Best Interest Standards, Change and Deferred Annuities

Some time ago, I got a call from a relative who had bought a variable deferred annuity, with a guaranteed income rider. His accumulation fund had dropped from around $100,000 to $60,000, due to a precipitous decline in the value of the investment subaccounts.

What should he do? Did he just lose $40,000? Was his contract now worth $60,000? His contract could be worth a lot less than $60,000, or a lot more. The actual value would depend on many factors, and a surrender might mistakenly turn an emotional loss into an actual loss.

(Related: 5 Things to Know About Valuing Annuities and Other Client Assets)

As recent market volatility has demonstrated, financial advisors had better be prepared to answer these kinds of questions.

Adding Insult to Injury: New Requirements for Advisors and Brokers

It seems somewhat unfair to require compliance of an advisor but provide no real guidelines or tools to help the advisor. Yet, that’s what’s happening.

Recent changes to the regulatory landscape, by the CFP Board (Code of Ethics and Standards of Conduct), the U.S. Securities and Exchange Commission (Reg BI) and the state of New York (Reg 187), address updates to current best interest standards. The updates will bring deferred annuities more into line with other financial products, and the updates will require that deferred annuities be offered under a fiduciary standard.

As a result, many financial advisors will now need to significantly improve their due diligence, to meet these best interest requirements, for their clients’ deferred annuity purchases and replacements, and for ongoing account management. This should include advice for 1) the estimated evaluation of the clients’ contracts, and 2) the contracts’ need for on-going monitoring and management.

This presents several challenges:

• There are currently no rules or methods for evaluating a deferred annuity contract.
• There are no rules for ongoing management and monitoring of a deferred annuity contract after its purchase.
• Evaluating and monitoring a deferred annuity contract would require very sophisticated software.
• Although insurance companies have very effective rules for evaluating deferred annuity contracts, some rules could not be used “as is” and would have to be adapted for this purpose.
• Even if accepted rules did exist, there’s no current resource to champion and shepherd these rules.

Insurance Companies and their Regulators: A Relationship That Works

Insurance companies are required, by law, to hold reserves to meet the future obligations for each and every deferred annuity contract on their books. For statutory reserves, they are regulated by the states, and are guided by their national body, the National Association of Insurance Commissioners (NAIC), with significant participation from the American Academy of Actuaries (AAA).

Insurance companies spend a lot of money and resources to value their deferred annuity contracts, but from their point of view. They use valuation methods such as “CARVM” and “PBR” that are the result of long-term analyses and vetting by the various valuation committees of the American Academy of Actuaries and the NAIC.

As a result, insurance companies are guided by a substantial and well-vetted set of complicated rules detailing how they must value their deferred annuity contracts. in addition, these rules require constant on-going re-calculation of insurance companies’ reserves.