Variable Annuity Switching


“replacements result in longer surrender periods, surrender charges and greater costs”

State Insurance and Securities Regulators consider variable annuity switching as a prevalent abuse among seniors and individuals planning for retirement. According to the Financial Industry Regulatory Authority (FINRA), the recommended purchase or exchange of a variable annuity requires that a financial brokerage firm and its financial advisors must make a reasonable inquiry as to a client’s situation to ensure that “switching” variable annuity contracts is a suitable investment recommendation. Variable annuity switching violations are detailed in FINRA rules and regulations. Brokerage firm and their financial advisor are required to consider the following before making a recommendation include:

  • age;
  • annual income;
  • financial situation and needs;
  • investment time horizon;
  • existing assets;
  • liquid assets;
  • investment experience;
  • investment objectives;
  • intended use of variable annuity;
  • risk tolerance, and
  • tax status.

Financial advisors who recommend the replacement (or switch) of a variable annuity contract should consider the following factors for the determination of whether the transaction is suitable for the contract owner:

  • surrender charges and/or bonuses received;
  • forfeiture of contract benefits (living or death);
  • changes in annual contract costs;
  • changes in the surrender charge period;
  • product enhancements and improvements obtained;
  • has customer replaced another variable annuity in preceding 36 months; and
  • use of qualified accounts.

In some instances, financial advisors recommend that investors invest a substantial portion of their financial assets in variable annuity contracts. Retirement funds invested in variable annuities contracts issued by insurance companies has grown substantially as a favorite recommendation for financial advisors. The growth in popularity amongst financial advisors can be attributed to many factors, including the high compensation paid to financial advisors who recommend their purchase. Whereas mutual funds provide sales volume discounts, variable annuity purchases are not subject to sales breakpoint discounts provided by mutual fund families which lower costs to investors. In some instances, a conflict of interest motivated by higher compensation paid to brokerage firms and financial advisors can explain why variable annuities are recommended as funding vehicles for Individual Retirement Accounts (IRA) instead of mutual funds that provide sales volume discounts to investors. IRA funds invested in a variable annuity adds an additional layer of costs, through contract mortality and expense charge which range between 1.00% and 1.25%, with no additional tax benefits. These factors lead many in the securities industry, including FINRA arbitrators, to conclude that variable annuities are unsuitable for retirement accounts.

Factors to Consider in Before Replacing Variable Annuities

Variable annuity replacements can result in longer surrender periods, potential surrender charges and greater costs that are associated with the compensation paid to a brokerage firms and financial advisors. Nonetheless, some variable annuity product enhancements such as certain living and death benefits provide contract holders with substantial economic benefits. The living benefits provided with enhanced policy contract provisions such as the ability to withdraw lifetime income which may make the variable annuity replacement suitable. These type of living benefits are considered a valuable benefit not available through other means. Due to the complexities of variable annuities, complete disclosure of all relevant benefits and costs need to be disclosed to investors.

Bonus Variable Annuity Contracts

Insurance company competition for variable annuity contract funds has led to the innovation of bonus annuity products that have resulted in significant abuses. Variable annuity bonuses are designed to provide an offset against any surrender charges incurred from the surrender of an existing annuity contract with the intention to replace the contract with a “better”” variable annuity contract. The recommendation to sell an annuity and to replace it with another one may be made only after fully assessing the suitability of the transaction for the customer. There are important factors to consider which require the disclosure of all relevant facts related to the replacement transaction. For instance, the bonus can result in higher ongoing contract costs, an extended surrender charge period and the loss of contractual living and death benefits. These costs are often minimized or not disclosed which result in a fraudulent misrepresentation when the motive of the financial advisor’s compensation is taken into consideration.

Unsuitable Subaccount Asset Allocation

FINRA sales practice rules that concern the replacement of variable annuity contracts requires brokerage firms to provide suitable allocation of the subaccount investments for the replacement variable annuity contract. This requirement holds the financial advisor and brokerage firm for any losses that were the result of an unsuitable allocation into the subaccount investment options for the variable annuity. Retired investors who purchased or exchanged a variable annuity near retirement age are reasonable to expect that the investment allocations recommended by the financial advisor are suitable for them.

Klayman & Toskes, P.A. can help you determine whether an investment loss is the result of a violation of sales practice rules concerning variable annuity replacements. If an investor suffers losses as a result of variable annuity replacements they may be able recover their losses in a FINRA arbitration claim for damages.

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