Annuities Securities Products

Regulatory Obligations

The SEC’s Reg BI1 establishes a “best interest” standard of conduct for broker-dealers and associated persons when they make recommendations to retail customers of any securities transaction or investment strategy involving securities, including recommendations of variable annuities and RILAs.

Pursuant to this standard, a broker-dealer and its associated persons must not put their financial or other interests ahead of the interests of a retail customer when making a recommendation. The standard of conduct established by Reg BI cannot be satisfied through disclosure alone. 

In addition, FINRA Rule 2330 (Members’ Responsibilities Regarding Deferred Variable Annuities) continues to apply to recommended purchases and exchanges of deferred variable annuities (referred to below as “variable annuities”). FINRA Rule 2330, among other things, requires member firms to establish and maintain specific written supervisory procedures reasonably designed to achieve compliance with the rule. Member firms must implement surveillance procedures to determine if any associated person is effecting deferred variable annuity exchanges at a rate that might suggest conduct inconsistent with FINRA Rule 2330 and any other applicable FINRA rules or the federal securities laws.

Findings

  • WSPs: Failing to have reasonably designed written supervisory procedures to achieve compliance with FINRA Rule 2330 or reasonably designed written policies and procedures to achieve compliance with Reg BI, as applicable, with respect to:
    • recommendations of variable annuities or RILAs to help ensure that customers are not over-concentrated in variable annuities or RILAs in light of their holdings in other illiquid asset classes;
    • consideration of the customer’s age in assessing whether the recommendation to purchase an annuity complies with FINRA Rule 2330 or Reg BI;
    • recommendations related to issuer buyout offers (e.g., registered representatives’ recommendations that investors surrender the contract pursuant to an insurance company’s offer to generate an exchange or new purchase);
    • registered representatives’ recommendations of additional deposits into existing variable annuity contracts, including review of any applicable disclosure, new surrender periods related to this transaction and rationale for the addition;
    • detecting rates of exchanges that may indicate a violation of FINRA Rule 2330 or Reg BI (e.g., recommending the same replacement of a variable annuity to many customers with different investment objectives); and
    • conducting training for registered representatives and supervisors regarding how to assess and compare costs and fees, surrender charges, and long-term income riders to determine whether exchanges complied with the standards of FINRA Rule 2330 and Reg BI.
  • Exchanges: Recommending variable annuity exchanges that did not comply with FINRA Rule 2330 or were not in the best interest of retail customers where the exchanges were inconsistent with the customer’s investment objectives and time horizon and resulted in, among other consequences:
    • increased mortality and expense, administration and rider fees to the customer;
    • the imposition of surrender fees for early liquidation of the customer’s existing product; or
    • the loss of material benefits (e.g., loss of a living benefit rider).
  • Reg BI Care Obligation Violation in Connection with Recommended Surrenders/Withdrawals:
    • recommending without a reasonable basis that customers surrender existing variable annuities or RILAs and then use the proceeds to purchase RILAs;
    • failing to consider the costs of terminating variable annuity living benefits and features, such as living benefit riders, when recommending a replacement or exchange; and
    • recommending partial withdrawals or full surrenders from RILAs "mid-segment" without considering interim value risk.2
  • Reasonably Available Alternatives: Pursuant to Reg BI, insufficient consideration of reasonably available alternatives to the recommended annuity purchase, surrender or exchange.
  • False or Misleading Documentation: Submitting paperwork for recommended variable annuities or RILA transactions that contain misrepresentations or omissions (e.g., falsely stating the transaction was not funded by another variable annuity; understating surrender charges; not indicating when customers had surrendered or exchanged a variable annuity in the past 36 months).
  • Poor and Insufficient Data Quality: Not collecting and retaining records on annuity transactions, particularly in connection with replacement/exchange transactions; relying on processes for data collection and retention in situations where the volume of annuity transactions renders these processes ineffective; and failing to address inconsistencies in available transaction data for variable annuities or RILAs (e.g., with respect to identifying and labeling replacements/exchanges), as well as data formats and reporting processes.

Effective Practices 

  • Applying FINRA Rule 2330’s Heightened Policies and Procedures to RILA Recommendations: As an effective practice, incorporating into a firm’s WSPs and written policies and procedures heightened policies and procedures for recommendations of RILAs, such as the explicit requirements that apply to recommendations of deferred variable annuities under FINRA Rule 2330, including, but not limited to requiring:
    • a registered representative to document and sign his or her rationale for a recommendation of a RILA based on the client’s specific needs and investor profile;
    • a registered principal to review and determine whether he or she approves of a recommended purchase or exchange of a RILA;
    • a registered principal (who reviews the transaction) to document and sign the basis for his or her approval (or rejection) of the recommendation;
    • the gathering of information regarding whether customers have had RILA exchanges (or replacements of VAs with RILAs and vice versa) within the preceding 36 months; and
    • implementation of surveillance procedures to determine if any of the firm’s associated persons have rates of effecting RILA exchanges (or replacements of VAs with RILAs and vice versa) that raise for review whether such exchanges evidence conduct inconsistent with Reg BI.
  • Addressing RILA Features: Providing guidance to associated persons on how to consider whether RILAs (including investment options) and particular features of a RILA are in a retail customer’s best interest, including:
    • the manner in which interest is calculated and credited;
    • the bounded return structure;
    • automatic renewals that occur at the end of a crediting period; and
    • applicable contract adjustments, including interim value adjustments (IVAs), market value adjustments (MVAs) or limits on the RILA’s performance.
  • Exchange Disclosures: Using exchange disclosure forms to provide the customer with meaningful information about the advantages and disadvantages of the recommended exchange, including:
    • a comparison of the fees (and in the case of RILAs, the economic costs of their bounded return structure as well as IVAs and MVAs) and surrender periods of the existing and new products;
    • disclosure of the loss of any benefits with the existing product (including a benefit base that exceeds the contract value); and
    • the representative’s rationale for the exchange.
  • Account Recommendations: Providing guidance on how to consider account types and costs when potentially recommending broker-dealer versus advisory annuity contract classes.
  • Automated Surveillance: Using automated tools, exception reports, and surveillance to review exchanges of variable annuities or RILAs (including, in some cases, those that take into consideration the “cumulative surrender charges” incurred by customers of a particular associated person over a given period and excessive rates of exchanges within the last one to two years of the surrender schedule); and implementing second-level supervision of supervisory reviews of exchange-related exception reports and account applications.
  • Detailed Rationales for Exchanges: Confirming that registered representatives’—and, where applicable, registered principals’—written rationales for exchanges for each customer address the specific circumstances for each customer and are not generic or insufficient; and requiring registered principals to verify the information in these rationales that registered representatives provide, including product fees, costs, rider benefits and existing product values.
  • Review Thresholds: Standardizing review thresholds for rates of exchanges; and monitoring for emerging trends across registered representatives, customers, products and branches.
  • Data Integrity: Engaging with insurance carriers (affiliated and non-affiliated) and third-party data providers (e.g., Depository Trust and Clearing Corporation (DTCC), consolidated account report providers) to confirm their data integrity (including general product information, contract class, riders and exchange-based activity).
  • Data Acquisition: Establishing a supervisory system that collects and uses key transaction data to supervise transactions and identify patterns.
  • Data Analysis: Considering the following data points when conducting a review of a recommended exchange transaction under FINRA Rule 2330 and Reg BI:
    • branch location
    • customer state of residence
    • policy riders
    • policy fees
    • issuer of exchanged policy
    • exchanged policy product name
    • date exchanged policy was purchased
    • whether the customer has had another exchange within the preceding 36 months
    • living benefit value, death benefit value or both, that was forfeited
    • surrender charges incurred
    • any additional benefits surrendered with forfeiture

Additional Resources

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1 See the Report’s Reg BI and Form CRS topic for additional information concerning Reg BI.

2 Interim value risk refers to the potential variability in the annuity’s value if an investor decides to access account value before the end of the segment term. RILAs typically assess gains or losses based on the performance of a chosen market index over a set period. Accessing account value prior to the end of this period necessitates an interim valuation, based on a calculation separate from index performance, which therefore may not align with the initial expectations of the contract holder and which may result in significant loss.