RCA - Spring 2002 - NASD Regulation Cautions Firms For Deficient Variable Annuity Communications

NASD Regulation recently concluded a review of NASD member firms' internal use only communications about variable annuities. The communications discussed annuities that provide for periodic investment into the variable subaccounts from a fixed account (dollar cost averaging programs) or offer bonus credits on the purchase price (bonus variable annuities). While firms must file with NASD Regulation advertisements and sales literature regarding variable annuities, internal use only communications such as those included in the review are not required to be filed pursuant to NASD Conduct Rule 2210.


Nevertheless, such communications must comply with all other aspects of the rule. The review revealed that firms had used communications that failed to provide sufficient disclosure with respect to these products. All of the firms cooperated with the staff in correcting the deficiencies found in their communications and ensuring that future deficiencies would be avoided. The staff issued letters of caution to the firms involved.


Dollar Cost Averaging Presentations

The dollar cost averaging programs in question require customers to invest in the fixed account of a variable annuity, then transfer all funds into accounts subject to market risk in equal installments over a relatively short time period such as six months or one year. The review revealed that members' communications had overemphasized high annual effective yields of the fixed accounts as an inducement to invest in the variable annuities. Because all of the money had to be transferred out of the fixed account in equal installments over a relatively short time period, the annual effective yield was paid on a declining balance. Thus, the actual return on dollars initially invested in the fixed account was much lower than the advertised annual effective yield. By overemphasizing the annual effective yield, the communications were misleading as to the value of the return that the fixed account offered. In addition, the emphasis on the high rates available for a limited time in the fixed account created confusion as to whether the product was a fixed or variable annuity.


While NASD Regulation does not object to discussions of dollar cost averaging programs in communications about variable annuities, such presentations must describe fairly how the programs operate, including the requirement that all monies be transferred out of the fixed account within a pre-set timeframe. In addition, if any type of yield or return is included, the communication must also disclose the actual return on investment the customer can expect to receive from the fixed account net of applicable fees and charges. The annual effective yield may be included provided it is not overemphasized and that it is accompanied by clear disclosure that it is a rate used to calculate the return on investment, but does not reflect funds the customer will receive.


Bonus Credit Concerns

Some of the communications prominently discussed the bonus credit features of variable annuities yet failed to prominently explain that fees and expenses for such contracts may be higher, and the surrender periods may be longer, than contracts that do not provide the bonus. Such an explanation is necessary to provide a sound basis for evaluating the facts with respect to the product as required by NASD Conduct Rule 2210.


NASD Regulation Guidance

Over the past two years NASD Regulation has provided guidance to NASD member firms about how to properly communicate about dollar cost averaging programs and bonus annuities through comment letters on member filings, presentations at industry conferences, and articles in the NASD Regulatory & Compliance Alert (see "Advertising Of Bonus Credit Variable Annuities," Summer 2000, and "Ask the Analyst," Summer 2001).


The Advertising Regulation staff is available to answer questions regarding members' communications at (240) 386-4500.