Over the past few years, insurers have been provided with suitability standards and guidelines with respect to recommending and selling annuity products to clients. This past year, FINRA (under Rule 2111) provided an expanded list of the type of information an advisor must obtain and analyze from a client prior to making a product recommendation. In addition, insurers have been given a suitability framework under the 2010 Suitability in Annuity Transaction Model Regulation (the Model Regulation) that addresses suitable annuity transaction sales, supervision, monitoring and reporting. Fortunately, the Model Regulation standards were written to be, where feasible, consistent with the suitability standards under FINRA 2111. This article will review the standards under both rules and highlight what companies are doing to comply.

Client suitability under FINRA 2111 states that, “a broker-dealer or associated person has a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer.” This past year, the rule was expanded to provide explicit guidance on the type of client information an advisor should obtain and analyze to determine suitability (referred to as the customer investment profile).

The following table reflects the information an advisor must attempt to obtain under FINRA 2111. The additional requirements, which were added under the new rule, are indicated by an asterisk in the Customer Investment Profile table below (age, investment experience, time horizon, liquidity needs, and risk tolerance). 

Although the new rule is specific with respect to client information an advisor must obtain and review before making a product recommendation, it does not provide explicit guidance on documenting evidence of suitability. Instead, the rule suggests that firms take a risk-based approach when documenting suitability determinations that most likely will vary based on the customer’s profile and the complexity, performance and risk of the recommended security.

However, for documenting evidence for an annuity transaction there is tangible guidance provided under the Model Regulation, which is:

A producer or insurer shall record any recommendation given, including evidence that a reasonable effort was made to obtain the client’s suitability information.

And for client discussions that did not result in a recommended product sale, the insurer should obtain:

Signed documentation stating customer refused to provide suitability information, or

Signed documentation that the annuity transaction is not recommended and is not based on the advisor’s recommendation.

Also, under the Model Regulation, insurers are required to establish a system to supervise recommendations to ensure the insurance needs and financial objectives of the client are met. The supervision system typically entails supervising procedures, training and spot checking recommendations. When conducting spot checks, the supervisor must review all supporting information the advisor used or created to establish a reasonable suitability basis for the product recommendation to the client. Hence the review is of the entire file that will contain suitability documentation the client provided as well as documentation the advisor created during the product and recommendation discussion with the client. 

Thus, having documented client signatures and a supervisory review process in place is a good practice to meet minimum requirements under the Model Regulation. However, there are additional steps companies have taken to ensure they have a sound suitability approach in place that will address regulatory inquiries. For instance, companies should consider developing and documenting a suitability approach and process that may contain all or some of the following steps:

Satisfying FINRA 2111:

Updating existing customer questionnaires (customer investment profiles) to ensure they address the new revised FINRA 2111 requirements.

Creating or updating risk tolerance questionnaires that test and quantify the client’s risk tolerance using a weighting or scoring approach.

Creating risk tolerance profiles (based on the risk tolerance scoring approach) that define the client’s risk appetite (conservative, moderate or aggressive).

Aligning product offerings to risk tolerance profiles (product risk matching) to ensure the advisor can only sell products that match a client’s specific risk profile.

Developing and conducting training on the firm’s suitability approach and process.

Documenting the firm’s suitability approach, process and training so that it is readily available to provide to a regulator, if requested.

Satisfying the Model Regulation:

Developing and conducting specific product training.

Providing a one-time, minimum four-credit-hour general annuity training offered by an insurance-department approved education provider.

Establishing a process to have a supervisor review a product recommendation prior to the issuance of an annuity.

Producing an annual report to senior management that includes compliance review results (pass/fail rates, exceptions, complaints, sanctions and corrective actions taken).

Creating an ongoing (e.g., quarterly) internal suitability compliance review and monitoring following the sale of a product.

The Model Regulation does permit companies to hire a third-party provider to establish its systems of supervision, including monitoring and conducting audits on behalf of the company. If a third-party provider does perform this role, then the company must obtain an annual certificate stating that the suitability function is being properly performed. 

Recent regulations have provided a suitability framework that companies selling investment and insurance products can use to create a suitability approach. The key to satisfying regulatory inquiries is to ensure that the approach, process and training are well documented, should the regulators inquire as to how companies are determining, supervising and monitoring that their advisors are selling suitable products to clients.

The views expressed herein are those of the author and do not necessarily reflect the views of Ernst & Young LLP.

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