Chapter 5 - Suitability, Replacement, and Compliance

Recommendation

- means advice provided by an insurance producer, or an insurer where no producer is involved, to an individual consumer that results in a purchase, exchange or replacement of an annuity in accordance with that advice.

Senior Financial Concerns

A number of concerns are common to older people. Fear, uncertainty, doubt about the future, and the importance of making prudent financial decisions must be addressed. Producers who work in the senior market MUST be aware of the questions seniors ask themselves. Answering these concerns in advance of a recommendation is the key to suitability.

Replacement

A transaction in which a new policy or contract is to be purchased, and it is known (or should be known) to the proposing producer or insurer, that by reason of the transaction, an existing policy or contract has been or is to be: - Lapsed, forfeited, surrendered or partially surrendered, assigned to the replacing insurer or otherwise terminated - Converted to reduced paid-up insurance, continued as extended term insurance, or otherwise reduced in value by the use of nonforfeiture benefits or other policy values - Amended so as to effect either a reduction in benefits or in the term for which coverage would otherwise remain in force or for which benefits would be paid - Reissued with any reduction in cash value - Used in a financed purchase The definition of "replacement" is derived from the NAIC Life Insurance and Annuities Replacement Model Regulation. If a State has a different definition for replacement, the State should either insert the text of that definition in place of the definition shown or modify the definition to provide a cross-reference to the definition of replacement that is in State law or regulation.

Surrender Charges

Does my qualified plan have surrender charges if I need the money soon? How will I be affected by surrender charges, taxes, and penalties if I am forced to retire before age 59½?

Suitability, Replacement, and Compliance

Due to government regulations and litigation, annuity suitability remains a current topic in the insurance industry. Carriers are paying closer attention to how producers are supervised and to the standards used to evaluate producer performance. Insurers are not only governed by each state's department of insurance, but companies that develop and market investment products are also regulated by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) whose mission is to protect investors by making sure the securities industry operates fairly and honestly. In addition to the federal oversight of securities based products, the National Association of Insurance Commissioners (NAIC), a membership-based organization of the country's chief insurance regulatory officials, has a mission to assist state insurance regulators, individually and collectively, in achieving the following regulatory goals: Protect the public interest Promote competitive markets Facilitate the fair and equitable treatment of insurance consumers Promote the reliability, solvency and financial solidity of insurance entities Support and improve state regulation of insurance The NAIC, working together with state insurance commissioners, developed a set of guidelines designed to assist states better address the issue of product suitability, specifically annuities.

Replacement, Disclosures and Recordkeeping Requirements

Every state establishes its own rules and regulations to govern disclosures, recordkeeping and policy replacement requirements. Most states follow the guidelines of the NAIC Model Recommendations pretty closely.

Long Term Care

How well will I age? Will I be able to remain in my current living situation? Can I afford to get sick? Will I require substantial assistance with the Activities of Daily Living (ADLs)? How long will my vision and my reflexes allow me to drive my car? Should I consider some form of assisted living eventually? What if I need a nursing home because of physical or mental limitations? Should I consider a reverse mortgage to take equity from my home to provide for my long term care? What will my eventual costs be for my long term care if an institution is the best place for receiving that kind of care? Should I purchase a long term care insurance policy? Would purchasing long term care insurance make the best financial sense for me and my family?

Defined Benefit Plans

If I am eligible for a defined benefit pension... Has my benefit been fully funded—and as promised? Will some unknown future event reduce the promised retirement pension payout? Does my pension benefit have a Cost Of Living Adjustment (COLA)? Will future inflation erode my buying power over the next 25 or 30 years of my retirement? How secure are pension plans that are covered by the Pension Benefit Guarantee Corporation?

Defined Contribution Plans

If I am eligible for a defined contribution plan (such as 401(k) or 403(b))... Will it contain enough funds for me to live on? Will I run out of money during my retirement years? Will I outlive my resources? Will I be in a lower tax bracket when I retire? Did I defer taxes at a lower tax rate when I was working, only to pay a higher tax rate when I retire? Should I consider a Roth IRA for some or all of my pre-tax retirement savings plans?

Disclosures

In addition to the collection of data, certain disclosures and product information must be shared with the consumer before a sale can be approved. The Model Regulation recommends that insurers and producers specifically disclose and discuss the following information with potential customers before a policy or contract can be finalized: - Potential surrender period changes and additional surrender charges - Potential tax penalties if the consumer sells, exchanges, surrenders or annuitizes the annuity (always recommending that a tax professional be consulted) - Mortality and expense fees - Investment advisory fees - Potential charges for and features of riders - Limitations on interest returns - Insurance and investment components - Market risk Regulations further state that the insurer and producer have no obligation to a consumer related to any annuity transaction if: - No recommendation is made - A recommendation was made and was later found to have been prepared based on materially inaccurate material information provided by the consumer - A consumer refuses to provide relevant suitability information and the annuity transaction is not recommended - A consumer decides to enter into an annuity transaction that is not based on a recommendation of the insurer or the insurance producer

Social Security

Should I take retirement benefits at the earliest possible age (62)? Should I wait until full retirement age (66-67) or delay it until age 70 before taking monthly retirement benefits? How do these answers affect my spouse if I am married? Will benefits be available to me whenever I retire? Will benefits be reduced when it's my turn to begin to receive them? Will my Social Security retirement benefits be enough for me to live on?

Health Insurance

The cost of health insurance is rising. How will this cost impact my retirement savings? What will happen to government programs such as Medicare or Medicaid in the future? How will Medicare and Medicaid affect me? Can I trust the government to provide my medical insurance? Will government changes in healthcare affect me personally? Can I keep my doctor? Will I have to wait for treatment? Will my choices for treatment be limited? Should I consider a supplemental medical plan to cover the gaps provided by Medicare coverage?

Suitability information

means information that is reasonably appropriate to determine the suitability of a recommendation, including the following: Age Annual income Financial situation and needs, including the financial resources used for the funding of the annuity Financial experience Financial objectives Intended use of the annuity Financial time horizon Existing assets, including investment and life insurance holdings Liquidity needs Liquid net worth Risk tolerance Tax status

The Issue of Buyer Competence

Be aware of the possibility that buyers who, because of advanced age or mental and medical conditions, may appear to be absolutely healthy in every way but may, in fact, be slightly, moderately, or largely impaired on a cognitive level. Insurance agents are not professionally or medically trained to evaluate whether someone is of sound mind. Agents must be ever alert for certain red flags or indicators that a prospective annuity buyer may lack the short-term memory or judgment to knowingly purchase an insurance product or annuity. These indicators may include one or more of the following: - Mental confusion and increased forgetfulness - Changes in physical surroundings, not as neat, clean, or orderly as before - Changes in physical appearance, personal hygiene, and dress—not as well-groomed as before A critical component of the decision making process is the inclusion of a senior client's close family and/or a legally appointed representative, especially if an agent suspects a cognitive impairment may exist. Asking a client to include a son or daughter may provide the agent with a better picture of the client's mental capacity than the agent could ever hope to have on his own, based on a few interviews. Involving the family can save an agent from costly legal ramifications down the road. It is not only the smart thing to do; it is also the right thing to do.

Practical Suitability Determination

Beyond mandated training requirements, insurers with decades of customer experience can offer more advanced training, further refining and isolating the specific needs and concerns of each potential client. Carrier best practices include tried and true guidelines to help producers navigate the sales recommendation process. These guidelines provide a toolkit of questions to help each potential consumer balance goals and reality, putting to paper the practical, and developing a strategy to execute a retirement plan. Every annuity transaction (a sale, exchange or replacement) must be measured against a suitability standard. If the answer to any of these questions is, "Yes", the producer and insurer will have to follow regulatory guidelines in order to prove suitability, should the transaction be called into question at a later date:

Required System of Insurer Supervision

First, the insurer is tasked with establishing a system of supervision to oversee the sale of every annuity product, recommended either by the carrier directly or by appointed producers. Each state's Insurance Department holds the insurer as the ultimate responsible party in the transaction of an annuity sale. Specifically, the insurer must make sure that before any annuity contract is issued: - Recommendations must be reviewed to ensure there is a reasonable basis to believe that the transaction being recommended is suitable, including the collection of specific consumer information. - The insurer must review all of the information the producer used to establish the reasonable basis for the recommendation. - The insurer may require additional information if necessary to confirm the reasonable basis of a recommendation.

Producer Training Requirements

Once the supervision system has been outlined, producer training initiatives must be developed, monitored and evaluated to make sure every appointed producer is trained on the features, benefits and limitations of the product he or she markets for the carrier. Product specific training includes compliance with the insurer's standards for product training, prior to soliciting an annuity product. The Model Regulation also recommends a one time, minimum four credit hour general annuity training course offered by an approved education provider. (This training cannot include sales or marketing techniques or product specific information.) Regardless of the course delivery method, insurers must verify that mandated training has been completed prior to allowing a producer to sell its annuity products. The NAIC Model Recommendations for producer training were not adopted in every state as written. It is important for every agent to know the resident requirements of their home state as well as the non-resident training requirements for other states in which business is conducted.

Checklist

Place the majority of a client's liquid assets into an annuity, especially where withdrawals are limited? Create a surrender penalty period longer than the client's life expectancy? Highlight contract benefits while omitting or minimizing negative aspects such as surrender charges, fees, annuitization requirements, forfeiture of interest, etc.? Match product features and benefits to the client's stated needs and goals? Require the policyholder to fulfill complicated contract requirements to obtain interest credited to the annuity or retain premium bonuses, especially with dual-tiered interest crediting methods? Cause the loss of valuable contract guarantees like nursing home and death benefits when one annuity is replaced with another? Offer bonuses that require the contract owner to meet complicated contract provisions to retain the bonus, especially with dual-tiered interest crediting methods?

Suitability as Defined by the Model Regulation

Purchasing or exchanging an annuity product can have serious financial repercussions if the sale is unsuitable for the customer's needs. Perhaps the most important outcome of producer training is the ability to determine suitability through the collection of specific customer information. The Model Regulation defines and outlines the information needed in order to match a consumer's needs and current financial situation to the insurance product being recommended. The regulation is a starting point, outlining the minimum considerations of importance to carriers and consumers.

Investing Retirement Plan Distributions

Should I take a lump-sum benefit and manage it myself? Should I roll it over to a portfolio manager? Should I roll it over to a guaranteed account at my local bank? Which would be better for me and my retirement money?A fixed annuity?A variable annuity?An indexed annuity? Is this the time to invest my retirement money in the stock market? Am I comfortable with market volatility and risk? Should I delay taking any withdrawals from my traditional IRAs or wait until Required Minimum Distributions at age 70½? Will RMDs provide the kind of regular retirement income I will require? Is there a better way to take retirement money from my plan?

FINRA

The Model Regulation accepts that sales made in compliance with FINRA requirements pertaining to suitability and supervision of variable annuity transactions as meeting its guidelines and recommendations. This applies to FINRA broker-dealer sales of variable annuities and fixed annuities if the suitability and supervision is similar to those applied to variable annuity sales. The insurer is specifically required to: - Monitor the FINRA member broker-dealer using information collected in the normal course of an insurer's business; and - Provide to the FINRA member broker-dealer information and reports that are reasonably appropriate to assist the FINRA member broker-dealer to maintain its supervision system.

NAIC Suitability in Annuity Transactions Model Regulation

The Model Regulation provides a set standards and procedures for suitable annuity recommendations and requires insurers to establish a system of supervision to review and approve producer recommendations. Many states have passed insurance legislation based on the NAIC Model, either in part or as written, to address the suitability concerns of the general market as a whole and the senior market in particular. The goals of the Model Regulation are simple; the NAIC Annuity Suitability Recommendations: - Establish a regulatory framework that holds insurers responsible for ensuring that annuity transactions are suitable in the marketing and sale of annuities - Require that producers be trained on the provisions of annuities in general, and the specific products they are selling - Where feasible and rational, to make these suitability standards consistent with the suitability standards imposed by the Financial Industry Regulatory Authority (FINRA)

Recordkeeping

The insurer is permitted, but not required, to maintain documentation on behalf of an insurance producer. At the time of sale, producers must: - Make a record of any recommendation - Obtain a customer signed statement documenting a customer's refusal to provide suitability information, if any - Obtain a customer signed statement acknowledging that an annuity transaction is not recommended if a customer decides to enter into an annuity transaction that is not based on the insurance producer's or insurer's recommendation

Compliance Mitigation and Penalties

The insurer is responsible for compliance with this regulation. If a violation occurs, either because of the action or inaction of the insurer or an appointed producer, the state insurance commissioner may order: - An insurer to take reasonably appropriate corrective action for any consumer harmed by the insurer producer's violation of this regulation - A general agency, independent agency or producer to take reasonably appropriate corrective action for any consumer harmed by a producer's violation of this regulation - Appropriate penalties and sanctions to be assessed Any applicable penalty for a violation of this regulation may be reduced or eliminated (according to a schedule adopted by the commissioner,) if corrective action for the consumer was taken promptly after a violation was discovered or the violation was not part of a pattern or practice.

Estate Planning

What size estate do I have and what will it be in the future? If I have substantial assets, do I care that estate taxes may drain a significant portion of assets? Should I consider estate legacy planning and tax planning? What charitable interests do I have (i.e., colleges, causes, and non-profit organizations I have been active in and that I care about)? Now that I am older, should I consider buying life insurance to replace highly appreciated assets that I donate to charity? Can I qualify medically for life insurance, given my health history? Drafting legal documents and purchasing life insurance may be a drain on my retirement assets. How much should I spend on these pursuits? What will the estate and gift taxes be in the future, and will they apply to me?

Senior Suitability Information

When the consumer is a senior, other factors must be recognized and carefully considered to determine product suitability. The senior market is composed of people ages 65 and older with financial and healthcare needs that are very different from those of the younger population. In most cases, a healthy, newly retired person is likely to be self-sufficient and able to manage retirement assets. On the other hand, someone over 80 is statistically more likely to have lost a spouse or developed physical limitations related to vision and hearing. Financial tasks like paying bills on time, balancing bank accounts, and effectively managing stocks, bonds, and mutual funds may be much more challenging for older consumers.

Senior Risk Tolerance

While the risk tolerance of any customer is important to measure, it is especially true in the senior market. Every area of risk: investment, inflation, and longevity must be closely evaluated with a senior consumer. Often the best way to understand suitability comes from asking questions. Will the senior's retirement portfolio decline in value? Losses at the beginning of retirement may be especially difficult to handle if the devaluation is not rectified quickly enough. Will price increases in the future significantly affect the purchasing power of the senior dollar? Did the retiree plan a retirement budget? Will savings and investments last? Underestimating longevity could easily end up causing the retiree to outlive retirement savings. What if long-term care is needed? Is there insurance to cover expenses or will retirement savings be drained?