| March 27
March 27 Variable annuities could spell double
trouble for stock brokers who eye fat commissions instead of the
rules in place for protecting investors.
Brokers can earn 7 percent or more in commissions on these
insurance products, but when they sell them to consumers who
aren't a good fit for them, they can face the wrath of
regulators as well as investors who try to reclaim their money
by filing securities arbitration cases.
At the Financial Industry Regulatory Authority, Wall
Street's industry-funded watchdog, variable annuities follow
stocks and mutual funds as the third most common source of
complaints. They include one from an elderly investor who will
be 102 before he can access the money he locked into his
Problems occur when brokers sell variable annuities without
considering the client's time horizon for needing those funds,
said Susan Axelrod, head of regulatory operations for the
Financial Industry Regulatory Authority (FINRA), Wall Street's
So-called "annuity switching" is another concern. That
happens when a broker encourages a client to trade in an older
annuity to buy a different one, often at significant cost to the
client and benefit to the broker. Some brokers also don't
disclose fees for cashing in, or surrendering the annuity,
RICH REWARDS, COMPLEX CONTRACTS
An annuity is a type of insurance product that offers
investors steady income payments, typically in exchange for a
lump-sum investment. Payments can grow if financial markets do
well because they are tied to an investment portfolio, usually
consisting of mutual funds holding stocks and bonds.
Investors defer taxes on the income and gains until they
withdraw their money, and typically the withdrawal period is
deferred for several years while the value of the annuity builds
up. Variable annuities are often sold to high-earning investors
who already are making maximum contributions to their workplace
retirement plans and want to invest more under similar tax
Variable annuity sales in the U.S. totaled $142.8 billion
last year, down a tad from $145 billion in 2012, according to
the Insured Retirement Institute and Morningstar Inc.
Brokers are well rewarded for selling variable annuities, in
part because of their high commissions and in part because those
commissions don't typically fall as invested amounts rise, the
way they do when money is put into mutual funds, for example.
Proponents argue that for their money, investors get those
valuable tax breaks as well as a death benefit.
But their clients may not realize that they are tying up
their money for as long as ten years. Clients may also not
understand that hefty surrender charges apply if they cash in
the product earlier, sometimes as much as 8 percent.
Even brokers who make a good-faith effort to explain the
product can still fall short, risking angry clients who may
complain to supervisors and regulators. "If the customer doesn't
understand the product, the broker shouldn't sell it," said Joel
Beck, a lawyer in Lawrenceville, Georgia who advises brokers.
One reason why clients may not grasp how a variable annuity
works: the brokers who sold them may not have understood the
product well enough to adequately explain, Beck said. "The more
complex these products get, the more homework the broker has to
do in terms of reviewing the product, the contract and marketing
materials," Beck said.
Brokerages must have procedures and systems in place so that
brokers can properly evaluate the costs and benefits of annuity
exchanges, FINRA's Axelrod said. At large brokerages, variable
annuity sales are typically subject to multiple screenings by
computer software and a centralized review team, one brokerage
Disciplinary cases involving variable annuities are not as
common in recent years as those stemming from other products,
such as privately issued securities, but that does not mean that
regulators are not looking.
FINRA barred a broker last month who coaxed a customer to
cash in one variable annuity and buy another. He told her that a
$15,000 surrender charge did not apply to the transaction when,
in fact, it did, according to a regulatory filing.
Florida insurance regulators have been examining what
happens when brokers convince clients to exchange older
annuities (which may have paid up front-loaded commissions) for
new ones with new commissions.
In one Florida case, a broker advised a client to cash in a
variable annuity and buy another that promised higher returns.
But he bungled the tax treatment, leading to an unexpected
$24,000 tax bill.
Brokers must do fact-finding about customers to determine if
a variable annuity is suitable, based on factors such as their
risk tolerance and age, said Lee Kell, who heads the bureau of
enforcement for the division of securities at Florida's Office
of Financial Regulation. That means becoming familiar with the
intricacies of annuity contracts and fees, Kell said.
CASHING IN AT 102
Brokers who do not face off with regulators may have to deal
with investors' lawyers in FINRA's arbitration forum. Investors
filed 174 arbitration cases involving variable annuities in
2013, according to FINRA.
The cases typically name brokerage firms, but individual
brokers usually must testify about the annuity sale and details
about the complaint appear on the brokers' public record.
One recent case involves a 90-year-old investor who met his
adviser at a free-lunch seminar, according to Scott Silver, his
lawyer in Coral Springs, Florida. The investor ended up with an
annuity that charges higher administrative fees than his
previous one, said Silver. The extra fees will grind down the
investors' returns over time, Silver said.
What's more, the new annuity has a 12-year holding period.
"He must wait until he's 102 for access to his money," Silver
said. "That certainly wasn't his objective."
(Reporting by Suzanne Barlyn; Editing by Linda Stern and