Key provisions of a new variable annuity suitability rule were the focus of sharp questions that attendees addressed to a panel of experts at the Deferred Variable Annuity Rule Symposium, held here last month and hosted by the Securities Industry Financial Markets Association.
The participants, including some 45 executives and principals at insurance and financial advisory firms, took issue chiefly with provisions of Rule 2821 of the Financial Industry Regulatory Authority respecting prior exchanges of deferred VAs; and with the requirement that a principal review and approve a customer application within 7 days.
Despite objections, the panelists stood firm in their support of the rule. “In many ways, we’re defending [deferred variable annuities] by creating this rule,” said Lawrence Kosciulek, director of investment companies regulation at FINRA, Washington, D.C. “You are bound by this rule.”
Added Stephen Hall, deputy general counsel of the North American Securities Administrators Association, Washington, D.C.: “Everyone appreciates the challenges [of compliance with the provisions]. But we applaud this rule.”
The Securities and Exchange Commission approved the VA suitability rule on September 7, stipulating that the rule would go into effect 180 days after FINRA issues a regulatory notice to its members.
The rule creates recommendation requirements (including a heightened suitability obligation), expanded principal review and approval requirements, as well as supervisory and training requirements for VA transactions. Of particular concern to symposium attendees is a provision mandating that advisors demonstrate whether other deferred VA exchanges had taken place within the “customer’s account” during the prior 3 years. Several participants noted the difficulty in making this determination, especially in cases where funds invested in the annuity are not held “in account form” with the advisor or broker-dealer, but rather by the insurance carrier.
Kosciulek counseled attendees to first inquire with wholesalers and carriers with whom they do business about such prior exchanges. And, if information from these sources isn’t forthcoming, then they should question the client directly–and document as much.
“If you could not determine on your own whether there was an exchange during the past 3 years, then I would advise getting confirmation directly from customer,” said Kosciulek. “In any event, how can you recommend an exchange if you don’t know what the customer owns?”
Also of concern to attendees is the provision of Rule 2821 mandating that a registered principal review and approve a VA transaction prior to submitting the customer’s application to the issuing insurer for processing, but no later than 7 business days after the client signs the application. Several participants suggested the 7 days is unrealistic, particularly in situations where the client holds the application and check for several days prior to handing it over to the advisor for processing.
Lourdes Gonzales, an assistant chief counsel of sales practices at the SEC, Washington, D.C., suggested that attendees may experience “cold comfort” in learning that the SEC and FINRA had extensive discussions over the timing of principal review, and that it was “a big deal” for the commission to issue an exemption order allowing a broker-dealer to hold an application and check for up to 7 days.
Clifford Kirsch, a partner in the law firm of Sutherland, Asbill & Brennan, New York, and the panel’s moderator, also questioned panelists about how to handle principal review in cases where the broker-dealer is “co-located” (or has merged operations) with the insurance carrier. Lourdes said FINRA has issued an interpretative ruling on this point.
“In co-located situations, [FINRA] would consider the application transmitted to the insurance company only when the broker-dealer’s principal has approved the transaction, provided the broker-dealer insures that arrangements exist to prevent an insurance company from issuing the contract prior to principal review,” she said. “So it’s up to the broker-dealer to insure that the insurance company doesn’t [prematurely] issue the contract.”
Kosciulek discounted still more concerns of attendees. Among them: that the 7-day deadline is arbitrary; that it could “make for bad customer experience;” result in the loss of new business for advisors; and prevent clients from taking advantage of market fluctuations if, for example, an application has to be renewed because the deadline wasn’t met.
“Day-to-day movements in the stock market should not be a factor in the decision to purchase a deferred VA,” said Kosciulek. “The customer is going to own this product for typically 5 years, 10 years or more. We have this  rule in part because of the mad turnover of VAs we’re seeing in the marketplace.”
Kirsch agreed, but suggested that the deadline might be a topic for further discussion at FINRA. “This issue still needs fleshing out [at FINRA],” he said. “In the interim, my recommendation for advisors and broker-dealers is to talk about the rule’s impact with staff and to revise procedures as necessary to insure compliance.”
Kosciulek emphasized that the Rule 2821 is limited in scope, noting that it applies only to purchases and 1035 exchanges of deferred variable annuities. While the rule covers variable-to-variable and index-to-variable purchases, a separate rule (2310) applies to variable-to-index exchanges. Likewise, the rule does not govern reallocations of investment sub-accounts–only the initial allocations.
NASAA’s Hall said the states need to make more progress in harmonizing their laws and regulations governing variable annuities. While some jurisdictions treat the products as securities, others provide for exclusions. Still other states do not address the status of VAs.
He added that the current “jurisdictional tug of war” between many state insurance departments and state securities departments serves no one’s interest.
“The fact is that it’s very appropriate for state securities regulators to partner with the insurance departments to address VA sales abuses,” he said. “This will ultimately help protect investors in an area that is plagued with problems.”