Financial Product Sales: Actions Needed to Protect Military Members
Published: 2005-11-17T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: In 2004, a series of media articles alleged that financial firms were marketing expensive and potentially unnecessary insurance or other financial products to members of the military. GAO's report for this committee examined (1) features and marketing of certain insurance and securities products being sold to military members and (2) how financial regulators and the Department of Defense (DOD) were overseeing the sales of insurance and securities products to military members. GAO also examined issues relating to DOD's oversight of insurance sales for a report issued in June 2005.
section_title: What GAO Found
paragraphs: A limited number of firms accused of using deceptive sales practices are targeting costly financial products to military members with features that reduce their benefits to military purchasers. Although some service members benefited from a product that combines insurance with a savings component, the additional coverage was more expensive than the low-cost government insurance almost all service members already receive. One feature reducing these products' benefits was that if the service member ever stopped making payments and did not request a refund, the accumulated savings is used to continue the life insurance coverage. With military members often leaving the service within a few years, most stopped their payments and likely failed to amass any savings from their purchase. Various regulatory and other actions have been taken against the insurance companies that sell these products in the past and new investigations are underway in 14 states over whether these companies have failed to clearly identify the products as insurance as required by law or whether the products' features comply with all state insurance requirements. A small number of broker-dealers were also marketing a securities product--the mutual fund contractual plan--that has largely disappeared from the civilian marketplace. Although potentially providing returns equivalent to other products if steady payments are made over a long period, these contractual plans proved more expensive to most military purchasers than other widely available alternative products because many military members stopped making payments in the first few years. In addition, the largest broker-dealer selling contractual plans has already been sanctioned by regulators for using misleading marketing materials and examinations into the practices of other firms marketing this product are also underway. A lack of routine complaint sharing by DOD prevented financial regulators from identifying inappropriate sales to military service members earlier. Although insurance regulators in some states review sales activities periodically, most rely on complaints to indicate that potentially problematic sales are occurring, particularly since no appropriateness or suitability standards exist for insurance. Securities regulators' efforts were also hampered by the lack of complaint sharing from DOD personnel. Because sharing with financial regulators can be complicated by privacy regulations and potential legal restrictions, DOD personnel at individual installations generally resolved matters involving product sales with companies directly. However, in light of the problems identified in our June 2005 report and the report issued for this committee, DOD has efforts underway to revise its solicitation policies regarding such sales, and has reviewed ways in which it can legally share additional information with financial regulators. However, DOD has not yet issued these new policies or coordinated with military installation personnel or with regulators on appropriate ways that additional sharing could occur.

section_title: Letter
paragraphs: I am pleased to be here to discuss GAO’s work on the sales of financial  products to members of the U.S. military. In 2004, a series of media reports  highlighted allegations of financial firms marketing expensive and  potentially unnecessary insurance and other financial products to  members of the military. These accounts included claims of insurance  companies improperly selling insurance as investment products and  broker-dealer firms marketing a mutual fund product with high upfront  sales charges that was rarely being offered to civilians. These media  reports raised concerns within Congress and elsewhere over whether the  men and women in the armed services were as adequately protected from  inappropriate financial product sales as their civilian counterparts.
Today, I will summarize the results from the report being released today  that we prepared at this committee’s request, which is entitled Financial  Product Sales: Actions Needed to Better Protect Military Members.  Specifically, I will discuss (1) the insurance and securities products that  were being sold primarily to military members and how these products  were being marketed, and (2) the ability of financial regulators and the  Department of Defense (DOD) to oversee the sales of insurance and  securities products to military members. Where applicable, I will also  present results from a related report entitled Military Personnel: DOD  Needs Better Controls over Supplemental Life Insurance Solicitation  Policies Involving Servicemembers.
A limited number of firms accused of using deceptive sales practices are  targeting costly financial products to military members with features that  reduce their benefits to military purchasers. About six insurance  companies are marketing products that combine high-cost insurance with  a savings component. Although some service members and their survivors  have benefited from these products, many have not. Most of the  purchasers of these products were unmarried individuals with no  dependents and thus may have had little need for more coverage beyond  that already provided through the low-cost government insurance offered  to service members. In addition, these products also appeared to be a poor  investment choice for service members because they include provisions  that allow the money accumulated in the savings fund to be used to keep  the life insurance in force if the service member ever stops making  payments and does not request a refund of this savings. Given that military  members move frequently and often leave the service within a few years,  many did not continue their payments and failed to cancel their policy and  request refunds, and as a result, few likely amassed any savings from their  purchase. Since the 1990s, state regulators, law enforcement authorities,  and DOD have taken various actions against the few insurance companies  that sell these products to military members and current investigations are  continuing in as many as 14 states. Among the allegations being  investigated is whether these companies are violating state laws by failing  to clearly identify the products as insurance. In addition, several states are  also reviewing whether the products’ features comply with all state  insurance requirements. Similarly, a small number of broker-dealers were  marketing a securities product—the mutual fund contractual plan—that  has largely disappeared from the civilian marketplace. Although  potentially providing returns equivalent to other products if steady  payments are made over a long period of time, these contractual plans  proved more expensive to most military purchasers than other widely  available alternative products because many military members stopped  making payments in the first few years. Securities regulators are also  concerned over the practices used to market these products and the  largest broker-dealer selling contractual plans recently agreed to pay a $12  million penalty to settle Securities and Exchange Commission (SEC) and  NASD allegations that it used misleading marketing materials. In addition,  these regulators are currently conducting examinations into practices of  the other firms that also marketed these products to military members.
A lack of routine complaint sharing between financial regulators and DOD  was the primary reason that regulators did not generally identify the  problematic sales of financial products to military service members until  such accounts appeared in the media. Although insurance regulators in  some states review sales activities periodically, insurance regulators in  most states generally rely on complaints from purchasers to indicate that  potentially problematic sales are occurring. One reason that insurance  company sales activities are not reviewed more extensively is because  most states lack any appropriateness or suitability standards for insurance  products. Although conducting periodic examinations of broker-dealers  sales practices, securities regulators’ ability to identify problems involving  the sale of contractual plans was also hampered by the lack of complaint  sharing from DOD personnel and the absence of standardized information  on the extent to which contractual plan purchasers were successfully  making their payments. Because sharing with financial regulators can be  complicated by privacy regulations and potential legal restrictions, DOD  personnel at individual installations generally resolved matters involving  product sales with the service member and the companies directly.  However, in light of the problems identified in our June 2005 report and  the report we issued for this committee, DOD has efforts underway to  revise its solicitation policies regarding such sales and has reviewed ways  in which it can legally share additional information with financial  regulators. However, DOD has not yet issued these new policies or  coordinated with its installation personnel or with regulators on  appropriate ways that additional sharing can occur. State insurance and  securities regulators also expressed concerns over whether their  jurisdiction over sales of financial products on military installations was  sufficiently clear.
Given the concerns over potentially inappropriate financial product sales  to military members, the need for definitive actions to better protect  service members appears overdue. The report we issued to this committee  recommends actions by Congress that are consistent with many of the  provisions that seek to improve protections for military members in the  bills that passed the House of Representatives and are under consideration  in the U.S. Senate. Because the features of the products being sold to  military members provided limited benefits to many military purchasers,  we believe that Congress should act to have all state insurance regulators  conduct reviews to ensure that only legal products are being sold to  military members and to have regulators work cooperatively with DOD to  develop standards that could help ensure that companies only market  products appropriate for the military members’ needs and circumstances.  Similarly, given the wide availability of less expensive alternatives,  Congress should act to amend the Investment Company Act to ban the sale  of contractual plans. Because financial regulators’ ability to adequately  oversee sales to military members was hampered by a lack of information  sharing about military members’ complaints and concerns, we also  recommend that Congress direct DOD to work with insurance and  securities regulators to overcome barriers to sharing information and to  clarify that state regulators have jurisdiction on military installations. In  the report prepared for this committee, we also recommend that DOD  issue its revised solicitation policies that will require military personnel to  share complaints with financial regulators. To improve oversight by state  insurance regulators, SEC, and NASD, we recommend that these  organizations designate specific members of their staff to receive  complaints and conduct outreach to proactively learn of problems  involving military members. In the event that contractual plans continue to  be sold, we also recommended that SEC and NASD improve the  information they have to assess the sales of contractual plans. DOD, SEC,  NASD, and the National Association of Insurance Commissioners (NAIC)  provided comments on our current report and indicated that they intend to  take steps to consider and implement our recommendations.
subsections: section_title: Costly Financial Products With Features Inappropriate for Military Members Raise Sales Practice Concerns
paragraphs: A limited number of insurance companies and broker-dealers are under  investigation for deceptive sales practices to target military members with  financial products that have features that reduce their benefit to service  members. Although most service members already receive considerable  low-cost life insurance as part of their government benefits, state  insurance regulators we contacted said that at least six insurance  companies have been selling a hybrid insurance product that combines life  insurance coverage with a side savings fund to thousands of service  members at installations across the United States and around the world.  For example, four of these companies were licensed to sell insurance in at  least 40 states, and the other two licensed in at least 35 states and five of  them had received DOD approval to conduct business at U.S. military  installations overseas. These insurance companies also appeared to  market primarily to junior enlisted service members. According to state  insurance regulators we contacted, the companies primarily sold  insurance policies to military personnel during their first few years of  service, including during their initial basic training or advanced training  provided after basic training.
Although the exact number of service members that have purchased these  products is not known, regulators told us that these companies sell  thousands of policies to military personnel each year. We also found  evidence that large numbers of these products were being sold. For  example, base personnel at one naval training facility we visited said they  regularly received several hundred allotment forms each month to initiate  automatic premium payment deductions from military members’  paychecks for these insurance products.
These products provide additional death benefits but are significantly  more expensive than other life insurance coverage available to service  members. For example, service members purchasing these products make  payments of about $100 per month for additional death benefits generally  ranging from $25,000 to $50,000. In contrast, all service members are  currently able to purchase $400,000 of life insurance through  Servicemembers’ Group Life Insurance (SGLI) for $26 per month.
Although the insurance products these six companies were selling also  included a savings component that recently promised to earn interest  between 6.5 and 8.1 percent, these products also included features that  reduced the likelihood that service members purchasing them would  accumulate large amounts of savings. As we reported, military members  move frequently and many leave the service after a few years, which which  may reduce their ability or willingness to continue making payments to  fulfill a long-term financial commitment. However, the products being  marketed by these insurance companies require a long series of payments  to result in significant benefits to their purchasers. For example, most of  the payments made in the earliest years—ranging from 1 to 7 years— would be used to pay the premiums for life insurance coverage. In  subsequent years, more of the service members’ payment would be  allocated to the savings component. In addition, these products also  included features that allowed the companies to use the money  accumulated in a service member’s savings fund to automatically pay any  unpaid insurance premiums. Although this would extend the period of  time that these service members would be covered under the insurance  policy, data we obtained from several of these companies indicated that 40  percent or more of the service members that purchased these products  stopped making payments within the first 3 years. With regulators  indicating that most purchasers failed to request refunds of their saving  fund balance, few likely accumulated any savings as a result of their  purchase.
According to our analysis, the amount of time that it takes for a service  member’s savings fund on these combined insurance and savings products  to become totally depleted through the automatic payment provision  varied. Figure 1 shows the impact on a service member who purchases the  product providing $30,000 of insurance coverage that requires full  payment of the total life insurance premimium during the first 7 years. As  the figure shows, the money in the savings fund of a service member who  makes the required $100 monthly payments for 4 years and then stops  paying would be totally depleted to pay the subsequent insurance  premiums in just over 1 year. This occurs because of the large premiums  due in the early years on this type of policy, and because the accumulated  value of the savings fund for this product was modest. For the other type  of insurance and savings product typically being sold to military members,  which involves lower but continuous premium payments over the life of  the policy, service members who halt their payments after 4 years would  have accumulated sufficient savings to extend the $30,000 of life insurance  coverage for another 13 years. In contrast, a service member could have  used the $100 monthly payment to instead purchase $30,000 of SGLI term  coverage at a cost of only about $23 per year and invest the remainder into  the Thrift Savings Plan (TSP), which is the low-cost retirement savings  plan available to military members and federal employees. Although  ceasing payments on SGLI after 4 years would terminate the service  member’s life insurance, the money contributed to the TSP and left to earn  just 4 percent interest would grow to about $9,545 in 20 years.
subsections: section_title: Insurance Companies Accused of Inappropriate Sales Practices to Military Members
paragraphs: The companies that market primarily to military members have been  subject to actions by state insurance regulators, the Department of Justice  (DOJ), DOD, and others. In the report we prepared for this committee, we  identified at least 17 lawsuits or administrative actions that had been taken  against companies that market primarily to military members. In many of  these actions taken by state and federal regulators, federal law  enforcement organizations, or others, the companies have been accused of  inappropriate sales practices and agreed to settlements as part of lawsuits  or administration actions involving fines, refunds, and other actions. For  example, in December 2002, DOJ announced a settlement against an  insurance company that had marketed a combined insurance and saving  product primarily to military members in which the company paid a  penalty and agreed to no longer sell insurance in the United States.  According to the DOJ complaint, this company had allegedly defrauded  military service members who purchased life insurance policies from the  company by having its agents pose as independent and objective  counselors representing a nonprofit fraternal organization that offered, as  one of its benefits, the ability to purchase the company’s life insurance.
The insurance companies that marketed primarily to service members  have also been accused of violating DOD’s own solicitation policies for  many years. For example, a 1999 DOD Inspector General report and a  DOD-commissioned report issued in 2000 found that insurance companies  were frequently employing improper sales practices as part of marketing  to service members. Among the activities prohibited by DOD that the  Inspector General’s report found were occurring included presentations  being made by unauthorized personnel, presentations being made to group  gatherings of service members, and solicitation of service members during  duty hours or in their barracks. More recently, DOD personnel conducted  an April 2005 proceeding in Georgia to review the practice of one of the  companies currently being investigated by state insurance regulators  regarding allegations of multiple violations of the DOD directive on  insurance solicitation. Among the practices alleged at this hearing were  misleading sales presentations to group audiences and solicitations in  unauthorized areas, such as in housing or barracks areas. DOD recently  began maintaining an online listing of actions taken against insurance  companies or their agents by various DOD installations. As of August 11,  2005, this web site listed 21 agents from some of the 6 companies that  market primarily to military members that are permanently barred—or  have had their solicitation privileges temporarily suspended—at 8  different military installations.
Our own work also found that problems involving sales of insurance  products to military members appeared to be widespread. We reported in  June 2005 that DOD only recently began systematically collecting and  disseminating information on violations of DOD’s solicitation policy by  sellers of financial products. However, as part of that report, we also  surveyed DOD personal financial training program managers and found  that nearly 37 percent believed that insurance company representatives  had made misleading sales presentations at their installations during 2004,  with 12 percent believing that such presentations were occurring  routinely. At the two bases visited as part of work for this report, we also  found evidence that problematic sales to service members were occurring.
For example, our review of statements taken from 41 service members  that military investigators interviewed at one Army base indicated that  more than 70 percent of the service members said that the insurance sales  personnel had described the product being sold as a savings or investment  product rather than as insurance, which violates state insurance laws.  Additionally, many of these service members also described conduct that  appeared to represent instances in which insurance company sales  personnel had violated one or more of the restrictions in DOD’s  solicitation policy, such as making these sales presentations during group  training sessions.
In addition to these past actions, insurance regulators in as many as 14  states are also conducting examinations of these six insurance companies,  as well as others that market to military members. Among the issues that  regulators are investigating are whether representatives of these  companies have not been clearly identifying these products as insurance,  as state laws require, but instead marketing them as investments.  Regulators and other organizations are also examining whether the sellers  of these products are misrepresenting information on the forms used to  initiate pay allotments to deduct the payments for the products directly  from the service members’ pay.
In addition, insurance regulators in some states are currently reviewing  whether these combined insurance and savings products that are being  sold to military members comply with all applicable state insurance laws  and regulations. For example, regulators in Washington state rescinded  approval to sell the products that had previously been approved for sales  by some of these companies because the savings component, which the  companies had been labeling as an annuity riders, was determined to not  meet that state’s annuity regulations. Regulators in Virginia also recently  ordered three companies that marketed primarily to military members to  cease sales of combined insurance and savings products because of  concerns over whether these products adequately complied with that  state’s insurance law. However, although these products may be marketed  in as many as 46 states, currently only 14 states are involved in such  reviews of the legality of these products. As a result, in the report we  prepared for this committee, we recommend that Congress act to have  insurance regulators in all states conduct reviews to ensure that the  products being marketed to military members adequately comply with  state insurance laws.
section_title: Companies also Selling Service Members a Mutual Fund Product with Features that Reduce Its Benefit to Most Military Members
paragraphs: Large numbers of service members, including officers, were also  purchasing a unique securities product, known as a contractual plan, with  features that reduce its benefit to military members. Under the terms of  the contractual plans sold to military service members, they would be  expected to make monthly payments of a set amount for long periods,  such as 15 years, that would be invested in the mutual funds offered by  some of the largest mutual fund companies. Under the terms of the  contractual plan, the broker-dealer selling the product deducts a sales  charge (called a load) of up to 50 percent from each of the first year’s  monthly payments with generally no further sales load deductions  thereafter. In contrast, conventional mutual funds typically deduct loads  that average 5 percent from each contribution made into the fund.  According to regulators, about five broker-dealers accounted for the bulk  of contractual plan sales to military members. According to the marketing  materials of the broker-dealer that was the largest seller of contractual  plans, this firm had nearly 300,000 military customers, with an estimated  one-third of all commissioned officers and 40 percent of active duty  generals or admirals as clients. This firm also employs about 1,000  registered representatives in more than 200 branch offices throughout the  United States, as well as locations in Europe and in the Pacific region. The  great majority of the firm’s sales representatives are former commissioned  or noncommissioned military officers.
While sales charges for contractual plans are initially much higher than  those of other mutual fund products, the effective sales load—the ratio of  the total sales charge paid to the total amount invested—becomes lower  as additional investments are made. Over time the effective sales load for a  contractual plan will decrease to a level comparable to—or even lower  than—other conventional mutual funds with a sales load. As illustrated in  Figure 2, if all 180 monthly payments are made under a contractual plan,  the effective sales load on the total investment decreases to 3.33 percent  by year 15. However, if a purchaser of one of these plans stops making  regular investments earlier, the effective sales charge can be much higher.  For example, halting payments after 3 years results in an effective sales  load of 17 percent of the amount invested.
At one time, contractual plans were the only way for small investors to  invest in mutual funds as in the past many mutual funds required large  initial investments, which prevented them from being a viable investment  option for many individual investors. However, today, other lower-cost  alternatives exist for small investors to begin and maintain investments in  mutual funds. For example, many mutual fund companies now allow  investors to open a mutual fund account with a small initial investment,  such as $1,000, if additional investments—including amounts as low as $50  per month—are made through automatic withdrawals from a bank  checking or savings account. According to a recent study by the mutual  fund industry association, over 70 percent of the companies offering S&P  500 index mutual funds in 2004 had minimum initial investment amounts  of $1,000 or less, with 9 having minimum investment amounts of $250 or  less. Securities regulators saw the wide availability of such products as  the reason that contractual plans were rarely being offered to most  investors. Another alternative investment option available to service  members since 2002 is the government-provided TSP. Comparable to  401(k) retirement plans available from private employers, service  members can currently invest up to 10 percent of their gross pay into TSP  without paying any sales charge. The various funds offered as part of TSP  also have much lower operating expenses than other mutual funds,  including those being offered as contractual plans. Service members could  also choose to invest as many other investors do in mutual funds offered  by companies that do not charge any sales load. Called no-load funds,  these are available from some of the largest mutual fund companies over  the telephone, the Internet, or by mail.
Although contractual plans can provide benefits to those holding them for  long periods, many service members were not making the expected  payments and thus ended up paying more than had they invested in other  alternatively available products. Given military members’ frequent moves  and with many leaving the service after a few years, regulators found that  most service members were not investing in their plans for the entire term.  For example, SEC and NASD found that only 43 percent of the clients that  purchased plans between 1980 and 1987 from the broker-dealer that was  the largest marketer of contractual plans had completed the full 15 years  required under the contract—with many service members ceasing their  payments after about 3 years and thus effectively having paid sales loads  of 17 percent on their investment. Regulators found that customers of the  other broker-dealers marketing these plans were similarly or even less  successfully making all of the payments expected under the plan—for  example, at one firm only 10 percent of customers had made payments for  a full 15 years.
Contractual plans have been associated with sales practice abuses for  decades. Concerns about excessive sales charges and other abuses  involving these products during the 1930s provided the impetus for  provisions in the Investment Company Act of 1940 that limited the  amounts that purchasers of contractual plans could be charged. Additional  concerns involving contractual plans during the 1950s and 1960s also led  Congress to amend the Act in 1970 to further limit the maximum sales  charges and to provide a period in which purchasers could obtain refunds  of their investment. Firms marketing contractual plans have again been  accused of inappropriate sales practices. In December 2004, SEC and  NASD sanctioned the largest broker-dealer marketing these plans to  service members after alleging that the firm’s marketing materials were  misleading. For example, according to the regulators, the firm’s marketing  materials allegedly included various misleading comparisons of  contractual plans to other mutual funds, including characterizing 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. This firm agreed to pay a total of about $12 million and has  voluntarily discontinued sales of contractual plan products. About $8  million of the total money paid by this firm is to be used to fund financial  education efforts for military members that are being developed and  administered by NASD. Regulatory examinations of the other four smaller  broker-dealers that continue to sell contractual plans are continuing.
Given the longstanding history of sales-practice abuses associated with the  contractual plans and the availability of viable alternative investments, we  believe that Congress should act to ban the further sale of contractual  plans. The bills currently under consideration in the Congress include  language that would amend the Investment Company Act of 1940 to render  sales of such plans illegal, thereby removing from the market a product  that appears to have little need to continue to exist.
section_title: Lack of DOD Complaint Sharing Hampered Regulators’ Ability to Identify Problems Involving Sales to Military Members
paragraphs: Additional actions by Congress, DOD, and regulators also appear  warranted to improve the effectiveness of insurance and securities  regulators in overseeing sales of financial products to military members.  As we reported, the ability of insurance and securities regulators to  identify problems involving sales to military members was hampered  because DOD personnel were not generally sharing service member  concerns and complaints. In addition to conducting routine examinations,  insurance and securities regulators use complaints from financial firms’  customers as an indicator that problems involving particular products, or  the practices of particular firms, exist. For example, state insurance  regulators conduct various types of reviews of the insurance companies  they oversee, including reviews focusing on insurance companies’  financial soundness. Regulators in some states also review some aspects  of insurance product sales as part of market conduct examinations that  may involve reviews of a range of company practices, including sales,  underwriting, and claims processing and payment. Although some states  routinely perform market conduct reviews of the companies they oversee,  most states only conduct such investigations when they receive  complaints from customers or otherwise obtain information that raises  concerns about the activities of an insurance company.
One reason that insurance regulators do not review insurance company  sales practices more routinely is that standards requiring that any  insurance products sold be appropriate or suitable for the purchaser do  not generally exist. As a result, under most state insurance laws, insurance  regulators do not have the authority to evaluate whether the product sold  to a military member was appropriate or suitable given the customer’s  needs. State regulators and others have previously attempted to establish  suitability standards for insurance products, but these efforts have had  limited success. For example, a NAIC working group originally formed to  develop suitability standards to apply to all insurance sales instead  concluded its efforts by developing standards that applied only to the sale  of annuity products to seniors age 65 and over.
To reduce the likelihood that service members will be marketed products  inappropriate to their needs, in the report we prepared for this committee,  we recommend that Congress act to have insurance regulators work  cooperatively with DOD to develop suitability or appropriateness  standards that would apply to the sale of financial products to military  members. The bills being considered in the U.S. Senate include provisions  to have these parties work together to develop such standards. Such  standards could ensure that companies offer only products that address  actual service member needs for insurance and that take into account  service members’ itinerant lifestyles and income levels. Having such  standards could also provide protection for service members that are  located in overseas installations not directly overseen by state regulators.
subsections: section_title: Securities Regulators Also Hampered by Lack of Complaints Involving Military Members
paragraphs: Similarly, the ability of SEC and NASD to identify problems involving sales  by broker-dealers to military members was also hampered by the lack of  complaints from DOD and for other reasons. For example, previous SEC  and NASD examinations of the largest marketer of contractual plans had  not identified any significant problems. However, staff from these  organizations told us that identifying the problems involving the sale of  this product was made more difficult because neither of the regulators had  previously received any complaints about the firm from service members.  The securities regulators’ ability to detect problems was also hampered by  the lack of standardized data on the extent to which customers were  completing contractual plans. For example, SEC examiners had obtained  data from the largest broker-dealer that purported to show that the  persistency rate for the contractual plans—which represented the  proportion of plans that were still open—was over 80 percent for the  previous 3 years. However, after press reports appeared, NASD and SEC  examiners reviewing this firm’s operations found that the firm maintained  various sets of data on its customers’ activity. However, these various sets  did not always include all customers’ information, which made regulators’  efforts to definitively determine the extent to which this firm’s customers  were continuing to make payments and successfully completing their  plans more difficult. By further analyzing the data, the regulators  determined that, by excluding any customer whose account remained  open but had not made any payments in the last year, the actual extent to  which this broker-dealer’s customers were successfully completing their  contractual plans was only 43 percent. As a result, the report we prepared  for this committee recommends that, if contractual plans continue to be  sold, SEC and NASD should consider ways (such as through revised  examination procedures or recordkeeping rules) to ensure that they obtain  better information on the extent to which broker-dealer customers are  successfully making their payments.
section_title: DOD Acting to Improve Sharing with Financial Regulators but Not All Efforts Complete
paragraphs: DOD has also taken some actions to address potentially problematic sales  of financial products to service members, although it does not currently  share all relevant information with financial regulators. A primary way that  DOD attempts to protect service members from inappropriate sales is  through its directive on commercial solicitation on military installations.  DOD staff within the Office of the Under Secretary of Defense for  Personnel and Readiness are revising this directive and, in April 2005,  sought public comments on a revised version that incorporates new  requirements. For example, the revised directive would expressly prohibit  insurance products from being sold as investments. The draft of the  revised solicitation directive includes provisions that would also require  installation personnel to report all instances in which they ban or suspend  the solicitation privileges of any companies or individuals selling financial  products to the Principal Deputy Under Secretary of Defense for  Personnel and Readiness. In our June 2005 report, we recommended that  DOD create a database of all violations of its solicitation policy. DOD has  collected and posted some of this information to a web site available to its  personnel and others. The bills under consideration in the Senate would  further require DOD to promptly notify insurance and securities regulators  of those individuals or companies whose solicitation privileges have been  suspended, limited, or revoked by DOD installations. In our June 2005  report, we also identified various improvements that DOD has agreed to  make to its oversight of insurance purchasers by military members,  including the regulations governing the pay allotment process. We  summarize these findings and DOD’s proposed improvements in appendix  I of this statement.
Although DOD personnel had not routinely shared service member  complaints with financial regulators in the past, DOD officials have told us  that they intend to require their personnel to report more of this type of  information to regulators. Under the current solicitation policy directive,  DOD personnel are not required to share information relating to service  member concerns or complaints with other parties, and the revised draft  that was published for comment also lacked any provisions relating to  such information. In addition, when we issued our June 2005 report on  DOD’s insurance solicitation oversight, DOD was reluctant to provide  information to regulators beyond indicating that DOD installations had  suspended or revoked a given firm’s or individual’s solicitation privileges  or that the violations involved the eligibility of the agent to hold a State  license or meet other regulatory requirements. However, staff in the  office that oversees the policy directive told us more recently that they  intend to specifically require in the new directive that base personnel  report to financial regulators any service member concerns or complaints  that relate to the quality of the financial products offered to them or  regarding the appropriateness of the practices used to market these  products. DOD has not, as of yet, issued this new directive. To ensure that  financial regulators have critical information that they need to identify  problematic products and sales practices, the report we prepared for this  committee recommends that DOD issue a revised DOD solicitation policy  directive that would require that information on service member  complaints related to financial product sales be provided to relevant state  and federal financial regulators.
DOD and financial regulators have also worked together to increase  education for military members. For example, NAIC and DOD personnel  have worked to together to develop a brochure that can be distributed to  service members that describes insurance products and lists the state  regulatory organizations to contact if they have concerns. In addition,  NASD was cooperated with DOD personnel as part of developing the  education campaign that is being planned using the money from the  broker-dealer contractual plan settlement.
However, DOD has not acted to fully address potential barriers to  increased sharing with financial regulators. For example, securities  regulatory staff told us that while they were conducting their  investigations of contractual plan sales, personnel at some DOD  installations were reluctant to share any information involving specific  service members for various reasons. According to these regulators, the  installation personnel cited military privacy regulations and the  restrictions that arise from attorney-client privilege if the service member  was being assisted by military legal counsel. According to the director of  the DOD office responsible for administering the solicitation policy, such  issues can affect their ability to share information with entities outside the  military. However, he explained that DOD has researched these legal  issues and now believe that they can share information that is deemed to  be necessary for the official needs of the requesting organization,  including financial regulators. This DOD official also acknowledged that  more coordination could be done to ensure that both military installation  personnel and financial regulatory staff understand how additional sharing  could appropriately occur  To ensure that financial regulators have critical information that they need  to identify problematic products and sales practices, the report we  prepared for this committee recommends that Congress direct DOD to  develop mechanisms to overcome any barriers and coordinate with its  installation personnel and with financial regulators on ways to share  additional information about problematic financial firm practices and  service member concerns. Our report further recommends that insurance  regulators, SEC, and NASD designate specific staff that would receive  complaints from DOD and conduct outreach with military installations to  proactively learn of issues or concerns involving product sales.
Another concern over whether military members are adequately protected  from inappropriate sales stems from uncertainty over financial regulators’  jurisdiction on U.S. military installations. Although most of the insurance  and securities regulators we contacted believed they had jurisdiction over  the sales of financial products on military installations, some regulators  expressed uncertainty over their authority to regulate sales on military  installations, where the federal government may have “legislative  jurisdiction.” For example, a Texas insurance department official told us  that he had trouble getting access to complaints information at a military  installation because installation personnel questioned his authority to  request such information. As part of the work on DOD’s oversight of  insurance sales that we reported on in June 2005, we surveyed the various  state and territorial insurance commissioners. Of those that responded to  the question regarding whether they had authority over sales of life  insurance on military installations, four commissioners indicated that they  did not have such authority. State insurance regulators also noted they  lack jurisdiction over sales taking place outside the United States at  overseas installations. At least one state securities regulator responded to  a North American Securities Administrators Association survey that it did  not have adequate authority over sales taking place on military  installations.
As a result, the report that we prepared for this committee also  recommends that Congress consider acting to clarify the jurisdiction of  state regulators over sales of financial products on military installations.  Of the legislation under consideration in the Congress, the bill that passed  the House of Representatives includes language stating that any state law,  regulation, or order pertaining to the regulation of insurance or securities  offers and sales are generally applicable to any such activities conducted  on Federal land or facilities in the United States and abroad, including  military installations. The version introduced in the U.S. Senate includes  similar language but would only apply to insurance activities.- - - - - - - - - - - - - - Mr. Chairman, this concludes my prepared statement and I would be  happy to respond to questions you or other members of the Committee  many have.
section_title: GAO Contacts and Acknowledgements
paragraphs: For further information regarding this testimony, please contact Richard J.  Hillman (202) 512-8678. In addition, others making key contributions to  this statement included Cody Goebel, Assistant Director; Jack Edwards,  Gwenetta Blackwell-Greer; Tania Calhoun; Barry Kirby; and Josephine  Perez.
section_title: Appendix I: Additional Actions Needed to Improve Oversight of Pay Allotments for Insurance for Military Members
paragraphs: As a result of a report we issued in June 2005, the Department of Defense  (DOD) has agreed with our recommendations to improve aspects of its  oversight of insurance purchases by military members.   At the request of  the chairs of the House Committee on Government Reform and House  Committee on Armed Services as well as various other members of the  House of Representatives, we reviewed DOD’s procedures to oversee the  sale of insurance products to military members, including the procedures  used to process pay deduction allotments to pay for insurance products.
Based on the work we conducted, we determined that DOD was not able  to monitor the extent to which service members were purchasing  supplement insurance because of problems with its personnel pay  databases. Pay information for service members is maintained by the  Defense Finance and Accounting Service (DFAS) in separate databases for  the different military services. However, we were not able, even with  DFAS assistance, to use information from these databases to reliably  determine the extent to which service members had purchased additional  insurance. For example, the codes in the databases used to identify an  insurance company are not the same for all services. Further, DOD and  service regulations permit the use of at least seven different allotment  forms, but not all of these forms explicityly identify which allotments are  for supplemental life insurance.
A major cause of these database-related problems is DOD’s systems  supporting service members’ pay, which we had previously found  unreliable. While a significant system enhancement project is under way  to improve the administration of military pay, DOD is likely to continue  operating with existing system constraints for several years. The  continued use of forms that do not require information and coding specific  to supplemental life insurance could cause allotment data to continue to  be unreliable for oversight purposes.
The absence of accurate data on the extent to which service members are  purchasing supplemental life insurance limits the ability of DOD policy  officials and installation solicitation coordinators to oversee such sales  and ensure that all relevant DOD policies are being followed. For example,  the lack of accurate data prevents DOD personnel from readily identifying  whether service members at a particular installation have submitted an  unusually large number of new allotments for supplemental life insurance  during a short period, which could indicate that a mass solicitation to  recruits or trainees has occurred in violation of DOD’s personal  commercial solicitation policy directive.
As a result, our June 2005 report recommended that DOD determine what  current and future modifications should be made to the regulations, forms,  and procedures used to initiate and electronically capture supplemental  life insurance allotments so that more useable data are available to the  DOD, service, and installation offices responsible for overseeing  supplemental life insurance solicitation. In its comments on a draft of our  report, DOD concurred with this recommendation and stated that the  department will consider our proposed changes for a future enhancement  of their pay system and will review the regulations and forms to determine  what further modification should be made.
Based on our work, we also found that weaknesses in DOD’s regulations  and forms prevented it from determining the extent to which its personnel  adhere to allotment regulations. For junior enlisted service members (pay  grades E-l to E-3), the DOD directive on personal commercial solicitation  requires that at least 7 days elapse before the allotment is to be processed  to allow these members to receive counseling about the purchase of the  supplemental life insurance. However, contrary to the regulation, we  found that some DOD financial personnel were accepting allotment forms  to start supplemental life insurance without verifying that a cooling-off  period had elapsed. Currently, the allotment forms that service members  use to start supplemental life insurance do not require certification that  the required cooling-off period and, possibly, counseling have occurred.  The absence of this information from allotment forms prevents finance  personnel from readily determining whether the 7 days have elapsed  before they certify the allotment. In addition, ambiguities in the language  of the solicitation policy directive may have also led to improper allotment  processing. For example, the directive was not clear as to whether the  counseling is required or optional during the cooling-off period. In  addition, the directive and the standard allotment forms do not contain  procedures for documenting whether the counseling took place.
To ensure better compliance with the directive, our June 2005 report  recommended that DOD clarify the requirements relating to the cooling-off  period in its upcoming revision to the solicitation policy directive, and  thereby eliminate the ambiguities about its requirements. In its comments  on a draft of our report, DOD concurred with this recommendation and  stated that it had identified an additional ambiguity in the current revised  directive regarding who is responsible for monitoring and enforcing the  cooling-off period for supplemental life insurance purchases. It indicates  that the proposed revision to the directive will address these issues.
We also found DOD personnel were not consistently complying with  regulations relating to ensuring that allotments were appropriately  authorized. According to DOD’s Financial Management Regulation,  establishment of, discontinuance of, or changes to existing allotments for  supplemental life insurance are to be based on a written request by a  service member or someone with a special power of attorney on behalf of  the service member. However, DOD personnel and insurance agents  indicated that some offices accepted allotment forms personally submitted  by insurance agents or through the mail with only the signature on the  form serving as proof that the service member initiated the allotment. For  example, finance office personnel at Naval Station Great Lakes said that  about half of all insurance allotment forms submitted to and processed by  their office came from insurance agents. In addition, we reported that a  life insurance agent was alleged to have submitted allotment forms at Fort  Bragg for service members who later said they had not wanted the policies  for which they were paying. Finance personnel said they accepted  allotment forms in this manner to ensure that polices start promptly, but  starting allotments without service members’ awareness can negatively  affect members’ finances and their unit’s morale and readiness.
To ensure that allotments are properly authorized, our June 2005 report  recommended that DOD issue a message to all finance offices and DFAS  offices that process allotments for supplemental life insurance to remind  personnel that DOD’s Financial Management Regulation indicates that  only service members or their designated representatives with special  power of attorney for the prescribed purpose are authorized to start, stop,  or modify financial allotments. In its comments on a draft of our report,  DOD concurred with this recommendation and stated that it will issue  such a statement.
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