Annuities at their most basic level are a simple concept to grasp — but as the old saying goes: the devil is in the details. Each contract has its own the unique set of provisions, which complicates the advisor's task of recommending suitable contracts for his or her client’s unique situation. As a result, many clients have been sold annuity contracts that do not meet their needs. Over the years, the annuity industry has developed new, more complicated types of contracts (EIAs, for example) and introduced new benefits that are not easily understood (such as enhanced living and death benefits). Government regulators at the state and federal level have noted this growth and its adverse impact on clients. As a result, they have imposed additional regulations on the sale of annuities. The purpose of these enhanced regulations is to protect consumers and aid advisors in their search for suitable investment recommendation. This chapter will explore two of these regulations: Florida's Senior Consumer Law and FINRA's Suitability Disclosures. These regulations, to some extent, overlap each other, but may not apply to every situation. Ethical advisors will want to follow the general principles of these regulations regardless of whether the strict language of the rules applies to a particular situation or not.
Before we explore these two regulations, a brief review of the regulatory framework and conflicting jurisdictions governing annuities is in order. Fixed annuities, including equity indexed annuities, fall under the purview of state insurance authorities. Variable contracts fall under both state and federal jurisdictions — state insurance commissioners regulate the variable contract itself as an insurance product, the SEC claims jurisdiction over the separate, subaccounts within the contract as an investment product. The SEC, in turn, delegates oversight of the sale of variable annuities to FINRA (Financial Industry Regulatory Authority). As a result, state laws govern the sale of fixed annuities (and to some extent, variable annuities); FINRA governs the sale of variable annuities only. Please note: one of the federal requirements imposed on separate investment accounts is that they be registered under the Securities Act of 1933 and the Investment Company Act of 1940 (the same requirement that applies to mutual funds). Insurance products, such as fixed annuities need not register with the SEC. In the parlance of federal regulations, fixed annuities are referred to as "nonregistered" securities. This does not mean that fixed annuities are unregulated. Fixed annuity contracts will be filed with state regulators, so the federal authorities' use of the term "nonregistered" can be a bit misleading to the casual reader.
The SEC has proposed that equity indexed annuities be treated as variable contracts, and therefore brought under their jurisdiction. That proposal has met with significant opposition by the National Association of Insurance Commissioners, or NAIC (who wish to preserve state regulations) and the annuity industry (which finds state regulation less binding). There are valid arguments on both sides of this question — and the ultimate outcome of the SEC proposal will eventually be settled in the political arena. Until such time as the status of EIAs is changed, assume that our discussion of fixed annuities includes EIAs as well.
Florida's Senior Consumer Law
In the late 1990s, state regulators across the country began to seriously address the sale of fixed annuities to "senior consumers". These laws typically required advisors to make minimum inquiries of their older client as to their financial situation and needs. Florida enacted these consumer protections, based on the NAIC's "Senior Protection in Annuity Transactions Model Law", in 2004. Analysis by the Department of Financial Services found that due to vague wording this law was ineffective. In 2008, the Florida legislature strengthened its language. This was in response to instances in which elderly clients were sold annuities that were deemed unsuitable for their needs — in particular, highly-illiquid contracts. One elderly couple from Venice, both in their eighties, were sold $600,000 in annuities with surrender charge periods that lasted longer than their life expectancies. The updated and strengthen state law, known as the "John and Patricia Seibel Act" is named for them. The Seibel Act contains several important features:
The initial NAIC model enacted in Florida was intended to create standards for recommending the purchase or exchange of annuities to consumers who are 65 or older, specifically that agents and insurers must have “reasonable grounds” for recommending annuities to seniors. The intent of the Seibel Act is to replace this subjective standard with a more objective standard. The initial law was ineffective because regulators needed clear and convincing evidence, not to prove that a particular transaction was indeed suitable for the client, but whether the agent reasonably believed it was. The new standard now requires an insurer or agent, who recommends purchase or exchange of an annuity to a senior consumer, to have “an objectively reasonable basis for believing the recommendation is suitable.” A "senior consumer" is defined as an individual purchaser age 65 or older — and the case of joint purchasers, if either is 65 or older. A "recommendation" is a transaction that is based on the agent's advice. “Annuity” is defined as fixed, indexed or variable contracts.
The Seibel Act specifies the minimum information that must be obtained from the consumer and requires use of a form designed by the Department of Financial Services. At a minimum, agents must ascertain the client's:
¨ age and gender of the purchaser(s),
¨ number and age of any dependents,
¨ investment objectives,
¨ risk tolerance,
¨ existing assets,
¨ annual income,
¨ tax status,
¨ liquid net worth,
¨ future financial concerns and needs (medical expenses, long-term care, bequests to heirs, projected retirement age, etc.),
¨ intended use for the annuity, and
¨ source of funds to be invested in the annuity.
The agent must also note any other information he or she used or considered in making the recommendation.
The agent must forward a copy of the completed questionnaire to the issuing company (or its authorized third party, such as a managing general agent or insurance agency) within 10 days. A copy of the completed questionnaire must be given to the client no later than the time the contract documents are delivered to the client.
Any recommendations given by the agent must be suitable based on the information the client provides to the agent at the time of purchase. The agent is absolved of the suitability requirements if the client refuses to give the agent the required information, the client provides false or incomplete information, or the client chooses to purchase annuities against the recommendation of the agent. If the client refuses to provide the required information, the agent or insurer must, before execution of a transaction, document the client's refusal on a form approved by the Department — and obtain the client’s signature. This form will disclose to the client that failure to provide the required information may limit the protections offered under this law.
If the client currently holds one or more annuity contract, the agent must also determine:
¨ the type of contract(s) the client holds,
¨ the issue dates(s),
¨ maturity or annuitization date(s),
¨ allocation of funds within the contract (for variable annuities),
¨ applicable surrender charges,
¨ any contract riders or endorsements, and
¨ liquidity within the contract(s) — prior to maturity and at maturity.
If the agent recommends a transaction to replace or exchange an annuity, the insurer or agent must provide a written comparison of the existing contract and the proposed contract, on an approved form. This disclosure form will compare:
¨ the benefits, terms, and limitations between the annuity contracts,
¨ any fees and charges between the annuity contracts.
This replacement form must also contain a statement by the agent describing the basis for recommending the exchange, including the overall advantages and disadvantages to the consumer if the recommendation is followed. The agent must also disclose other information used or considered to be relevant by the insurance agent or the insurer in making his or her recommendation to replace the annuity contract.
As with the basic questionnaire, a copy of the replacement comparison form must be forwarded to the proposed issuing company within 10 days, and to the client no later than delivery of the contract documents.
Agents who recommend the purchase of an annuity or propose to replace an annuity must disclose to the client that such actions may have tax consequences and that the applicant should contact his or her tax advisor for more information. The law does not require that this disclosure be in writing, or on any particular form, but cautious agents will want to permanently document this disclosure.