The Securities and Exchange Commission (SEC) and the National Association of Securities Dealers (NASD) are clamping down on “1035″ exchanges of variable annuity contracts. These exchanges occur when brokers convince VA contract holders to switch to a new policy so the broker can earn an upfront commission on the sale. But these switches rarely benefit the policyholders, and usually end up costing them money.
Paul Roye, director of the SEC’s Division of Investment Management, said at a recent gathering of investment professionals that the SEC and NASD are “aggressively examining the firms and registered reps that sell variable products for [1035 exchanges] and other types of improper sales practices, and enforcement proceedings should be expected where they are found.” Roye cited recent NASD complaints against Waddell & Reed and its president and national sales manager for recommending 6,700 variable annuity exchanges to customers without assessing the suitability of the transactions. According to the complaint, Roye said, “the firm pressured clients to replace variable annuity contracts with similar annuities in order to advance the firm’s commercial interests and in direct contravention of the best interests of its clients. These ‘switching’ transactions are alleged to have generated $37 million in commissions and cost customers nearly $10 million in surrender fees.”
A senior official at one independent broker/dealers says he expects regulators to ask insurance companies offering VA contracts, “What percentage of your sales are 1035 exchanges?” He says this information can be derived from data in insurers’ annual reports. The thing to look for, he says, is net new asset growth versus sales. This CEO says regulators are especially keen on looking for instances where a client has signed a VA contract allowing its surrender after, say, seven years. Then a salesperson convinces the client to change over to a new contract before the period is up and earns a commission on the new sale.