Variable Annuities
Much like other certain dubious investments, often variable annuities are not purchased by investors, they are sold to investors. Variable annuities have their place and offer certain benefits, but in many cases, have 
inappropriately become a large part of the retirement and investment plans of many investors. Stockbrokers and investment professionals like annuities because the remuneration or commission that they receive can typically range between 6% and 10%, the highest of any investment product in the marketplace. These same financial incentives render variable annuities most frequently the subject of abuse and deceptive sales practices. Variable annuities are investment contracts and are therefore securities under the federal securities laws.
How Variable Annuities Work
A variable annuity is basically a contract between you and an insurance company or one offering the variable annuity, whereby typically, the investor makes a lump sum or series of periodic payments to the insurance company in exchange for the insurance company’s promise to pay some form of benefit in the future. How much the insurance company will pay you back or the return varies or is variable, but in essence in the case of a variable annuity, the investment is made into one or a series of mutual fund like sub-accounts, which can offer a broad range of asset classes and investment objectives from fixed income securities to international growth funds.
In any event, what the annuities offer to generally do is provide a rate of return that is either based upon generally the performance of these funds or some other minimum rate of return until the annuity is generally annuitized, which in most cases can be at least ten years. Investors wishing to sell or cash in their annuities prior to annuitization generally are only entitled to the performance of the sub accounts. Investors wish to sell or liquidate their variable annuities typically within the first seven years, will be made to pay a surrender penalty, so that the offerror can recover the commissions paid to the broker, which may generally start out a 7% and thereafter decrease each year the investor owns the annuity.
During this time, depending on the bells and whistles or features of any particular variable annuity product, the investor is generally charged administrative fees and other fees that may be associated with a death benefit or disability benefit, which may offer the investor an enhanced return should the investor die or become disabled during the term of the annuity. These fees can range from 2% to 6% per year and are deducted from the value of the sub accounts.
The benefit of the variable annuity is that income or returns generated during the accumulation of the annuity, can accumulate before tax, like an IRA or qualified retirement account, and are not taxable until they are withdrawn. An annuity containing death benefits or a stepped up basis upon death may be attractive to investors that might otherwise be unable to secure reasonably priced life insurance.
The problem with annuities is that very often stockbrokers in connection with the sale of these products will tell unsuspecting customers that their investment is guaranteed or that a specific rate or minium rate of return is guaranteed. However, most often the customer is not told that in order to receive any guaranty, at least in the short term, they must die. Moreover, with respect to a minimum or stated rate of return, i.e. the highest value of the sub accounts or some expressed percentage, whichever is greater, these expressed returns only represent the amount to be annuitized, or converted into a stream of income for a finite period, and that once annuitized, the investor is in essence trading their principal investment for this stream of future payments.
Securities regulators have found that in disciplinary actions involving the sale of variable annuities to retirees, that among the most common misrepresentations, is the misrepresentation that “Variable life policies were not insurance but were an investment savings or retirement plan.” The “reason many brokers are prone to commit these abuses is that the combined commissions from the sale of a typical variable annuity are higher than the commissions from almost any other product.”
Over the last ten years, the North American Securities Administrators’ Association (NASAA) has ranked the sale of Variable Annuities “often pitched to seniors” as one of the “Top Ten” investment scams affecting the investment public, and particularly senior citizens.
A Joint SEC/NASD Report on Examination Findings Regarding Broker-Dealers Sales of Variable Insurance Products, found that “[u]nsuitable variable product recommendations were made without a reasonable basis in light of information the broker may have had regarding the customer’s:
Age;
Financial or tax status (e.g., sales that exceed a pre-determined percentage of the customers net worth; sales that require the mortgage of a home to finance the purchase;
Sales that require a customer to borrow from an existing life insurance policy or annuity; or sales to a corporation, trust, or other non-natural entity that did not hold as agent for a natural person, and whose purchase therefore caused the loss of tax-deferral status in the annuity);
Investment objectives (e.g., same product recommended to all customers (one size fits all), or a customer’s current need for income);
Investment sophistication and ability to understand the complexity of variable products generally, and to monitor the investment of the separate account;
Low risk tolerance (e.g., high risk equity funds are recommended to an investor with low risk tolerance);
Need for liquidity (e.g., sale of an illiquid variable product to persons who need their funds soon, and as a result incur surrender charges to obtain their funds);
Lack of need or desire for life insurance.
Financial Industry Regulatory Authority Guidance
FINRA subsequently enacted Conduct Rule IM-2821 which specifically provides that: Prior to recommending the purchase or exchange of a deferred variable annuity, a member or person associated with a member shall make reasonable efforts to obtain, at a minimum, information concerning the customer’s age, annual income, financial situation and needs, investment experience, investment objectives, intended use of the deferred variable annuity, investment time horizon, existing assets (including investment and life insurance holdings), liquidity needs, liquid net worth, risk tolerance, tax status, and such other information used or considered to be reasonable by the member or person associated with the member in making recommendations to customers.
Guiliano Law Group
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