Suitability takes center stage

Annuities are getting increased attention as Americans survey the shaky economic landscape of the past few months and realize the vulnerability created by a lack of guarantees in their retirement portfolios.

A June 2011 report from the Government Accountability Office noted that “as life expectancy increases, the risk that retirees will outlive their assets is a growing challenge.” As such, its primary recommendation was for retirees to “systematically draw down their savings and convert a portion of their savings into an income annuity to cover necessary expenses.”

This endorsement helped shine a spotlight on the benefits that annuities can provide. However, increased attention comes with increased scrutinyand rightly so, since most annuity purchases require a significant investment of retirement funds. Agent sales practices have always been a key component of confirming that consumers are satisfied with their purchase. As annuities evolve, insurers are taking on more of responsibility to ensure their products are being sold suitably.

This issue of suitability is at the forefront of the annuity conversation and will remain so due to the fact that annuities are not right for every consumer and every financial situation. As long-term financial products, fixed index annuities are designed to provide safety and protection of principal, with those guarantees backed by the financial strength of the individual carrier. But they also carry with them certain penalties if not held to maturity. This is why it is so crucial that each and every annuity sale is vetted by not only the agent, but also the issuing company.

With a fixed index annuity purchase, consumers are balancing three key attributesvolatility, liquidity, and risk of loss of principal or return on investment. Annuities are not as liquid as some other financial products, and to obtain full benefits the annuity must be held for a defined period, generally five to 10 years. If not communicated properly at the point of sale, this can lead to problems, whether they are misunderstandings about access to funds, surrender charges or even the very purpose for owning an annuity. Agents have a responsibility to explain these factors to their clients, but insurers need to be equally, if not more stringent in their review of the sales process involving their products.

Evolution of suitability

The industry has taken many steps to safeguard consumers, particularly with the sales of fixed index annuities. 

Until recently, suitability standards were primarily dictated by individual states. This creates a lot of inconsistency and opportunity for issues to arise. As one example, not all states require a comprehensive suitability review of every new fixed index annuity purchase. Instead it may only be for a specific age group. Fast forward to 2011, under the new National Association of Insurance Commissioners (NAIC) Model Enhancements, the fixed index annuity industry is required to tighten its system of supervision, from reviewing transactions to providing producer training and oversight. As part of the review process, issuers are now required to understand that the agent had reasonable grounds for believing their fixed index annuity recommendation is suitable, based on relevant information regarding the consumer’s needs and financial objectives before they issue the product.

Perhaps more significant is what individual insurance companies are doing to improve fixed index annuity sales suitability. Some insurers are showing true leadership in this matter and are exceeding state requirements to ensure customers are protected. Early on, this took the form of better consumer education, including plain-language documents like a Statement of Understanding that explains product details in an easy-to-understand format.

For some insurance companies, the next step was to standardize suitability forms for every applicant and establish an automated review process. After the form is received by the insurer, it is reviewed by a suitability rules engine, which analyzes the data and triggers further review in the event the data indicates a potential problem or question about whether the product sold is suitable for the consumer. After the contract is issued, there is often a “free look period” where the consumer can receive a premium refund if they feel the product they purchased in not appropriate for their situation.

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