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Should Advisors Help Their Clients Evaluate Annuity Buyout Offers?

Beginning a little over a decade ago many Variable Annuity issuers felt comfortable making projections that allowed them stay competitive and created and widely sold variable annuities with Guaranteed Minimum Lifetime Withdrawal Benefit and Guaranteed Minimum Death Benefit (GMLWB GMDB) Typically, these guarantees were riders that, for an extra fee, promised steady streams of annual income for the buyer’s lifetime, even if the underlying fund accounts became depleted, or enhanced death benefits, or both. But time, the markets, and the interest rate environment have not been kind to that vision. The reserves required today to fund those promises have placed onerous demands on some of the issuing firm‟s financials. These demands have not gone unnoticed by public companies‟ stockholders, and in some cases, has driven down the value of the insurer‟s stock or even forced some to exit the business entirely. Those remaining in the business are considering ways to mitigate this growing liability and asset gap by some or all of the following;
1. Exercising their seldom-used contractual rights to refuse additional purchase payments into those contracts, thereby reducing payments that could increase the issuer‟s liability,
2. Creating offers to existing GLWB and GMDB customers that seek to pay a portion of the current reserving gap to the client in the form of increased annuity account value now, in return for the client agreeing to forever give up receiving those future guarantees of income withdrawals or death benefit or both,
3. Offering a one-time bump in value in exchange for giving up the riders,
4. Telling clients whose subaccounts are in more aggressive funds to either move the funds by a certain date to more moderate accounts or lose the guaranteed rider,
5. Increasing the fees charged for these riders.
These products were quite popular and thousands of independent and captive registered representatives across many firms sold billions of dollars of these products between 2000 and 2008. The products were popular since these variable annuities offered individuals a tax-advantaged way to invest in (sometimes aggressive) stock and bond funds while still insulating oneself from market risk and volatility, or so they thought. As the industry competed for new clients, insurers increasingly sold annuities with more generous guarantees. After the insurers spent millions developing, advertising and distributing the products, the equity and bond market’s collapse during the 2008-09 financial crises exposed the true underlying risks posed by these guarantees.
How did this happen? Although many insurers ran hedging programs to mitigate those risks, the costs to sustain those hedges has increased since 2008 and most insurers have had to substantially boost their reserves and capital to meet state regulatory requirements and ensure they will be able to fulfill their obligations to the contract holders. A few insurers even found they needed to avail themselves of additional capital and took government aid during the crisis. The bottom line? They guessed wrong and the assumptions used did not envision a market collapse of that magnitude nor did they foresee a protracted near-zero interest rate environment.
A close reading of the offers being made to the customers noted above reveals that the issuers will stay well away from offering individuals any sort of investment advice and will tell clients directly that they should seek out their own advisor or financial representative when considering
whether or not to accept the offer. Representatives will face challenging questions from their clients, as these buyout offers come on the heels of increased regulations over annuity suitability by both state and federal level variable annuity regulators namely; FINRA, state securities departments, and state insurance departments, where most of the latter are operating under the new 2010 NAIC Model regulation,#275 Suitability in Annuity Transactions regulations. Together these all had the net effect of ramping up the suitability review and supervision by broker dealers, and issuers alike over all transactions and specifically, annuities.
So what are advisors to do? Most significantly for broker dealer registered representatives trying to help clients evaluate these buyout offers, FINRA recently enhanced its already strong annuity suitability regulations by introducing a new general suitability regulation that would cover a representative simply telling a client to stay put, in other words “do not accept the offer.” Larry Koscuilek, Director of Investment Company Regulation at FINRA, has commented publicly in several forums that for a variable annuity, the “stay put” advice is a recommendation to “hold” and under FINRA Rule 2111, would require documentation of a review of that recommendation by a supervisory principal. Larry agrees that these offers place most registered representatives and their firms in an awkward position, they did not make the offer, they probably don‟t have all the information they might need to evaluate its precise value, they most likely will not receive any compensation if the client stays put or accepts the offer, and if they offer advice, no matter what the client decides, they could later face a complaint that it was the wrong call. The offers vary and doing the math on what might be best for your client can be at best, intricate, and at its worst, nearly impossible without an actuarial degree and a crystal ball. Larry also reminded firms that any recommendation by a registered representative to accept the buyout on a variable annuity and move to a new product would obviously be a recommendation covered under FINRA Rule 2330 and be subject to principal review as well, even if the product purchased was a fixed annuity.
On the state level, and for advisors and clients in those states which have adopted the NAIC model regulation referenced above, it should be noted that the regulation requires both agents and companies alike to make only suitable annuity recommendations to clients, and to have a system of supervision that ensures those recommendations are suitable. Some states may be reviewing these and future offers with an eye towards their suitability to all clients receiving them.
So what is a reasonable approach when helping clients decide what to do? A best practice is to ask your firm for guidance on what they will expect you to give them in the way of documentation to be reviewed by a principal and using that guidance, walk the client through a number of steps that cover all the possible outcomes and circumstances. Some firms will require a representative to document the reasons for the recommendation in the client file, or in the case of a hold recommendation to create a “hold” ticket for entry in the firm‟s suitability system or other recordkeeping systems. Among the questions representatives should ask as they try to help clients evaluate the offer are;
1. Do we have enough information to assess the value of the offer as compared to the benefit being forfeited or reduced?
2. Does the client still need the lifetime income benefit?
3. What other income resources do they have?
4. Has their health changed?
5. Has their beneficiary situation changed?
6. Is there a current or near term need for an increased death benefit and does the offer increase what their beneficiaries might receive in the short term?
7. If they decline the offer will they still be able to select from all available subaccount options or will they be limited to “plain vanilla” moderate risk choices??
8. If they accept the added cash and, at a future date, try to reinvest that value in a similar product what would the projected income stream be?
9. If they take the offer and cash out are there tax consequences?
10. What are the charges associated with those transactions?
On the „take the deal side” some advisers, and SEC filings by some of the companies, have said that the new offers can make sense for a person whose health has deteriorated and who doesn’t expect to be able to take full advantage of the lifetime income benefits. Those people would likely prefer the chance to increase the account value, perhaps cash out of their underlying funds at an amount greater than the current balance, or have an increased death benefit should the offer provide that for in the near term in exchange for dropping the guarantees.
On the “stand pat” side, some holders of these contracts with these guarantees may still benefit from the promised lifetime income streams because they don’t have other fixed pension plans to draw on, and are worried about outliving their savings.
Determining the true value of the offer can be very difficult and, in many cases, impossible without sophisticated mathematical, actuarial and economic analysis. The company is not making this offer out of anything but its own self-interest, and customers and representatives should understand that the incremental increase in account value being offered is certain to be less than the difference between: the current account value and the total present value using today‟s assumptions of what the client might receive in total future guaranteed benefits and/or the amount by which the issuer must increase its reserves by in order to fund that future benefit. All agree that this number can be a moving target and vary greatly based on today‟s current value of the contract, any prior withdrawals taken, the past performance of the subaccounts, the current account allocation, and interest rates generally. In its 2013 Regulatory Examination Priorities Letter, FINRA observed that “Where the insurance company offers to buy back the (annuity) product or increase the account value to forgo product guarantees, it may present both brokers and investors with a less-than-clear picture of the financial benefit to the investor as well as the challenge of finding a similar product with the features included the prior product.” Joe Tomlinson, FSA, CFP, and owner of Tomlinson Financial Planning, LLC, agrees, he is an actuary and was in charge of annuity products at John Hancock before making a career change and forming his own financial planning firm ten years ago. “It would actually require a sophisticated valuation of the option to receive lifetime income based on current circumstances about account value, benefit base etc. and economic variables like interest rates and stock volatility, something that is beyond the skill level of most financial planners and advisers, and even if they were skilled in this area, they may not have access to all of the information needed to perform the analysis.” Joe went on to say “The best move might be to assess what would the
client do if they took the buyout versus what would happen if they did not, using standard financial planning tools to measure the impact on bequest values and cash flows.”
The bottom line? Try to reach a consensus with the client on what is the value of what they may be giving up. Follow your firm‟s guidance on what questions to ask, what facts to gather, and what documentation to forward to the firm. Regardless of the decision, document the discussion noting in the file any changes in circumstances, all the factors considered, and the client‟s wishes.
Regulatory Maven has the depth of industry best practices and regulatory knowledge to work with your team on drafting procedures which will meet the regulations, your firm‟s business model and the resources you have to deploy to satisfying the requirements. Contact us at or to learn how we can assist.

Larry Niland, CLU
Regulatory Maven Compliance Consultant

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