Annuities Securities Products

Regulatory Obligations

The SEC’s Regulation Best Interest (Reg BI) establishes a “best interest” standard of conduct for broker-dealers and associated persons when they make recommendations to retail customers of any securities transaction or investment strategy involving securities, including recommendations of variable annuities and registered index-linked annuities (RILAs) (referred to collectively below as “annuity” or “annuities”).

Pursuant to this standard, a broker-dealer and its associated persons must not put their financial or other interests ahead of the interests of a retail customer. The standard of conduct established by Reg BI cannot be satisfied through disclosure alone.

In addition, FINRA Rule 2330 (Members’ Responsibilities Regarding Deferred Variable Annuities) continues to apply to recommended purchases and exchanges of deferred variable annuities (referred to below as variable annuities). FINRA Rule 2330, among other things, requires member firms to establish and maintain specific written supervisory procedures reasonably designed to achieve compliance with the rule. Member firms must implement surveillance procedures to determine if any associated person is effecting deferred variable annuity exchanges at a rate that might suggest conduct inconsistent with FINRA Rule 2330 and any other applicable FINRA rules or the federal securities laws.

Emerging Trend: RILAs

  • The market for RILAs has grown significantly in recent years, with annual RILA sales of $47.4 billion in 2023 alone, 15 percent higher than in the prior year, and more than quintupling since 2017.1
  • A RILA is one of several types of annuity contracts offered by insurance companies. An investor in a RILA allocates purchase payments to one or more investment options under which the investor's returns (both gains and losses) are based at least in part on the performance of an index or other benchmark over a set period of time known as a crediting period.2
  • RILAs are complex financial products sold to retail investors, and have certain characteristics—such as those listed below—that can impact RILAs’ performance:
    • unlike other investments, such as mutual funds, RILA investors periodically realize gains and losses at the end of each crediting period, essentially forcing liquidation (the sale of the investment option) at a specified date, even if market conditions are unfavorable;3
    • the performance of an index-linked option may be based on a “price return” index rather than a “total return” index, which typically results in a lower return since a price return index does not reflect reinvestment of dividends of the underlying securities;4
    • while most RILAs have no explicit fees (other than surrender charges), a RILA’s bounded return structure is a feature of RILA contracts that, generally, will limit the investor’s gains if the performance of the index goes up in value, as well as limit the investor’s losses if the performance of the index goes down in value.5 This bounded return structure requires investors to agree to tradeoffs that come with their own economic costs and benefits, typically by:
      • limiting the ability of investors to take certain actions during the crediting period (e.g., surrender, withdrawal, payment of a death benefit, start of annuity payments, change of investment) without bearing adjustments,6 which can be negative and can result in significant loss; 
      • limiting investors’ abilities to participate in upside index performance (through features such as “cap rates”7 or “participation rates”8); and
      • limiting investors’ losses if the performance of the index goes down in value (through features such as “buffers”9 or “floors”10). 
  • For additional information, please see the SEC’s Proposing Release and Adopting Release concerning recent rulemaking on RILAs.

Findings and Effective Practices

Findings

  • WSPs: Failing to have reasonable supervisory procedures to achieve compliance with FINRA Rule 2330 or reasonably designed written policies and procedures pursuant to Reg BI, as applicable, with respect to: 
    • recommendations of annuities to help ensure that customers are not over-concentrated in variable annuities or RILAs in light of their holdings in other illiquid asset classes;
    • consideration of the customer’s age in assessing whether the recommendation to purchase an annuity is in the retail customer’s best interest;
    • recommendations related to issuer buyout offers (e.g., registered representatives’ recommendations that investors surrender the contract pursuant to an insurance company’s offer to generate an exchange or new purchase);
    • registered representatives’ recommendations of additional deposits into existing variable annuity contracts, including review of any applicable disclosure, new surrender periods related to this transaction and rationale for the addition;
    • detecting rates of exchanges that may indicate a violation of FINRA Rule 2330 or Reg BI (e.g., recommending the same replacement of a variable annuity to many customers with different investment objectives);  
    • conducting training for registered representatives and supervisors regarding how to assess and compare costs and fees, surrender charges and long-term income riders to determine whether exchanges complied with the standards of FINRA Rule 2330 and Reg BI.
  • Exchanges: Recommending variable annuity exchanges that were unsuitable for, or not in the best interest of, retail customers where the exchanges were inconsistent with the customer’s investment objectives and time horizon and resulted in, among other consequences:
    • increased mortality and expense, administration, and rider fees to the customer;
    • the imposition of surrender fees for early liquidation of the customer’s existing product; or 
    • the loss of material benefits (e.g., loss of a living benefit rider).
  • Reg BI Care Obligation Violation for Recommended Surrenders/Withdrawals of Variable Annuities and Purchases of RILAs: 
  • Reasonably Available Alternatives: Pursuant to Reg BI, insufficient consideration of reasonably available alternatives to the recommended annuity purchase, surrender or exchange. 
  • False or Misleading Documentation: submitting paperwork for recommended variable annuities transactions that contain misrepresentations or omissions (e.g., falsely stating the transaction was not funded by another variable annuity; understating surrender charges; not indicating when customers had surrendered or exchanged a variable annuity in the past 36 months).
  • Poor and Insufficient Data Quality: Not collecting and retaining records on annuity transactions, particularly in connection with replacement/exchange transactions; relying on processes for data collection and retention in situations where the volume of annuity transactions renders these processes ineffective; and failing to address inconsistencies in available transaction data for annuities (e.g., with respect to identifying and labeling replacements/exchanges), as well as data formats and reporting processes.

Effective Practices 

  • Applying Heightened Policies and Procedures to RILA Recommendations: Incorporating into a firm’s WSPs and written policies and procedures heightened policies and procedures for recommendations of RILAs, such as the explicit requirements that apply to variable annuities under FINRA Rule 2330, including, but not limited to requiring:
    • a registered representative to document and sign his or her rationale for a recommendation of a RILA; 
    • a registered principal to review and determine whether he or she approves of a recommended purchase or exchange of a RILA;
    • a reviewing principal to document and sign the basis for his or her approval (or rejection) of the recommendation;
    • the gathering of information regarding whether customers have had RILA exchanges (or replacements of VAs with RILAs and vice versa) within the preceding 36 months; and
    • implementation of surveillance procedures to determine if any of the member’s associated persons have rates of effecting RILA exchanges (or replacements of VAs with RILAs and vice versa) that raise for review whether such exchanges evidence conduct inconsistent with Reg BI.
  • Addressing RILA Features: Providing guidance to associated persons on how to consider whether RILAs (including investment options) and particular features of a RILA are in a retail customer’s best interest, including:
    • the manner in which interest is calculated and credited;
    • the bounded return structure; 
    • automatic renewals that occur at the end of a crediting period; and 
    • applicable contract adjustments, including interim value adjustments (IVAs), market value adjustments (MVAs) or limits on the RILA’s performance.
  • Exchange Disclosures: Using exchange disclosure forms to provide the customer with meaningful information about the advantages and disadvantages of the recommended exchange, including: 
    • a comparison of the fees (and in the case of RILAs, the economic costs of their bounded return structure as well as IVAs and MVAs) and surrender periods of the existing and new products; 
    • disclosure of the loss of any benefits with the existing product (including a benefit base that exceeds the contract value); and 
    • the representative’s rationale for the exchange.
  • Account Recommendations: Providing guidance on how to consider account types and costs when potentially recommending broker-dealer versus advisory annuity contract classes.
  • Automated Surveillance: Using automated tools, exception reports and surveillance to review annuity exchanges; and implementing second-level supervision of supervisory reviews of exchange-related exception reports and account applications.
  • Detailed Rationales for Exchanges: Confirming that registered representatives’—and, where applicable, supervisory principals’—written rationales for annuity exchanges for each customer address the specific circumstances for each customer and do not inappropriately replicate rationales provided for other customers; and requiring supervisory principals to verify the information in these rationales that registered representatives provide, including product fees, costs, rider benefits and existing product values.
  • Review Thresholds: Standardizing review thresholds for rates of annuity exchanges; and monitoring for emerging trends across registered representatives, customers, products and branches.
  • Data Integrity: Engaging with insurance carriers (affiliated and non-affiliated) and third-party data providers (e.g., Depository Trust and Clearing Corporation (DTCC), consolidated account report providers) to confirm their annuity data integrity (including general product information, contract class, riders and exchange-based activity). 
  • Data Acquisition: Establishing a supervisory system that collects and uses key transaction data, including, but not limited to:
    • transaction date;
    • representative name;
    • customer name;
    • customer age;
    • investment amount;
    • whether the transaction is a new contract or an additional investment;
    • contract type (qualified vs. non-qualified);
    • contract number;
    • product issuer;
    • product name;
    • source of funds;
    • exchange identifier;
    • contract class; and
    • commissions.
  • Data Analysis: Considering the following data points when conducting a review of a recommended exchange transaction under FINRA Rule 2330 and Reg BI:
    • branch location;
    • customer state of residence;
    • policy riders;
    • policy fees;
    • issuer of exchanged policy;
    • exchanged policy product name;
    • date exchanged policy was purchased;
    • whether the customer has had another annuity exchange within the preceding 36 months;
    • living benefit value, death benefit value or both, that was forfeited;
    • surrender charges incurred; and
    • any additional benefits surrendered with forfeiture.

Additional Resources

Previous:
Private Placements
Up:
Annuities Securities Products
Next:
Market Integrity

1 The fourth quarter of 2023 marked the first time RILA sales surpassed variable annuity sales. See LIMRA, “LIMRA: Record-High 2023 Annuity Sales Driven by Extraordinary Growth in Independent Distribution,” news release (Mar. 12, 2024); see also LIMRA, “LIMRA Secure Retirement Institute: Total Annuity Sales Continued to Decline in 2017,” news release (Feb. 21, 2018). 

2 Under a RILA, an insurance company will credit positive or negative “interest” to an investor’s contract value at the end of each crediting period. The amount credited is based, in part, on the performance of a specified index or benchmark (e.g., the S&P 500). Crediting periods for an index-linked option in a RILA contract generally range from one to six years. RILA contracts typically state than an investor will be automatically renewed at the end of a crediting period into the same or substantially similar index-linked options, often with a new limit on gains. See Registration for Index-Linked Annuities; Amendments to Form N-4 for Index-Linked and Variable Annuities, Proposed Rule, Securities Act Release No. 11250 (Sept. 29, 2023), 88 FR 71088 (Oct. 13, 2023) (“RILA Registration Proposed Rule Release”) at 71090-1; see also Registration for Index-Linked Annuities and Registered Market Value Adjustment Annuities, Final Rule, Securities Act Release No. 11294 (July 1, 2024), 89 FR 59978, 59981 (July 24, 2024) (“RILA Registration Final Rule Release”), 89 FR at 59981.

3 See SEC Office of the Investor Advocate, “Investor Testing Report on Registered Index-Linked Annuities” (September 2023), at page 7.

4 Similarly, the performance of an index-linked option may be based on an index that deducts fees and costs when calculating its performance, therefore lowering the index return.

5 See RILA Registration Final Rule Release, 89 FR at 59981.

6 The insurance company typically will apply an “interim value adjustment” (IVA) to the contract value if the investor partially or fully withdraws amounts from an index-linked option before the end of its term. If amounts are withdrawn from the contract, the company also might apply a market value adjustment or MVA to the amount withdrawn. Contract adjustments could be made in response to a number of contract transactions, such as a surrender, withdrawal, payment of a death benefit, or the start of annuity payments, and an investor could experience a negative contract adjustment even when the investor takes an otherwise permissible withdrawal, such as under a guaranteed living benefit.

7 A “cap rate” places an upper limit on investor’s ability to participate in the index’s upside performance.  For example, if a RILA has a 5 percent cap rate, and the index increases by 10 percent, at the end of the crediting period the investor’s contract value will be credited with only 5 percent positive interest. Id.

8 A “participation rate” sets an investor’s return to some specified percentage of the index’s return. For example, an 80 percent participation rate would result in an investor receiving positive interest of 80 cents on the dollar of gains in the index. Id.

9 A “buffer” limits the investor’s exposure to losses up to a fixed percentage. For example, with a buffer of minus 5 percent, if the index is down 2 percent, the investor will not lose anything, but if the index is down 7 percent, the investor will lose 2 percent (the difference between the loss and the buffer rate). Id.

10 A “floor” places a lower limit on the investor’s exposure to loss. For example, with a floor of minus 5 percent, if the index is down 2 percent, the investor will lose 2 percent, but if the index is down 7 percent, the investor will lose only 5 percent. Id.

11 Section 1035 of the Internal Revenue Code allows for a tax-free transfer of an existing annuity contract, life insurance policy, long-term care product or endowment for another of like kind.