A mission-critical component of our compliance and supervisory infrastructure is to protect clients or members and their best interests — while helping financial professionals protect their businesses.

We aim to provide the tools and information needed to understand the regulatory and emerging risks in our industry, as well as proactive measures for financial professionals to adapt and help avoid regulatory mishaps. This article highlights critical areas of regulatory focus around annuity sales practices.

Throughout the investment industry, annuities continue to be a source of regulatory focus. Accordingly, annuities are prominently listed year-after-year as an exam priority for both FINRA and the SEC. Annuities are considered complex products and require a unique level of care to address the complex nature and risk considerations applicable to such recommendations.

Replacements and exchanges

Section 1035 of the Internal Revenue Service code allows investors to maintain the tax deferral on the underlying assets when one annuity is exchanged for another. While this provision can be beneficial, loss of benefits and applicable fees may negate the tax benefit.

Regulators scrutinize transactions that involve surrender charges and loss of benefits that may accompany the replacement or exchange and take particular interest in clients, members or contracts that show a history of exchange activity. Consider the following in these scenarios:

• The best interest rationale that is specific to the client’s or member’s current circumstances — e.g., changes in needs or strategy since the original purchase, consideration of all reasonable alternatives and the client’s or member’s level of sophistication to understand the proposed transaction
• Documentation is critical and must demonstrate the transaction will align with client needs and result in a material economic benefit to the client or member
• Preparation of accurate and balanced disclosure forms, especially all fees/expenses associated with both the existing and proposed contract, along with any loss of benefits

Regulators continue to focus on trends that might be indicative of problematic annuity sales practices. This focus is usually specific to a trend or pattern of:

• High exchange rates within annuity business
• High concentration in the same product across clientele
• The use of similar rationales
• Detailed notes that address any of these key risk areas will help financial professionals mitigate such risk and the need for any inquiry. 

Annuity concentration

Another area of focus that’s highly scrutinized is an undue concentration of liquid assets. Most annuities provide some level of liquidity. Still, unlike other product solutions, that liquidity often comes with high potential fees and penalties, adverse impacts on existing benefits and likely substantial tax implications due to the deferred nature of growth in subaccount investments. Furthermore, annuities still carry sponsor and credit rating risks even if the underlying investments in subaccounts are well-diversified.

Anytime a client or member has investments that make up a significant portion of their liquid assets, be sure to document and consider their liquidity needs, emergency funds and how they may account for other financial responsibilities. If they have other annuity contracts, it’s important to note how the different annuities will be used, complement their other investments and when they may be out of their surrender period. Generally, a client’s investments should not exceed 50% of the client’s liquid net worth. In certain limited instances, exceeding this guideline may be client-appropriate, but only with a documented and detailed rationale outlining the necessity and how it is in the client’s best interest.

Accuracy of client or member financials 

Having accurate and up-to-date financial information from clients and members is key to helping them make a well-informed investment decision. There’s added emphasis on the accuracy of this information when making annuity recommendations due to the reliance on these financial metrics for compliance with regulatory expectations and firm policies. 

When making recommendations to purchase or exchange an annuity, financial professionals must be proactive to help ensure clients’ and members’ financial profiles are current and accurate. Never assume the information provided on a previous purchase or at account opening is still an accurate portrait of their profile. 

Use the opportunity to educate and explain to them how to calculate net worth, liquid net worth and income to document the client or member profile. As always, we encourage financial professionals to keep contemporaneous notes. This practice is valuable when a supervisory review is being conducted. 

We encourage financial professionals to reach out to their firm’s compliance department whenever questions or concerns arise around a proposed transaction or their existing annuity business.