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Suitability Standards For Annuities-Reality Or Myth?

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Recent years have seen an increase in litigation against insurers and distributors involving sales of various types of annuities. There has also been an increase in regulatory actions involving virtually all types of annuities.

Many of these lawsuits rely on various suitability standards as the basis for the sought-after recoveries. Much of the regulatory action also questions the suitability of the annuities sold to various types of consumers.

We have complained in past articles that some consumers have been treated by regulators and others as needing “special” protections because of age when reality dictates that no annuity should be sold to any person of any age without a valid suitability determination.

This leads us then to question what exactly constitutes a “suitable” sale of an annuity–of any type of annuity.

Variable annuities have long been subject to suitability standards imposed by the self-regulatory organization for the securities distribution industry, the NASD. Today, the NASD operates under a new name, the Financial Industry Regulatory Authority (FINRA), but the suitability rules, at least at the present time, remain the same.

Recently, state insurance regulators have begun imposing suitability requirements on sales of all types of annuities. The National Association of Insurance Commissioners, in June 2006, adopted a set of model regulations characterized as the Suitability in Annuity Transactions Model Regulation. The model regulation is now being adopted on a state-by-state basis.

Meanwhile, various versions of a new proposed NASD Rule (“Proposed Rule 2821) are pending. The goal is to impose more rigorous and enhanced suitability procedures for sales of deferred VAs. (By comparison, the model regulation applies to all annuities, not just deferred VAs.)

While Proposed Rule 2821 and the model regulation are not inconsistent with each other, the fact that Proposed Rule 2821 imposes more rigorous standards will require insurers and distributors that offer both VAs and non-variable annuities to create parallel procedures for each of the two types of products. But it is probable that some insurers and distributors will adopt the stricter standards of Proposed Rule 2821 for all their annuity sales in order to avoid the confusion that could develop from having two different sets of procedures for different types of products.

Plaintiff’s lawyers have discovered there are opportunities for instituting various types of litigation, due to suitability standards on sales of annuities.

Such standards, whether imposed by FINRA rules or state insurance regulations, do not by their terms provide for private rights of action by purchasers of annuities.

However, the courts and similar tribunals seem to have adopted suitability as the duty owed by insurers and distributors to their annuity customers; they therefore have no problem granting relief to such customers when suitability standards have not been observed.

Likewise, the NASD and the Securities and Exchange Commission have taken action against broker-dealers for suitability violations, and a number of state insurance regulators and state attorney generals have taken similar actions.

The bottom line: Suitability standards and procedures, while clearly in a state of transition, are very much a reality and will undoubtedly become an even larger reality as new, more rigorous standards are implemented.

This gives rise to the question broached earlier: What constitutes a suitable sale of an annuity?

Suitability, like beauty, is very much in the eye of the beholder. During the early days of the VA business, the suitability standard merely required that the purchase of a VA not be recommended if the product was “unsuitable” for the needs of the purchaser.

Obviously, it is easier to determine if something is unsuitable than to determine it is suitable. This probably reflects the fact that ugly is easier to identify than beauty!

Nevertheless, Proposed Rule 2821, which will probably remain applicable only to deferred VAs, requires deferred VA sellers to take certain steps (see chart).

It also imposes new requirements for suitability processes, recordkeeping and supervision for sales of deferred VAs.

At present, unless and until Proposed Rule 2821 is adopted, the suitability rules applicable to VA sales apply only when the sales person makes a “recommendation” to the customer to make such a purchase. Under Proposed Rule 2821, however, supervisory personnel are required to review every deferred VA sale, whether or not a recommendation was made. (Note: The standards for such review are slightly different when no recommendation has been made.)

While there is no bright line determination of whether the sale of an annuity is or is not suitable, we know of at least one compliance officer who reviews annuity sales with the suitability standard of “would I want my mother to purchase this annuity?” Suitability is here to stay and the “mother” standard may be as valid as any other.

Norse N. Blazzard JD, CLU, and Judith A. Hasenauer JD, CLU, are attorneys in the Pompano Beach, Fla. office of Blazzard & Hasenauer, P.C. Their email address is: .