annuities explanation by getfresh

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									Independent Firms Conference

Understanding Variable Annuity Regulation and Compliance April 24, 2007

Variable Annuity Regulation
w NASD Viewpoint- Rule 2820 w Proposed Rule 2821 w Equity Indexed Annuities- NTM 05-50 w Life Settlements- NTM 06-38 w Supervision of Reps changing firms- NTM 07-06
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Michael S. Hill, JD, CFP®, CAMS Executive Vice President Chief Compliance Officer

Annuity Supervisory Best Practices
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Point of sale disclosures & acknowledgements
4 Pending regulation 4 Litigation trends 4 Senior concerns

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Supervisory review and documentation
4 Multiple principals 4 Suitability determination worksheet

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Enhanced suitability measures
4 KYC & transaction explanation 4 Client calls

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Questions?

mhill@summitbrokerage.com 561-338-2614

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NASD’S STATISTICS REGARDING THE NUMBER OF ARBITRATIONS INVOLVING THE SALE OF ANNUITIES
Year Total # of Arbitration Out of VAs # Arising Claims Made

2003 2004 2005 2006 2007

8945 8201 6074 4614 531 (through 2/07)

721 ( 8.1%) 596 (7.3%) 460 (7.6%) 446 (9.7%) 35 (6.6%)

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w Reps fail to adequately advise the client of the risks associated
with VAs.

w Reps fail to clearly advise the client of the surrender period and
the fees associated with early withdrawal of funds from a VA.

w Reps sell to clients age 65 and older without obtaining

supporting documentation from clients regarding adequate disclosure.

w Reps fail to obtain supporting documentation from clients when
one VA is being surrendered in order to purchase another VA.

w The rate of commission for the sale of VAs are high, and
therefore create an inference of impropriety.
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CLAIM EXAMPLE

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CLAIM EXAMPLE

ALLEGATIONS:

w Rep sold a variable annuity with an investment of $80,000 to
an 80 year old female California resident with a 10 year surrender period, an alleged unsuitable investment for this client. exposing himself to treble damages.

w Rep violated the California Elder Abuse Statutes thereby

DAMAGES SOUGHT: $ 320,000, in addition to attorney’s fees and interest.

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CLAIM EXAMPLE

OUTCOME: This claim was settled on day 3 of an arbitration hearing for $250,000 as the Rep was unable to provide any logical explanation for having recommended the variable annuity to his client. Of significance, it was established during the hearing that the Rep violated a basic tenet of the NASD, “know your client”, and was unable to prove that he had provided his client with sufficient documentation concerning the product, the surrender period and the fees associated with early withdrawal of funds from the annuity.

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HOW DOES A REP CREATE A DEFENSIBLE VARIABLE ANNUITY SALE?

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DEFENSIBLE VA SALE

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Have the client sign a detailed disclosure statement with every annuity sale and when one annuity is being surrendered for the purchase of another. Never complete or sign a client ’s application for them. Review the application with a client before the client signs it to ensure accuracy of information, specifically, but not limited to, the client ’s age, risk tolerance, asset information, short and long-term financial objectives and annual income.

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Maintain copies of the application and the signed disclosure statement in the client’s file and provide your client with a copy of these documents. Terminate the sale if at any time the senior seems confused or unable to understand or remember the product or appears in any way to have diminished capacity. Consult the client’s family member, trusted advisor, or legal representative prior to finalizing the purchase. Always document your conversations with the client’s advisors or relatives and have them review and approve the sale before it is finalized. Provide the client with a prospectus before investing the funds into the VA.
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EQUITY INDEXED ANNUITIES WHAT ARE THEY?
EIAs have characteristics of both fixed and variable annuities. The key distinction is that the EIA is not a registered security, but instead is an insurance product which invests only in bonds and in the issuing company’s general account, enabling the issuers and agent/Rep to market and sell it without regulation or qualification under securities laws. Their return varies more than a fixed annuity, but not as much as a variable annuity. So EIAs give more risk (but more potential return) than a fixed annuity but less risk (and less potential return) than a variable annuity. One of the most confusing features of an EIA is the method used to calculate the gain in the index to which the annuity is linked. There are several different indexing methods, as well as varying participation rates, the rate which decides how much of the increase in the index will be used to calculate the index-linked interest.

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WHY DO THE SALES OF EIA’S EXPOSE REPS TO CLAIMS?

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The method by which interest is earned is complicated for both the Agent/Rep and the client. EIAs are subject to a surrender period. If the contract is terminated before the annuity matures, the investor may lose all of the index-linked interest in addition to incurring early termination fees and penalties. The failure of the Agent/Rep to advise the client that dividends are not paid on EIAs. Agents/Reps fail to advise the client of the participation rate, which affects the amount of interest, if any, earned on the EIA. Agents/Reps fail to disclose the amount of commission earned on the sale of the EIA, which may be substantial and therefore create an inference of impropriety.

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CLAIM EXAMPLE

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CLAIM EXAMPLE

ALLEGATION: The Agent sold an EIA in the amount of $70,000 to an elderly Florida couple, ages 80 and 78. It is alleged that the Agent intentionally failed to advise his clients of the surrender penalties associated with early termination of the 10-year contract, which exceeded the clients’ life expectancy. It was also alleged that the Insurance Company failed to properly train and supervise its agent with respect to the sale of EIAs. DAMAGES SOUGHT: Plaintiffs are seeking return of their investment with interest, in addition to attorney’s fees, costs and punitive damages under the Florida Elder Abuse Statute, § 415.

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OUTCOME:
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Trial has been scheduled for the summer of 2007. However, discovery conducted to date has revealed the following facts, compromising the ability to defend this suit: The agent completed the application for his clients. The agent failed to obtain a signed disclosure statement from the clients regarding the sale of an existing annuity to purchase the EIA. It has been confirmed that the clients suffered a penalty when they surrendered the existing annuity. The agent failed to obtain a signed disclosure statement from the clients regarding their purchase of the EIA. No documents exist in the client file maintained by the agent to support his contention that he advised the clients of the surrender period and the surrender fees for early withdrawal of funds or early termination of the EIA contract. The surrender period terminated after the clients’ expected life expectancy, thereby creating a presumption that this was an unsuitable product for these clients. 19

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HOW DOES A REP CREATE A DEFENSIBLE EIA SALE?

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Have the client complete the application him/herself and review the application before the client signs it. Execute a disclosure form every time a client surrenders an annuity to purchase another annuity. Determine what, if any, surrender penalties the client will incur. Execute a disclosure form every time a client invests in an EIA after clearly advising the client of the applicable surrender period, surrender fees, the index method used to determine earnings, the participation rate and the minimum and maximum interest earned on the EIA. The Agent/Rep should follow the recommended sales practices related to the sale of annuities, in addition to the above recommendations.

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WHAT SHOULD A BROKER DEALER DO WITH RESPECT TO SUPERVISING THE SALE OF EIAs?

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BDs should maintain a list of approved and authorized EIAs and prohibit their Agents/Reps from selling any other EIAs without the firm’s written confirmation that the sale is acceptable. Require that all sales of unregistered EIAs are processed through the BD, requiring the BD to supervise the marketing material, suitability analysis and other sales practices in the same way it supervises the sale of securities through the firm. Provide the Agents/Reps selling any unregistered EIAs through the BD with the proper training to ensure they understand the features of the EIAs and the extent to which the EIAs meet the needs of a particular customer.

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WHICH STATES IMPOSE THE MOST PROTECTION TO THE “ELDERLY” UNDER STATE ELDER ABUSE LAWS?

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w California provides protection of its elderly population, defined
as any person residing in the state, 65 years of age or older, under Chapter 11. Elder Abuse and Dependent Adult Civil Protection Act. The scope of the California Financial Abuse Statute is broad and has determined violative conduct toward the elderly to include: taking, secreting, appropriating, or retaining real or personal property of an elder or dependent adult to a wrongful use or with intent to defraud, or both.

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w Florida’s Elder Abuse Statute §415, defines “elderly” as any
individual 65 years of age or older. Florida also provides protection to its elderly under Florida Statute 627.4554, which requires recommendations made to senior consumers which result in a transaction involving annuity products to appropriately address the senior’s insurance needs and financial objectives at the time of the transaction. This statute applies any time a recommendation to purchase or exchange an annuity, fixed or variable, is made by an insurance agent, registered rep or an insurer, and the purchase or exchange actually occurs.

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WHAT IS THE IMPACT OF THESE LAWS?

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IMPACT OF LAWS

w Potential Increased Damages w Both California and Florida’s Elder Abuse Laws impose

treble damages if they have been violated. Although allegations that the Elder Abuse Statutes are frequently pled against agents, registered reps and broker/dealers, the statutes for both States require a finding that there was intent to defraud a senior.

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IS THE SALE COVERED UNDER YOUR E & O POLICY?

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Many E & O policies exclude coverage for claims arising out of the sale of EIAs. Many policies impose conditions that address procedures that the Reps must follow before extending coverage for claims arising out of the sale of VAs or EIAs.

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EXAMPLES OF POLICY CONDITIONS
w Catlin Policy Language:

The Policy will not apply to any claim arising out of, based upon, or in consequence of any variable annuity placed or recommended to be placed in an IRA, 401-K plan or other tax-deferred vehicle unless prior to the placement of the Client funds the Client was provided with a written disclosure statement concerning the nature of the variable annuity, the associated investment risks, the investment purpose in relation to the Client’s documented financial needs or objectives, and the expenses associated with such investment; and obtained a signed acknowledgment from the Client concerning the receipt of such written disclosure statement.

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EXAMPLES OF POLICY CONDITIONS CONTINUED
w CNA Policy Language:
The Policy shall not provide coverage for claims arising out of or in any way involving: a. b. the sale of a Variable Annuity to a Client over 75 years of age recommended by a Rep; or the sale of a Variable Annuity to fund an IRA recommended by a Rep.

However, the foregoing shall not apply if the Rep submitted the transaction to the BD for review and the BD has approved the Suitability of the sale in writing. A record of the approval of the sale must be maintained by the BD and be made readily accessible to the carrier upon the carrier’s request in the event of a claim.

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Questions?

wWhat does your firm do??

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