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.”
Marc Silverman, CLU, CFP with Silverman Financial in Miami, Florida says his firm requires pre-sale completion of a VA-disclosure form that details the contract’s fees and requests other financial information from clients. “It asks if they have life insurance; it asks if they have emergency reserves,” he says. “It goes through what I would say are pretty in-depth questions regarding the annuity so the client is fully apprised of what they are purchasing. They must sign off on it; you must sign off on it.”
Document the Process
The product’s potential complexity may lead to client misunderstandings. At the end of client meetings, Silverman dictates his meeting notes for recording using the Copytalk service. He asks clients to monitor his dictation and correct any errors; he then receives a transcript of the call for his records.
Dorfman’s firm records client meetings to ensure compliance and for follow-up documentation. Additionally, advisors call VA-buyers after the buyers receive their first quarterly account statement. The call is an excellent opportunity to address any client concerns and reaffirm the investment decision, in his experience.
“I have found that most of the problems that occurred in the past have occurred because they received a quarterly statement and they didn’t really understand the protected value account, they didn’t understand that they were actually in mutual funds, they might not have understood certain of the guaranteed minimum accumulation rights or withdrawal benefits,” he says.
“So, we like to call them up and use that quarterly statement as an opportunity to readdress and highlight some of those features that are baked into their products.”