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Good Suitability Screening Makes Good Sense For Annuity Sales

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Hardly a day goes by that there is not something reported in the trade press or even in the general financial press about suitability issues in the sale of annuities.

These reports affect all types of annuities: fixed, variable and variations of these (such as index annuities). Insurance regulators and securities regulators have weighed in on the suitability issue, and many states have adopted suitability requirements for sales of all life insurance products.

At the present time, the Securities and Exchange Commission and the NASD are still struggling with completion of the new suitability rule (proposed NASD Rule 2821) for deferred variable annuities. This proposal to change suitability requirements for deferred VAs has been kicking around since the summer of 2004.

All elements of the annuity industry, including insurers, broker-dealers and trade associations, have submitted comments on the proposed rule. Many of these comments say, in effect, that it seems inappropriate for one single type of security to be singled out from among all others for special suitability treatment.

Despite these comments, it seems clear that the rule will be adopted, at least in some form.

Regardless of what happens with proposed Rule 2821, it is obvious that suitability requirements for sales of annuities–all types of annuities–are here to stay.

Therefore, everyone involved with annuity sales should be prepared to understand the requirements and to be able to satisfy the needs for the documentation that these requirements impose.

Norse has had the privilege of providing expert witness testimony on suitability litigation regarding VAs. This has provided insight into suitability issues from the buyer point of view. Consider:

The downturn in the stock market that occurred in the 2000-2002 period adversely affected the value of many VA contracts. As a result, owners of a number of such contracts sought the assistance of plaintiff’s lawyers to seek to recover their losses–from the persons and entities that sold them the VAs in the first place. The usual complaint, in these cases, is that the VA purchasers did not understand and were not explained that the stock market could go down. They believed it could only go up!

Moreover, purchasers complain there was inadequate suitability screening when the VA was sold to them. They believe it was unsuitable to sell a product where there could be erosion in contract values as a result of a downturn in the stock market.

In essence, they contend they should have been sold a fixed annuity or some other form of a less expensive or less volatile investment.

The VA suitability issues involved are fairly straightforward. The NASD suitability rules provide a well-established pathway for attorneys, the courts and arbitrators to follow.

Suitability itself is a somewhat subjective term. If adequate risk profiling is done at the time of sale, however, it is possible to overcome the subjectivity with a more concrete standard. The hard issue is to determine what constitutes “adequate” risk profiling, particularly when the determination will be made after the fact, in a courtroom or arbitration hearing setting.

Our observation is that the critical factor in customer risk profiling is extensive documentation.

The suitability screening forms provided by most broker-dealers have been carefully prepared to establish the legal basis for suitability. Nevertheless, of equal importance are the notes of the sales personnel documenting conversations with the purchasers. Every customer contact should be documented with detailed notes outlining the time, place and method of conversation as well as notation of the subjects discussed.

Anything that will allow the conclusion that the customer was knowledgeable about investments and in control of the transactions helps in the event of future litigation.

With the extension of suitability requirements to all forms of annuities, the practices used with VAs can provide a good roadmap for sales of products that have not heretofore had to be concerned with suitability issues.

Again, suitability screening, backed up by extensive documentation, is key to establishing a sound legal basis for the sale of any annuity.

Although it is sad that the insurance industry must conduct business with an eye toward eventual litigation, it is an inescapable fact of life in the 21st century. If industry professionals fail to understand this, they should not be surprised if they do not like the inevitable unhappy result.


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