Chapter 1 — Suitability

• Fixed annuities are regulated by state insurance authorities; variable annuities fall under both state and FINRA/SEC jurisdiction
• The Dodd-Frank Act (2010) permanently classified most equity indexed annuities (EIAs) as fixed annuities subject to state regulation only
• Florida’s Seibel Act of 2008 strengthened the state’s senior consumer protection rules by requiring an “objectively reasonable basis” for recommending annuities to seniors
• Agents must complete a detailed suitability questionnaire Form DFS-H1-1980 and forward a copy to the issuing company within 10 days
• For replacement transactions, agents must complete a comparison form Form DFS-H1-1981 and disclose potential tax consequences
• Issuing companies and third-party marketers must maintain supervisory systems and retain records for at least five years
• FINRA-affiliated agents should apply FINRA rules to variable annuities and comply with state suitability requirements for fixed annuities sold to senior consumers
• The NAIC has drafted model suitability laws covering all ages; Florida currently applies suitability requirements only to senior consumers (age 65 and older)

Annuities at their most basic level are a simple concept to grasp — but as the old saying goes: the devil is in the details. Each contract has its own unique set of provisions, which complicates the advisor’s task of recommending suitable contracts for his or her client’s unique situation. As a result, many clients have been sold annuity contracts that do not meet their needs.

Over the years, the annuity industry has developed new, more complicated types of contracts — such as equity indexed annuities — and introduced new benefits that are not easily understood, such as enhanced living and death benefits. While these new products can offer prospects a greater range of options to meet their financial needs, they often confuse clients and agents alike. Government regulators at the state and federal level have noted this evolution of product design and its adverse impact on clients. As a result, they have imposed additional regulations on the sale of annuities.

This chapter explores two key amendments to Florida’s Senior Consumer Law: the Seibel Act, passed in 2008, and the Safeguard Our Seniors Act, signed by the governor in 2010. There is an exemption in this law for transactions governed by FINRA — but ethical advisors will want to follow the general principles of these regulations regardless of whether the strict language of the rules applies to a particular situation.

Before exploring these two regulations, a brief review of the regulatory framework governing annuities is in order:

• Fixed annuities (including equity indexed annuities) fall under the purview of state insurance authorities.
• Variable contracts fall under both state and federal jurisdiction — state insurance commissioners regulate the variable contract itself; the SEC claims jurisdiction over the separate sub-accounts as investment products. The SEC delegates oversight of variable annuity sales to FINRA.
• As a result, state laws govern the sale of all annuities; FINRA governs the sale of variable annuities only.

In 2008, the SEC proposed Rule 151A, which would have treated equity indexed annuities as variable contracts. That proposal met significant opposition. In June 2010, a federal court found the SEC’s analysis flawed, and shortly thereafter Congress passed the Dodd-Frank Act, which permanently classified most EIAs as fixed annuities subject to state regulation only.

In the late 1990s, state regulators began addressing the sale of fixed annuities to “senior consumers.” Florida enacted initial consumer protections in 2004 based on the NAIC’s Senior Protection in Annuity Transactions Model Law. Analysis by the Department of Financial Services found that due to vague wording this law was ineffective.

In 2008, the Florida legislature strengthened its language in response to instances where elderly clients were sold unsuitable annuities — particularly highly illiquid contracts. One elderly couple from Venice, both in their eighties, were sold $600,000 in annuities with surrender charge periods that lasted longer than their life expectancies. The updated state law, known as the “John and Patricia Seibel Act,” is named for them.

The primary focus of the Seibel Act is to strengthen protections for elderly annuity purchasers. The new standard now requires an insurer or agent who recommends the purchase or exchange of an annuity to a senior consumer to have “an objectively reasonable basis for believing the recommendation is suitable.”

The Seibel Act replaced the prior subjective standard with a more objective one. The prior law required clear and convincing evidence not that a transaction was suitable, but whether the agent reasonably believed it was. The new law requires an “objectively reasonable basis for believing the recommendation is suitable.”

Disclosure Requirements

The Seibel Act specifies the minimum information that must be obtained from a senior consumer and requires use of a form designed by the Department of Financial Services (Rule 69B-162.001). FINRA Rule 211 (July 2012) updated these. At a minimum, agents must ascertain the client’s:

1. Age;
2. Annual income;
3. Financial situation and needs, including debts and other obligations;
4. Financial experience;
5. Insurance needs;
6. Financial objectives;
7. Intended use of the annuity;
8. Financial time horizon;
9. Existing assets or financial products, including investment, annuity and insurance holdings;
10. Liquidity needs;
11. Liquid net worth;
12. Risk tolerance, including but not limited to, willingness to accept non-guaranteed elements in the annuity;
13. Financial resources used to fund the annuity;
14. And Tax status.

The agent must forward a copy of the completed questionnaire to the issuing company within 10 days, and provide a copy to the client no later than delivery of the contract documents.

If the client currently holds one or more annuity contracts, the agent must also determine the type, issue date(s), maturity dates, fund allocation (for variable annuities), surrender charges, riders, and liquidity within the existing contracts.

For replacement transactions, agents must complete a comparison form (Form DFS-H1-1981) comparing benefits, terms, limitations, fees, and charges between the existing and proposed contracts, including a statement describing the basis for recommending the exchange. Agents must also disclose that the transaction may have tax consequences and recommend the client consult a tax advisor.

Scope and Exemptions

The disclosure requirements apply to the sale of annuities to individual senior consumers (age 65 or older). The following transactions are specifically exempt:

• Sales resulting from direct mail solicitation where no recommendation is made by the agent
• Contracts sold to qualified retirement plans (ERISA, 401(k), 403(b), 457 plans)
• Sales to employer-provided non-qualified deferred compensation plans