How To Get A Fixed Annuity From A Mutual Fund

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1 Presentation on Suitability in Variable Annuity Sales - How to avoid [Your Name Here] pays $2 million to Missouri, other states, over variable annuity sales Introduction: Jefferson City, Mo. - Two companies will pay fines to the state of Missouri and could be refunding money to consumers over concerns about unsuitable sales of variable annuities. The Missouri Department of Insurance, along with regulators from four other states, has reached a settlement with [Your Name Here] requiring the company to pay $2.1 million in penalties. Missouri's portion of the settlement is $264,303. State regulators became concerned that variable annuities were sold improperly to investment clients of [Your Name Here]. The biggest concern for regulators was [Your Name Here] encouraging clients to move their investment dollars from one annuity to another that may have been less suitable and had a lower death benefit. In addition, the clients paid nearly $10 million in fees for these transactions. Huff says with the uncertainty of the stock market in recent years, more investors may be turning to annuities, which can offer guaranteed returns. Also, President Obama recently announced an initiative to educate consumers about the pros and cons of annuities as a way to secure income during retirement. This is an actual headline from an article in a local paper with the obvious deletion of the name of the company. We can use this as a good reminder of why we are here today. Variable annuity sales have increasingly become a priority of both securities and insurance regulators. The reason for this scrutiny has been the unsuitable nature of these products for the majority of those who purchased them. FINRA issued a Regulatory Notice to Members in February on Variable Annuities Sales reminding firms of their obligations in the offer and sale of these products and the NAIC issued its Suitability in Annuity Transactions Model Regulation in March Today, we will cover the contents of the NAIC Model Regulation and FINRA Notice and the corresponding state regulations on suitability in VA transactions. Then we will go over some suggested supervisory procedures for the sale of variable annuities. NAIC Model Code, FINRA Regulatory Notice Reminding Firms of Their Responsibilities Under FINRA Rule 2330 (issued January 2010) and Mo 20 CSR Rule 2330(b) and 20 CSR : (1) No member shall recommend the purchase or exchange of deferred VA unless such member has a reasonable basis to believe: (A) That such transaction is suitable in accordance with the Rule and in particular there is a reasonable basis to believe that: (i) The customer has been informed, in general terms, of various features of deferred VA such as:

2 (ii) (iii) 1. potential surrender period and surrender charge; 2. Tax penalty if customer sell or redeem the VA before reaching 591/2 y/o; 3. Mortality and expense fees; 4. Investment advisory fees; 5. Potential for and features of riders; 6. Insurance and investment components of the VA; and 7. Market risk The customer would benefit from certain features of the VA such as tax deferred growth; annuitization; or a death or living benefit; and The particular V A as a whole; 1. the underlying subaccounts; and 2. the riders and similar product enhancements. (B) In the case of an exchange of a deferred V A that the exchange is consistent with the above taking into account the additional considerations exchange: (i) Whether the customer would: 1. Incur a surrender charge; 2. Be subject to a new surrender period; of an 3. Lose existing benefits such as death or living or other contractual benefits; 4. Be subject to increased fees or charges; 5. Benefit from product enhancements and improvements; and 6. The customer has had another deferred VA exchange within the preceding 36 mos. (e) Prior to the execution of VA transaction the following factors must be taken into account, at a minimum.: 1. The customer's age; 2. The customer's annual income; 3. Financial situation and needs; 4. Investment experience; 5. Investment objectives; 6. Intended use ofthe deferred VA; 7. Investment time horizon; 8. Existing assets (investment and life insurance holdings); 9. Liquidity needs; 10. Risk tolerance;

3 11. Tax status; 12. And any other info to be reasonable in making the recommendation. Suitability Violations Fall Into Two Categories (or Degrees): There are two types of an unsuitable variable annuity sale: 1. Not knowing the Product. VAs are a good example of this with their complicated workings of riders, subaccounts, surrender charges, fees and expenses. Other examples are; auction rate securities, EIAs, life settlements. This type of violation is like negligence in civil law. These violations don't contain an intent mentality, are less offensive and should be treated less harshly by a regulator. Compliance procedures should focus on adequately training on the products offered to ensure they are reasonably knowledgeable on the nature and risks of the product (and not training from vendors only), when to offer the product (after a determination the product is reasonably suited for that particular customer) and how to properly conduct the sale for that customer (document thorough customer specific suitability analysis); and 2. You mayor may not know the product and you sell it without regard to the customer's interest (whether a fiduciary duty applies or not). The correlating legal standard is gross negligence or willful. This is a more severe violation and should be treated more severely by the regulator. Compliance procedures should focus on supervisory procedures to detect and prevent such an unsuitable sale. Compliance Procedures: No one size fits all. Firms should use a risk based supervisory procedures, those procedures could include the following (taken from Protecting Senior Investors: Compliance, Supervisory and Other Practices Used by Financial Services Firms in Serving Senior Investors, issued in Sept 2008 by the SEC, FINRA, and NASAA): 1. Identify accounts or transactions for heightened review that may include the following: a. using a filtering program based on age and investment objectives to assist securities professionals in selecting appropriate annuity products for investors; 2. Implement product specific practices or limitations to reduce the likelihood of an unsuitable sale. You may want to have age-restrictions in your product specific practices such as: a. limiting or prohibiting purchases of certain investment products such as certain structured products based on an investor's life stage and risk profile;

4 b. prohibiting purchases of certain variable life insurance products by investors who are above a certain age; c. imposing an age maximum on certain annuity riders that have actuarially little or no benefit to persons above that age; and d. requiring completion of additional or targeted suitability documentation before a transaction is processed. 3. Implement heightened reviews of all VA purchases. For senior investors, deferred annuities may pose special appropriateness concerns depending on the investor's liquidity needs and investment time horizon. You may want to have a heightened supervisory review procedures for VAs such as: a. creating a central review and approval process for all VA transactions with special focus on purchases with riders. Some firms have a process independent of the securities professional which compares the attributes of the product to the needs of the investor; b. training a dedicated team of annuity application reviewers to be aware of the special nuances of these products; c. requiring a heighted review of annuity applications for investors over a certain age in a low tax bracket or with low liquid net worth; d. requiring securities professionals to fill out an annuity worksheet with the information used to assign a risk score to determine if a more enhanced review is required; e. requiring the investor to select an investment time horizon for a variable annuity purchase to review the subaccount allocations for consistency with the designated time horizon; f. implementing a hard block that prohibits VAs to be sold to investors above a certain age based on the time horizon required for the product to accrue any benefit to the investor, and/or the length of the surrender period in light ofthe age group's typical time horizon and liquidity needs.

5 Besides a Regulator's transaction: enforcement action what else you and the firm can face for an unsuitable FINRA Arbitrations also Reflect an Increase in Filings on Annuities- Variable annuities comprised a threefold spike in arbitration claims, rising to 123 cases filed with FINRA last year. Only 47 were filed in The products were the focus of a number of disciplinary actions as well, including a $1.5 million fine against Mutual Services Corp. for supervisory failures related to exchanging variable annuities. "We've seen a definite uptick in the last 12 months in variable annuity cases," said Andrew Stoltmann, a plaintiffs attorney. "Just a year to two years ago, the markets were tight and the brokers wanted to put clients into a high-commission product." He added that many of the variable annuity cases he has seen involved products with risky subaccounts and clients over 60 with 10% to 25% of their net worth in the annuity. Conclusion: Most of what was discussed here focused on the point of sale. However, you would be remiss if you thought your obligation ended there. Suitability is a continuing obligation. What was appropriate for a client once, may not be now. Where riders, subaccounts, or even the annuity itself, made sense at one time it may not continue to be suitable. You must engage in continuing dialogue with your clients. As investment advisers your fiduciary duty requires you to perform "due diligence" in a continuing manner, At least once a year you need to identify your client's needs, risk tolerance, "life stage", income, etc. and if, and how, they have changed. Some of you I'm sure already do this as a way to develop your business and relationship with the client, but it needs to be more than that. Use the opportunity to make sure your are continuing to meet your fiduciary obligation to provide investment advice that is in the best interest of the client.