Variable annuities have experienced significant growth in sales of variable annuity contracts by insurance companies and represent a substantial portion of the retirement assets held by individual investors. The growth in sales has been attributed to many factors, including the high compensation paid to financial advisors who recommend their purchase. Variable annuity purchases are not subject to sales breakpoint discounts provided by mutual fund families. In some instances, higher compensation paid to brokerage firms and financial advisors can explain why variable annuities are recommended compared to mutual funds which provide sales volume discounts to investors at the expense of lower commissions paid to the financial advisor, which result in conflicts of interest between client and advisor.
Variable annuities pay substantial commissions to financial advisors but, there are greater costs and surrender charges incurred by investors. Financial advisors have substantial financial incentive to tout the benefits of new variable annuity contract in comparison to an existing variable annuity in an attempt to replace the annuity. This type of transaction may be considered variable annuity switching and a violation of securities and insurance industry conduct rules. A purchase of a variable annuity through sales proceeds from another variable annuity with similar features and investment options is prohibited by securities and insurance regulators, unless there is an economic benefit to the investor. If there is no economic benefit to the investor, it is assumed the reason for the recommendation was solely for the generation of commissions. An investor should consider the financial advisor’s financial incentives and whether the recommendation represents a breach of fiduciary duty between the client and advisor.
To facilitate variable annuity replacement transactions, frequently insurance companies offer bonus credits to investors 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 new 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 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 can result in a fraudulent misrepresentation and omission of material facts when the motive of the financial advisor’s compensation is taken into consideration. According to securities industry conduct rules, due to the complexities of variable annuities, complete disclosure of all relevant benefits and costs need to be disclosed to investors.
In 2009, the Financial Industry Regulatory Authority (FINRA) issued an Investor Alert, Variable Annuities: Beyond the Hard Sell, which highlighted various fees and expense risk charges, administrative fees associated with special riders including:
- Stepped-up death benefits;
- Guaranteed minimum income benefits;
- Principal protection benefits;
- Guaranteed minimum withdrawal benefits; and
- Long term care benefits.
FINRA sales practice rules concerning the recommended purchase or replacement of an annuity requires that, at the time of investment, a brokerage firm and their financial advisor are responsible for making a suitable allocation of the subaccount investments inside the new 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. 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.
The Silver Law Group can help you determine whether an investment loss is the result of a brokerage firm and their financial advisor’s violation of variable annuity switching rules. If an investor suffers losses as a result of variable annuity switching they may be able recover their losses in a FINRA arbitration claim.
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