In early May FINRA toughened its sanctions guidelines and increased penalties for brokers and brokerage firms that violate investment suitability guidelines. For advisors selling variable annuities (VAs), that means they should continue to monitor their compliance programs.
Fortunately, the number of investor complaints about VAs has been declining. In 2011 and 2012, FINRA reported 212 and 220 arbitration cases, respectively, involving VAs. Those numbers declined to 174 in 2013 and 120 in 2014, with 32 cases reported through this past April.
FINRA spells out its guidelines for VA sales in Rule 2330, “Members’ Responsibilities Regarding Deferred Variable Annuities.” Here’s the relevant text on determining VA suitability (italics added): “Prior to recommending the purchase or exchange of a deferred variable annuity, a member or person associated with a member shall make reasonable efforts to obtain, at a minimum, information concerning the customer’s age, annual income, financial situation and needs, investment experience, investment objectives, intended use of the deferred variable annuity, investment time horizon, existing assets (including investment and life insurance holdings), liquidity needs, liquid net worth, risk tolerance, tax status, and such other information used or considered to be reasonable by the member or person associated with the member in making recommendations to customers.”
Because it’s easier to avoid compliance problems versus resolving them, we asked several experienced advisors how they comply with the rule.
Know the Client
“I suppose the first rule is know your client and that’s done by way of a very extensive fact-finder,” says Mark Dorfman, CLU, ChFC with Oberlander Dorfman in Lynnbrook, New York. “When you want to figure out if a product is suitable for the client, there are some basic rules. You want to make sure that the client is going to be able to hold this product till at least they’re age 59-1/2, that they somehow could benefit from tax-deferred growth, they could benefit from some of the other features like annuitization or the living or death benefits that are part of the contract.”
Gilbert Armour, CFP with SagePoint Financial in San Diego, California shared several suitability parameters his firm uses:
- Does the VA purchase represent a large portion of the client’s assets?
- Does the client still have a significant position in liquid assets?
- Is the surrender penalty period abnormally long?
- Are the underlying expenses reasonable and competitive?
- Will the client likely need access to more than a nominal amount of the principal in the surrender penalty years?
If a VA is an appropriate solution, Armour submits a pre-approval form to his firm’s sales supervision team. There is additional scrutiny in cases of contract replacement. “Then the guidelines get a little stricter and you want to make sure that the new one is significantly better than … the old one,” he says. “If there are any surrender penalties involved with getting rid of the old one, then there really has to be a strong case for moving on to something else when there would be a surrender penalty involved.”