Now that VAs face suitability requirements, is life insurance far behind?
Variable annuities now have stricter suitability rules than apply to other securities. FINRA and the SEC have determined that the logical purchaser of a variable annuity needs more consumer protection than is necessary for other investments. In addition, recent years have seen the state insurance regulators follow FINRA's and the SEC's lead and began the process of requiring greater suitability screening for fixed annuities. While these new requirements are not yet in effect in all jurisdictions, it is only a matter of time until they will be applicable--not just to products like fixed indexed annuities, but to all annuities. Thankfully, the state insurance regulators have not added a second layer of suitability regulation for variable annuities at the state level to that already applied by FINRA and the SEC--at least not yet.
Now that suitability screening is a priority of regulators with respect to annuities, can similar requirements be far behind when it comes to other life insurance products? The reason for increased suitability screening for annuity transactions as stated by the National Association of Insurance Commissioners is "to protect consumers from the unlawful or unethical practices of producers and insurers who gain from unsuitable sales transactions." Apparently, the NAIC, along with FINRA and the SEC, believes that annuities are so complex and difficult to understand that consumers need special protections to ensure that these products are "suitable" for their needs. It is not a great leap to determine that traditional life insurance products are of equal or even greater complexity than annuities, so the trend toward greater suitability standards may well extend to other life insurance products in the not too distant future.
No one can argue with the concept that consumers should not be pressured to buy inappropriate or unsuitable financial products; particularly when such products may involve a substantial portion of the consumer's net worth. Unfair trade practice laws and regulations have been in effect in most states for decades. These laws and regulations are intended to prevent consumers from being preyed upon with respect to most types of transactions. Only securities, and now annuities, have been singled out as needing enhanced consumer protection. These suitability requirements lead us to this question: What is the definition of a "suitable" transaction?
Obviously, a "perfect" product would, in all instances, be a "suitable" one. Yet, perfection, like beauty, is in the eye of the beholder. A review of FINRA arbitration claims would lead to the conclusion that, with respect to variable annuities, a "suitable" product is one that always increased in value--that is, was not subject to downward market fluctuations. Many consumers who purchased variable annuities seem to have the opinion that when the market goes up, the variable annuity they purchased was "suitable." On the other hand, when the market goes down, the product was "unsuitable" and the person who sold it to them engaged in misconduct.
"Suitability" is difficult to define as a positive term. It is easier to define as a negative term, that is, what is "unsuitable." Thus, it is far easier to find that a particular product is not suitable than to determine that it is suitable. The rules require that the suitability determination be a positive one where the salespeople (and those responsible for supervision of salespeople) determine that an annuity is "suitable" for the consumer's needs. We have long believed that such a determination is, in fact, difficult to make. Instead, a determination that a product is not "unsuitable" makes more sense. Unfortunately, the legal standard does not agree so sales people and their supervisors must make a positive determination that an annuity is "suitable"--whatever that means.
Traditionally, a financial advisor was only obligated to make a suitability determination on the sale of a variable annuity if the advisor made a recommendation to the customer to purchase the product. Recent years have seen an effort to impose the necessity for suitability screening even if the purchase of the variable annuity originated with the customer with no recommendation by the financial advisor. Fortunately, both with respect to variable annuities and fixed annuities (for those states that have followed the NAIC model) there is no requirement for a suitability determination unless a recommendation is made.
The general scheme imposed by both FINRA with respect to variable annuities and by state insurance regulators with respect to all annuities is that the financial advisor and the advisor's supervisor have determined that there is a reasonable basis to believe that the customer has been informed about the important features of the product and the impact on the customer's situation; that the customer would benefit from the features of the product and, that in general the product is suitable for the needs of the customer. The special FINRA requirements (enunciated in FINRA Rule 2330) applies only to deferred variable annuities. The state requirements apply to all annuities. However, the states generally accept the FINRA standards with respect to both variable and fixed annuities. Both FINRA and the states require that financial advisors selling annuities receive special training and that appropriate suitability and compliance screening procedures are put in place.
The pressure for enhanced suitability requirements for annuities derives from the feeling among some legislators and regulators than the natural prospects for such products--people of more advanced age--are more vulnerable to being taken advantage of than are younger people. Indeed, some states have toyed with requirements that annuities should not be sold to people beyond a certain age. Although these people are allowed to vote, they should not be permitted to rely on their own judgment when it comes to securing their financial futures. Recently highly publicized Ponzi scheme scandals have clearly indicated that it is not only the elderly who are foolhardy when it comes to investments that are too good to be true.
If suitability standards are expanded to other life insurance products, it will make the job of insurance agents and financial advisors even more difficult than at present. There are libraries full of treatises on how much insurance is the correct amount of insurance, not to mention myriad uses of the wide variety of types of life insurance products. Life insurance transactions are used in such a wide array of financial situations that it is almost impossible to come up with a meaningful standard that would enable a financial advisor to determine that the product is "suitable" for the particular purpose for which it is sold. Instead, the negative determination that a product is not "unsuitable" clearly makes more sense in this context.
The "suitability" train has left the station. It will be a matter of time before we can ascertain its ultimate destination.