and DOD work cooperatively to develop  suitability or appropriateness 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, income levels,  and likely inability to make payments for extended periods of time. This  could also provide protection for service members that are located in  overseas installations not directly overseen by state regulators.
Similarly, military members were also being widely marketed a securities  product—the contractual plan—that has largely disappeared from the  civilian marketplace. Although potentially providing returns equivalent to  other products if steady investments are made over the required 15-year  term, these products were likely less beneficial to the many service  members that failed to make payments for that extended length of time. In  the many years since contractual plans were first offered, a variety of  alternative investments have become widely available for individuals with  modest incomes, including other load funds, no-load funds, and TSP, which  is now available to service members and likely offers the lowest investment  expenses of any product. Given the longstanding history of sales practices  abuses associated with the contractual plans and the availability of viable  alternative investments, we believe that congressional approval of the  legislation currently under consideration, which includes language to ban  these products, would remove products that appear to have little need to  continue to exist.
Although insurance and securities regulators have taken actions since  allegations of inappropriate sales to military members have come to light,  additional actions could mitigate some of the limitations that hampered  regulators’ ability to address these problems. As our work found, state  insurance and securities regulators sometimes were uncertain of the  adequacy of their authority over sales taking place on military installations.  As a result, some of these regulators and officials from associations  representing state insurance and securities regulators expressed support  for congressional action to clarify that state financial regulators have  jurisdiction over sales taking place in such locations.
In addition, congressional action could serve to better ensure that financial  regulators are made aware of potentially inappropriate sales involving  military members. As we found, federal and state insurance regulators’  ability to more promptly identify inappropriate sales of financial products  involving military members was hampered by the lack of information  sharing by DOD. DOD officials have expressed their willingness to provide  financial regulators with information on actions taken against individuals  or firms that violate DOD’s solicitation policies. They have also indicated  their intention to require their personnel to provide information regarding  service member complaints and concerns. However, they note that privacy  requirements can pose perceived barriers to such sharing. In addition, they  remain reluctant to share information about all instances in which sellers  of financial products violate DOD solicitation policies. However, such  information could allow financial regulators to determine whether such  situations also represent potential violations of federal or state laws. As a  result, we believe that congressionally-mandated direction is needed to  ensure that DOD identifies ways to overcome these barriers and  coordinates with its installation personnel and with financial regulators  about ways to share additional information about problematic company  behavior and service member concerns.
Additional DOD actions also could help protect service members from  firms using unscrupulous sales practices. DOD officials have indicated that  having their personnel share some information relating to service member  concerns and complaints is appropriate. Including such a requirement in  the revision of DOD’s solicitation policy would better ensure that financial  regulators receive this important information. DOD is also currently  attempting to provide personal financial management training to improve  financial literacy and competence among military members. Such training  would also appear to be a useful forum for informing military personnel  about proper procedures for submitting concerns or complaints. Given that  more senior officers were customers of some of the financial firms that  target military members, periodically providing such training to service  members at all levels throughout the military would also likely raise  awareness and assist them in making sound financial decisions.
Financial regulators also appear to have opportunities to improve their  ability to protect military members from inappropriate sales. Because  complaint information is a critical input to their regulatory processes,  proactively seeking such information from DOD and its installations would  likely improve regulators’ oversight efforts. Given the uniqueness of the  military environment, having staff or offices within regulators’ own  organizations that serve as liaisons with DOD and individual installations  could allow both DOD and financial regulators to build trust and gain  experience in sharing information and assisting investigations of  potentially problematic financial product sales. Ensuring that financial  regulators’ staff also make use of any listings compiled by DOD of  individuals or firms that have been sanctioned by the military for activities  relating to financial product sales to target examination and investigation  resources would also likely improve the protections that are afforded to  military members.
SEC and NASD efforts to oversee broker-dealers marketing contractual  plan mutual funds were hampered by a lack of standardized data at these  firms on the success of clients in investing in these plans. In the event that  such plans continue to be legally sold, having these regulators evaluate  how best to ensure they will have such information in the future would  improve their ability to oversee these products. Some possible ways to  ensure such information is readily available would be to implement a rule  requiring broker-dealers to maintain standardized records that show how  successfully their customers are completing any contractual plans  purchased. Alternatively, SEC and NASD examiners could routinely request  such information prior to conducting a review of the broker-dealers selling  these products.

	Matters for Congressional Consideration

To better protect military service members from financial products with  limited benefits to them, the Congress should consider taking the following  five actions:  Provide that products being marketed primarily to military members are  reviewed by state insurance commissioners to ensure that all such  product provisions are in compliance with existing state laws, and  provide for reports through NAIC to relevant congressional committees  on the results of these reviews within 12 months.
Provide that state insurance commissioners work cooperatively with  DOD to develop appropriateness or suitability standards for sales to  military service members.
Ban the sale of contractual mutual fund plans.
Specify that state insurance and securities regulators have full access to  persons and information necessary to oversee sales taking place on  military installations or involving service personnel.
Require DOD to work cooperatively with financial regulators to develop  mechanisms that overcome existing barriers to sharing information  about insurance and securities firm activities and  service member  concerns and complaints that can allow financial regulators to  determine whether violations of existing federal or state laws or  regulations are occurring.

	Recommendations

To better protect service members from unscrupulous sales of financial  products, the Secretary of Defense should take the following two actions:  Issue a revised DOD solicitation policy requiring that information on  service member complaints related to financial product sales be  provided to relevant state and federal financial regulators.
Include in the personal financial management training for all service  members information and materials developed in conjunction with  insurance and securities regulators that explains how and to whom  service members should raise concerns or complaints about potentially  inappropriate sales of financial products, including providing the  information necessary for contacting these regulators. Such training  should also periodically be offered to service members of all levels.
To better ensure that federal, state, and other financial regulators can  oversee sales of insurance and securities products to military members, the  heads of SEC, NASD, and state insurance and securities regulators should  designate staff to receive complaints from DOD and conduct outreach with  DOD headquarters and individual installations to proactively learn of issues  or concerns regarding product sales.
These staff should also make use of any listings that DOD maintains of  individuals or firms that have been sanctioned by the military for improper  solicitation practices.
In the event that contractual mutual funds are not banned, the Chairman of  SEC and the Chairman of NASD should consider various means of better  assuring that their staff has adequate information to assess the sales of  contractual plans.

	Agency Comments

We provided a draft of this report to DOD, NAIC, NASD, and SEC for  comments. Each of these organizations provided written comments  expressing general agreement with our report and its recommendations  (these comments appear in appendixes IV through VII). In concurring with  our recommendation that DOD require that information on service member  complaints be provided to financial regulators, a letter from DOD’s acting  principal deputy for the Undersecretary for Personnel and Readiness  indicated that their revised solicitation directive will require installations to  report such information to regulators. The principal deputy’s letter also  indicates they concur with our recommendation to provide all service  members with information during personal financial management training  on how to complain to regulators and states that they have developed a  strategic plan for programs to assist members with determining  appropriate financial products for their needs and how to remedy concerns  or complaints. They also intend to approach state regulatory agencies to  assist in providing educational information to all service members and  provide such information during new comer orientations and through toll- free assistance lines.
In SEC’s letter, the director of that agency’s Office of Compliance  Inspections and Examinations stated that they shared our concerns that  securities products be properly marketed to military members. She also  stated that in the event that Congress does not ban the sale of contractual  plans they will consider our recommendation that SEC consider ways to  ensure that it have adequate information to assess sales of such products.  In NASD’s letter, the NASD Chairman and Chief Executive Officer states  that men and women of the U.S. armed forces deserve the same protection  from inappropriate financial product sales as their civilian counterparts  and that our report will help NASD and others to ensure that this is  achieved. NASD’s letter also describes the actions the organization has  taken against the largest seller of contractual plans, including noting, as our  report acknowledged, that they began reviewing this firm in 2003. NASD’s  letter also describes their efforts to develop education for military  members.
In its letter, NAIC’s Executive Vice President and Chief Executive Officer  notes that we ask Congress to direct the states to review currently  approved products being marketed to military members. In response, she  indicates that a number of states are examining companies that have  engaged in questionable practices involving these products and that an  NAIC committee plans to review life insurance sold with a side fund to  recommend a position on products being offered in the marketplace in  2006. Regarding our request that Congress direct DOD and the insurance  regulators to work together to improve information sharing, NAIC’s letter  indicates that they are in the process of;   compiling a list of insurance department contacts to ensure that DOD  has the proper contact information for further state assistance;   updating NAIC's Complaint Database System form to identify  complaints that are submitted by military personnel; and   providing DOD with a state-by-state premium volume summary for  those companies that state insurance regulators know are soliciting or  have solicited insurance products on military bases.
Regarding our recommendation that DOD and regulators work together to  develop training materials, NAIC’s letter indicates that they have worked  with DOD to develop a consumer brochure and a Web site specifically  addressing life insurance information for military personnel and remain  committed to developing other materials to fill any financial literacy needs  that DOD identifies.
We also received technical comments from each of these organizations that  we incorporated where appropriate.
As agreed with your offices, unless you publicly announce its contents  earlier, we plan no further distribution of this report until 30 days after the  date of this report. At that time, we will send copies of this report to the  Chairman and Ranking Minority Member, Senate Committee on Armed  Services; Chairman and Ranking Minority Member, House Committee on  Armed Services; and Chairman and Ranking Minority Member, House  Committee on Financial Services. We will also send copies of this report to  the Secretary of Defense, Chairman, SEC; and Chairman, NASD. We will  also make copies available to others upon request. In addition, the report  will be available at no charge on GAO’s Web site at http://www.gao.gov.
If you or your staff have any questions regarding this report, please contact  me at (202) 512-8678 or hillmanr@gao.gov. Contact points for our Offices of  Congressional Relations and Public Affairs may be found on the last page  of this report. Key contributors to this report are listed in appendix VIII.

Objectives, Scope, and Methodology

To identify the insurance products being sold and how these were being  marketed to military members, we reviewed prior Department of Defense  (DOD) reports, spoke to officials at the National Association of Insurance  Commissioners (NAIC), and met with regulatory officials from several  state regulators that are currently conducting or have previously conducted  reviews of insurance companies that market primarily to military members.  This work included interviewing regulatory officials and reviewing  available documentation from the Georgia Insurance and Safety Fire  Commissioner, the Texas Department of Insurance, the Florida Office of  Insurance Regulation, and the Illinois Department of Insurance, and the  Virginia State Corporation Commission Bureau of Insurance.  In addition,  we contacted staff from the Maryland Insurance Administration and the  Washington Office of the Insurance Commissioner to discuss their past  investigations of certain insurance companies targeting junior enlisted  service members and reviewed documents pertaining to such  investigations. We also visited Fort Benning, Georgia, and Great Lakes  Naval Training Center, Illinois, to better understand the insurance  solicitation issues present at two large military training installations.   During these site visits we interviewed staff judge advocate personnel and  reviewed documents pertaining to current and past investigations of sales  of insurance products at these locations. Furthermore, we obtained data  on the characteristics of military members making allotments to three  different insurance companies in this market from DOD’s Defense Finance  and Accounting Service (DFAS), which maintains military personnel pay  records. In our prior report, we were unable to reliably determine the total  number of service members who have allotments for supplemental life  insurance products or the number of dollars that service members pay to  life insurance companies through the DFAS systems because not all  allotments for insurance were identified as such. To provide accurate  information for this report, we instead obtained from DFAS the dependent  status of service members for allotments that were being routed to specific  banks being used by some of the insurance companies that market  primarily to military members, which produced results that we did believe  were sufficiently reliable to highlight that a significant percentage of  service members who had made allotments to specific companies had no  dependents. Further, we contacted officials from the six insurance  companies identified by the multistate investigation as being those  companies that primarily market to service members, and reviewed their  marketing materials for the product sold to service members.
To illustrate the cost and the possible performance of sample insurance  policies offered by these companies we obtained and analyzed sample  policies for a junior enlisted service member from six companies.  We also  compared the cost and performance of these products to other products  offered to service members by the government including Servicemembers’  Group Life Insurance (SGLI), Veterans’ Group Life Insurance (VGLI), and  the Thrift Savings Plan (TSP), as well as insurance products offered by a  private insurance company.  We chose the TSP G Fund as the savings  component to be coupled with the government-offered insurance because  of its low risk and its comparable return rate to the minimum rates claimed  by the insurance companies. We assumed a 4 percent rate of return for all  of our analysis based on the guarantee rate claimed on the policies typically  marketed to service members by the six companies we reviewed. For  approximating the projected TSP return, we compounded the 4 percent  rate on a monthly basis. To project the return on the insurance products’  savings components, we used the method of crediting interest in the  products’ terms, in which interest is credited on the lesser of the average  balance during the year or the year-end balance. We also conducted  analysis to illustrate the performance of the products after a service  member stops making payments at the end of the fourth policy year.  Further, the analyses we conducted are for illustrative purposes only and  do not necessarily depict actual policy, plan schedules, or are adjusted  according to various proprietary risk classes that could apply for a  particular individual.
To identify the securities products being sold and how these were being  marketed to military members, we interviewed staff from NASD (formerly  called the National Association of Securities Dealers), Securities and  Exchange Commission (SEC), and North American Securities  Administrators Association (NASAA). We also interviewed officials from  the largest broker-dealer firm that markets to military members, which  represents 90 percent of the military market segment, and two of the  investment management firms that manage mutual funds underlying the  contractual plans sold to service members. To determine the cost and  performance of the contractual plan product offered by this broker-dealer  firm, we conducted analysis to illustrate a contractual plan product  typically marketed to career service members using a $600 front-end load.
To illustrate how this product compared to other similar products we  analyzed the cost and performance of a typical fund using the Investment  Company Institute recommended 5 percent load and TSP C Fund with no  load. We chose the TSP C Fund because it invests in common stocks and  was therefore comparable to the contractual plan product. We analyzed  these products for a 15 year--or “full term”--period. We assumed a 7 percent  annual return that we compounded monthly for all products.  Further, we  reviewed SEC and NASD investigation files of the sales of securities  products to military service members.
To assess how financial regulators and DOD were overseeing financial  product sales to military members, we interviewed state insurance and  federal, state, and other securities regulators. We also reviewed available  materials pertaining to product approval, investigations, and regulatory  activities and actions involving firms marketing to military members.  Specifically, to assess how insurance regulators were overseeing sales of  insurance products to military service members, we interviewed officials  from NAIC, including the staff working on the multistate investigation of  insurance sales involving service members. We also spoke with officials  and reviewed available documents on activities and actions from several  state insurance departments, including those in Florida, Georgia, Illinois,  Maryland, Texas, and the state of Washington, that have previously  investigated, or are currently investigating, companies targeting military  members. Further, we reviewed legal actions taken against certain  insurance companies as part of Department of Justice (DOJ) investigations  and law suit cases.
To determine the extent to which state insurance regulators received  complaints from military service members or had any concerns about their  jurisdiction on military installations, we relied on an E-mail survey to the  insurance commissioners for the 50 states, the District of Columbia, and  four territories: American Samoa, Guam, Puerto Rico, and the Virgin  Islands administered as part of our June 2005 report. We received  completed surveys from 46 states, the District of Columbia, and one U.S.  Territory, yielding an overall response rate of 87 percent. Further, to make  the same determination in regards to the sales of securities products to  military members, we relied on the results of a survey administered by  NASAA. Additionally, we contacted DOD officials, conducted fieldwork at  Fort Benning, Georgia and Naval Station Great Lakes, Illinois—two large  military training installations--and reviewed findings from other recent  work concerning supplemental life insurance sales conducted at several  other military installations throughout the country.
We performed our work from November 2004 to October 2005 in  accordance with generally accepted government auditing standards.

Actions Taken Against Financial Companies that Have Frequently Marketed to Military Members

Table 2 summarizes various actions that we identified during the course of  our review that have been taken by regulators or others against companies  that were identified as primarily marketing products to military members.  As indicated, many of the actions were settlements in which the companies  did not admit to any wrongdoing.

Performance of Contractual Plans Compared to Alternative Investments

Because of the structure of their sales charges, contractual plans are not  likely to offer superior returns to a long-term investor compared to other  alternative products. Table 1 illustrates that investing $100 per month for 15  years in a contractual mutual fund plan that earns a 7 percent return would  result in an account worth less than one in a conventional mutual fund with  a 5 percent sales load in which the same payments were made and the same  projected return was earned. As shown in the table, the amount that would  be accumulated in a contractual plan does not exceed that of a  conventional mutual fund until after 16 years. The contractual plan’s  accumulated value lags behind the conventional fund because its high up- front sales charge reduces the amount of money that is invested and  available to earn the return of the underlying mutual fund from the  beginning. In contrast, investing $100 monthly in TSP and earning a 7  percent return would result in an account worth $1,600 more than that  accumulated in the contractual plan after 15 years.
As table 1 also shows, investors that terminate their periodic investments  earlier than the full 15 years are even more likely to be better off with a  conventional mutual fund or TSP. For example, an investor ceasing  payments after 4 years in the contractual plan would have an account  worth about $4,785. However, after 4 years, the account of the conventional  mutual fund would be worth almost $5,275 and the TSP account would be  worth about $5,553.

Jurisdictions in Which at Least One of the Six Insurance Companies That Target Military Members Were Licensed to Sell Insurance

Comments from the Department of Defense

Comments from the Securities and Exchange Commission

Comments from NASD (Formerly Called the National Association of Securities Dealers)

Comments from the National Association of Insurance Commissioners

GAO Contact and Staff Acknowledgments

	GAO Contact

	Staff Acknowledgments

In addition to the individual above, Cody Goebel, Assistant Director;  Joseph Applebaum; Gwenetta Blackwell-Greer; Tania Calhoun; Rudy  Chatlos; Lawrence Cluff; Barry Kirby; Marc Molino; Josephine Perez; David  Pittman; and Amber Yancey-Carroll made key contributions to this report.

Summary:
Why GAO Did This Study

In 2004, a series of press articles alleged that financial firms were marketing expensive and potentially unnecessary insurance or other financial products to members of the military. To assess whether military service members were adequately protected from inappropriate product sales, GAO examined (1) features and marketing of certain insurance products being sold to military members, (2) features and marketing of certain securities products being sold to military members, and (3) how financial regulators and the Department of Defense (DOD) were overseeing the sales of insurance and securities products to military members.

What GAO Found

Thousands of junior enlisted service members have been sold a product that combines life insurance with a savings fund promising high returns. Being marketed by a small number of companies, these products can provide savings to service members that make steady payments and have provided millions in death benefits to the survivors of others. However, these products are much more costly than the $250,000 of life insurance--now $400,000--that military members already receive as part of their government benefits. In addition, the products also allow any savings accumulated on these products to be used to extend the insurance coverage if a service member ever stops making payments and fails to request a refund of the savings. With most military members leaving the service within a few years, many do not continue their payments and, as a result, few likely amassed any savings from their purchase. Several of the companies selling these products have been sanctioned by regulators in the past and new investigations are underway to assess whether these products were being properly represented as insurance and whether their terms were legal under existing state laws. Thousands of military members were also purchasing a mutual fund product that also requires an extended series of payments to provide benefit. Known as contractual plans, they expect the service member to make payments for set periods (such as 15 years), with 50 percent of the first year's payments representing a sales charge paid to the selling broker-dealer. If held for the entire period, these plans can provide lower sales charges and comparable returns as other funds. However, with securities regulators finding that only about 10 to 40 percent of the military members that purchased these products continued to make payments, many paid higher sales charges and received lower returns than had they invested in alternatively available products. Regulators have already taken action against the largest broker-dealer that marketed this product and are investigating the few remaining sellers for using inappropriate sales practices. With the wide availability of much less costly alternative products, regulators also question the need for contractual plans to continue to be sold. Financial regulators were generally unaware of the problematic sales to military members because DOD personnel rarely forwarded service member complaints to them. Insurance products also usually lacked suitability or appropriateness standards that could have prompted regulators to investigate sales to military members sooner. Securities regulators' examinations of contractual plan sales were also hampered by lack of standardized data showing whether customers were benefiting from their purchases. Although recognizing a greater need for sharing information on violations of its solicitation policies and service member complaints, DOD has not revised its policies to require that such information be provided to financial regulators nor has it coordinated with these regulators and its installations on appropriate ways that additional sharing can occur.