Variable Annuity Securities Fraud Claims

Variable annuity securities fraud claims have become an increasing concern for investors nationwide. The White Law Group has handled numerous claims involving the improper sale of these products, often through FINRA arbitration.

These cases often highlight the complexity and confusion that annuity products can cause for everyday investors. What may appear to be a safe retirement option on the surface can actually carry hidden fees, high risks, and long-term restrictions. To help make sense of these issues, this post breaks down the essentials of variable annuities and highlights key considerations for investors.

In this post, you’ll learn about:

• An overview of variable annuity securities
• Their risks, including exposure in sub-accounts
• The differences between variable vs. fixed annuities
• The high costs, commissions, and fees tied to these products
• How unsuitable recommendations can lead to significant financial losses

Variable Annuity Securities Fraud Claims | Variable Annuity Attorney

The White Law Group provides an overview of variable annuities, highlighting some of their numerous pitfalls and the improper sales of such investments that often result in litigation and FINRA arbitration.

Variable Annuity – Defined

A variable annuity is an insurance contract in which, at the end of the accumulation stage, the insurance company guarantees a minimum payment. The remaining income payments can vary depending on the performance of the managed portfolio.

The portfolio generally invests in equity securities, and its performance determines the amount of this total payment. Just as with any investment in securities, the underlying sub-accounts can fluctuate in value depending on the performance of the investments.

As such, one common misconception of variable annuity securities is that they are somehow safer than, say, mutual funds. The safety of a variable annuity depends entirely on how the secondary accounts are invested. In many arbitration cases, this misunderstanding has been central to claims involving variable annuity securities fraud.

According to a recent Investment News report, the following firms are the top participating issuers of annuities:

• MetLife
• Prudential Financial
• Jackson National
• TIAA-CREF
• Lincoln Financial Group
• SunAmerica/VALIC
• Nationwide
• AXA Equitable
• Ameriprise Financial
• AEGON/Transamerica
• Allianz Life
• Pacific Life
• Sun Life Financial
• Protective
• New York Life

The variable annuity securities providers contract with financial advisors nationwide to sell their products. The annuity provider then pays a commission to the financial advisor for selling their product to the customer.

Variable vs. Fixed Annuity

A fixed annuity is a contract offered by an insurance company that is much like a bank CD. You deposit a certain amount of money, and the insurer agrees to pay a specific interest rate over a specified period.

But there are a couple of twists that make a fixed annuity slightly different. On the plus side, unlike with a bank CD, the interest you earn in a fixed annuity isn’t taxed until you withdraw the money from the annuity.

In addition, insurers typically charge an early withdrawal penalty for withdrawals made within the first seven to 10 years that you own the annuity. These early withdrawal penalties can start as high as 10 percent and then usually decline by a percentage point annually until they disappear after seven to 10 years.

A variable annuity, by contrast, works more like a mutual fund. You invest in one or more sub-accounts. When advisors gloss over the variable vs. fixed annuity trade-offs, investors may not realize that one product prioritizes predictable guarantees. At the same time, the other exposes them to market volatility and risk.

There are some crucial differences, though, between a mutual fund and variable annuity securities. For one thing, a variable annuity has an additional set of fees, usually referred to as insurance costs or M&E (mortality and expense) charges, that result in higher annual operating expenses compared to mutual funds.

Frequently, the combination of the investment management fees to run the underlying investment portfolio plus the insurance charges drives a variable annuity’s annual costs above 2 percent a year. These costs can make variable annuity securities one of the more costly investments sold by financial advisors, potentially leading to claims of securities fraud.

The primary difference, though, between a fixed and variable annuity deals with risk. With a fixed annuity, the annuity provider guarantees a rate of return, and the primary risk is that the provider is unable to pay that return. A variable annuity, on the other hand, has the same risk as any other investment, including the risk of a total loss. This comparison is at the heart of many disputes involving variable vs. fixed annuity recommendations.

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Underlying Sub-Accounts

One common mistake with investing in variable annuity securities is the false sense that you can’t lose money in your annuity, so it’s okay to invest more aggressively in the secondary accounts. This is a false assumption.

Although annuity companies often offer a nominal guaranteed growth, any meaningful increase in the value of the annuity (either the present value or the death benefit) comes from the value of the underlying investments.

As such, dramatic losses in the sub-accounts will substantially impact both the present value and likely the ultimate death benefit of the annuity. In many cases, these mistakes fuel claims of variable annuity securities fraud.

Common Misuse of Variable Annuities

There is a time and place for virtually any investment sold by a brokerage firm. Annuities have tax benefits that can be attractive, as well as other benefits that are not the subject of this piece. The problem with variable annuity securities is that they are often oversold (or sold as too large a percentage of the investor’s particular net worth).

Just as with any other investment, it is never wise to over-concentrate your assets in any particular investment. Brokers often convince clients that, because you can diversify the underlying sub-accounts, it is ok to invest a significant percentage of your net worth in a variable annuity. This ignores the illiquidity of annuities as well as the costs associated with early withdrawals.

Suppose your financial advisor recommends that you put all your eggs in one basket. In that case, there is likely a reason—and that can lead to variable annuity securities fraud claims.

Costs and Commissions

Most of the problems with annuities revolve around the costs. Of course, it is precisely these costs that incentivize financial advisors to sell them (and attract bad brokers to oversell them). The primary costs associated with variable annuity securities are as follows:

1. Surrender Charges: Most insurance companies charge a surrender fee (usually on a five to seven-year scale). These fees often start at around 8% in the first year, down to 0% in year seven. A $100,000 investment could cost you $8,000 (8%) in surrender fees if you take your money out in the first year.
2. Up-front Commissions: Annuities are still primarily a commission-based product. They can pay commissions of 5% or more to the agent who sells them to you. That’s $5,000 or more in commissions for each $100,000 invested.
3. Annual fees, administrative charges, mortality expenses, and other charges: There are a variety of charges that the annuity provider charges the customer for administering the annuity contract. These fees directly impact performance and make it difficult for variable annuity securities investors to outperform the market, regardless of how the sub-accounts are invested.

These heavy commissions and surrender fees are at the core of many variable annuity securities fraud claims. Of course, it is these costs that make the investments so profitable for insurance providers, and this is why they are willing to pay such a high commission to financial advisors who are eager to sell the products. For many clients, the choice between a variable and fixed annuity becomes crucial.

Variable Annuity Switching

Selling an existing variable annuity securities contract to buy a new variable annuity is a hot-button issue for most securities regulators. Since demonstrating that a variable annuity purchase is suitable for a client is challenging, selling one annuity to buy another is a particular red flag.

The factors to be considered by any financial advisor before recommending a variable annuity are as follows:

• The age of the investor
• The investor’s annual income
• The investor’s financial situation and needs
• Their investment experience
• Their investment objectives
• Intended use of variable annuity securities
• The investor’s investment time horizon
• Their existing assets (liquid and non-liquid)
• The investor’s risk tolerance
• Their tax status

If a financial advisor is recommending an annuity swap, they must also consider the following: any surrender charges and/or bonuses received:

The loss of existing benefits (living or death) in giving up the existing annuity

• Any increased annual contract costs
• Any increases in the surrender charge period
• Any product enhancements and improvements obtained
• Whether the customer has recently replaced another variable annuity

In light of all these considerations and the high costs of these investments, it is challenging for a financial advisor to justify a variable annuity swap or switch, which can lead to variable annuity securities fraud claims.

Regulatory Scrutiny

Due to some of the issues discussed above, the sales practices of those who sell variable annuity securities have been subject to considerable regulatory scrutiny. The sheer number of regulatory notices issued by FINRA on variable annuities should tell you that the improper sale of variable annuities is a problem of which FINRA is acutely aware.

FINRA and the SEC continue to monitor sales practices, issuing notices and alerts that often cite the rising number of variable annuity securities fraud claims. For the full breakdown on the SEC’s position on variable annuities, visit http://www.sec.gov/investor/pubs/sec-guide-to-variable-annuities.pdf.

Determining Whether a Variable Annuity Recommendation is Suitable

FINRA Rule 2111 on Suitability states that:

“A member or an associated person must have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer’s investment profile. A customer’s investment profile includes, but is not limited to, the customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the customer may disclose to the member or associated person in connection with such recommendation.”

FINRA Rule 2330 also discusses suitability and applies explicitly to variable annuity securities recommendations and recommendations on how to invest the initial sub-accounts.

FINRA Rule 2330 states that a variable annuity transaction:

“Is suitable in accordance with Rule 2111 and, if there is a reasonable basis to believe that (i) the customer has been informed, in general terms, of various features of deferred variable annuities, such as the potential surrender period and surrender charge; potential tax penalty if customers sell or redeem deferred variable annuities before reaching the age of 59½; mortality and expense fees; investment advisory fees; potential charges for and features of riders; the insurance and investment components of deferred variable annuities; and market risk; 

(ii) the customer would benefit from certain features of deferred variable annuities, such as tax-deferred growth, annuitization, or a death or living benefit; and 

(iii) the particular deferred variable annuity as a whole, the underlying sub-accounts to which funds are allocated at the time of the purchase or exchange of the deferred variable annuity, and riders and similar product enhancements, if any, are suitable (and, in the case of an exchange, the transaction as a whole also is appropriate) for the particular customer based on the information required by paragraph (b)(2) of this Rule.”

Although suitability is an investor-specific inquiry, variable vs. fixed annuity comparisons are often ignored by advisors who push clients toward variable products without disclosing that a fixed option may have been more suitable. These omissions have played a role in numerous variable annuity securities fraud claims filed through arbitration.

Variable annuity securities are often considered unsuitable in the following contexts:

1. When the age of the purchaser is above 70
2. When the client’s original objective was for immediate income
3. When the assets invested are already tax deferred (i.e, IRA funds)
4. When the purchaser has a high net worth (and therefore has little need for insurance)
5. When the annuity is being purchased through an exchange (including a 1035 exchange)

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Misrepresenting Key Benefits

One of the most common problems we see in litigating these investments is that financial advisors often misrepresent the key benefits of a variable annuity contract to induce their customers to purchase the investment.

One benefit that is often misrepresented is the “guaranteed minimum income benefit” rider, also known as the “living performance guarantee.” Different providers have different names for this rider, but essentially, the feature provides guaranteed income regardless of actual performance.

The rub is that brokers often gloss over or fail to mention that the rider requires the contract to be kept in force for a long time, typically ten years or more, before it can be utilized. Additionally, the investor must annuitize the contract to get the guarantee (i.e., the investor must transfer the principal to the carrier in exchange for the guaranteed payments).

The insurance company is then betting the client dies before the full value of the funds has been paid out. The real problem for the investor, though, is that these riders are costly and rarely does the math work for the investor, creating potential variable annuity securities fraud claims.

FINRA Arbitration

Financial advisors have two main obligations to their clients. The first is a duty to perform due diligence on any investment they recommend. The second is to ensure that any investment recommendation made is appropriate for the client, taking into account the client’s age, investment experience, investment objectives, and net worth.

Suppose a broker or brokerage firm makes an unsuitable recommendation or performs inadequate due diligence. In that case, they may be liable for any losses in FINRA arbitration related to variable annuity securities fraud claims.

Frequently Asked Questions

1. Can I transfer my annuity?

In many cases, yes. Many annuity contracts allow transfers, but the rules can be tricky. Imagine trying to move your retirement savings from one locked box to another. You’d want to be sure you aren’t giving up valuable benefits in the process. Transfers often trigger concerns, including surrender fees, new waiting periods, or the loss of add-on benefits, such as income or death riders.

2. What is a 1035 exchange? How does it apply to annuities?

This type of exchange is a special IRS rule that allows you to swap variable annuity securities products without incurring an immediate tax bill. On paper, it sounds like a win. You keep your tax deferral and move to a “better” product. But here’s the catch: these exchanges are often pushed by brokers who earn a fresh commission when you switch, sometimes without clearly explaining the variable vs. fixed annuity alternatives.

3. What are mortality expenses in variable annuities?

Mortality and expense (M&E) fees are a standard charge in most variable annuity securities. They’re supposed to cover the insurance company’s risk of guaranteeing benefits like lifetime income or death payouts. In practice, however, these changes quietly erode returns year after year. It’s like filling up a bucket of water that has a small hole in the bottom; no matter how much liquid you pour in, you’ll continue losing some of it.

Free Consultation

If you believe that you were sold a variable annuity improperly, please call the securities attorneys of The White Law Group at 312-238-9650 for a free consultation.

The White Law Group is a national securities fraud, securities arbitration, and investor protection law firm with offices in Chicago, Illinois, and Seattle, Washington.
 

Investment Losses? Contact us now for a free consultation!