/>iThe Variable annuity contract (“Contract”) sales practices were again included in the Financial Industry Regulatory Authority’s (“FINRA”) 2013 Regulatory and Examination Priorities Letter as among the “key investor protection and market integrity issues” that it will focus on in the coming year. This article discusses two potential risk areas that broker-dealers should consider in connection with the Contracts that their registered representatives (“Advisors”) sell, and steps that they can consider to mitigate these potential risks.
Contracts often contain provisions permitting the annuity provider to implement future changes or require action by the policyholder (the “Client”) as a condition to receiving the guaranteed payment. Broker-dealers whose Advisors recommend Contracts to Clients that include these provisions should consider whether those Contracts should be monitored on an on-going basis to ensure continued suitability, and to determine whether future Client communications would be prudent.
Broker-dealers whose Advisors recommend Contracts have an obligation under FINRA rules to ensure that recommended products are “suitable” in light of the Client’s financial needs, investment objectives, and other relevant information. As a general matter, to carry out this obligation, the broker-dealer and/or Advisor will evaluate the Contract’s terms, asset allocation and investment line-up and determine whether those characteristics align with the Client’s financial needs, objectives and circumstances. What if - after undertaking this analysis and recommending a Contract that is suitable for the Client - the Contract’s terms, asset allocation and/or investment line-up is significantly modified?
Recently, annuity providers have exercised their contractual right to make changes to existing Contract terms, including investment line-up changes, shifts in asset allocation and the imposition of investment restrictions. These changes have presented a challenge for Advisors because a Contract as modified in this way may no longer be suitable for the Client. In addition, Contracts may contain provisions that require the Client to take action in order to avoid lapse of the guaranteed payment. If a Client fails to take such required steps, and as a result loses the guaranteed benefit, the Client may try to claim that the Advisor had an obligation to remind them of the required action. These provisions create risk that broker-dealers may want to consider mitigating.
How can broker-dealers address these challenges? One of the most effective ways to address these issues, at least as a first step, is Advisor training. Broker-dealers can review their Advisor training materials to ensure that the issues discussed above are addressed in an appropriate manner. Secondly, broker-dealers may want to consider a specific suitability review process for Contracts, to ensure that these issues are considered by the Advisor at the time the Advisor is making a recommendation of a specific Contract to a specific Client. Finally, broker-dealers may want to consider whether specific compliance/supervisory procedures that monitor changes to Contracts purchased by Clients are feasible. Broker-dealers also should consider whether proactive steps for existing Contracts are warranted as a risk mitigation tool.
These steps could include identifying those Contracts held by Clients that contain these provisions and determining whether monitoring of these Contracts is warranted and feasible. Where an existing Contract requires policyholder action to avoid lapse of the guarantee, broker-dealers should consider whether a communication to Clients about the lapse and the steps the Client needs to take to avoid the lapse is feasible.
