This month’s Compliance Corner blog entry will focus on a topic that regulators are consistently concerned about: replacements of annuity contracts. Replacements, also referred to by some as exchanges or switches, occurs when an agent recommends that a customer replace one annuity contract for a new one. Regulators have often argued that agents make commissions from these transactions, but customers are not always in a better position in the end. In some cases, the customer may be assessed a surrender penalty and may never reach the level of returns they would’ve achieved by staying with their existing annuity contract.
Most state insurance departments have adopted the NAIC’s Replacement Model Regulation or their own form thereof. Essentially, this regulation sets forth the obligations of both insurance companies and agents regarding the information that is required to be gathered, disclosed and reviewed as part of a recommendation for a replacement of an annuity contract. Some states require a very detailed side-by-side comparison of the existing annuity contract versus the proposed new annuity contract, such as Regulation 60 in New York, while other states are less onerous. One should always verify their specific state insurance department’s regulations prior to making a replacement recommendation so there is an understanding of what the specific obligations are.
There are many red flags that regulators look for when assessing replacements. Some of these red flags may become known via customer complaints and compliance reviews, while others may come from regulatory examinations of insurance companies and/or advisors themselves. Here are few key items to consider:
- Agents recommending replacements of annuities they previously wrote. Regulators look for reasons why the previous contract was sold if it was simply to be replaced in the future. This is commonly referred to as annuity churning as the agent makes a commission each time the annuity is replaced. While there is a clear benefit to the writing agent, the customer may be assessed a surrender charge and will start over in a whole new surrender schedule, thus allowing only conditional access to the account value.
- Recommending another annuity to replace a “bad” annuity product sold by another agent. If a customer feels that they were misled and purchased an annuity product that wasn’t suitable for them, seeking a replacement may not be the best first step. The customer may have a valid complaint to lodge with the issuing insurance company and/or their department of insurance. In some instances, the customer may be able to leave their existing contract without any penalties.
- Using product bonuses in the new annuity contract to offset surrender charges in the existing. Bonuses are designed to give customers a bump in their initial account values. Bonuses are not designed to offset surrender charges for replacements. Regulators look for this issue in examinations.
- Regulators also seek out agents whose books of business have a high percentage of replacements.
While this is not an exhaustive list, this is simply meant to be food-for-thought and to raise awareness. Replacements may not always bad, especially if the customer has a demonstrated need and has access to certain benefits or features that weren’t previously available to them. Nonetheless, thorough documentation and disclosure is essential so customers are well informed and agents have a defensible position should they every be questioned in the future.
As always, should you have any compliance questions, we are always here to help. Please feel free to send an email to firstname.lastname@example.org.