Investigation of Variable Annuities and Variable Annuity Switching

(FeedPublish) Did your broker recommend a variable annuity investment?

Variable annuities are a type of alternative investment.  Basically, they are insurance contracts issued by insurance companies and sold by financial advisors or sales agents holding insurance licenses.  The investor’s money is invested in mutual fund-like accounts called sub-accounts.  You could say they are like mutual funds in an insurance wrapper.

Immediate and Deferred Variable Annuities

There are two types of variable annuities we want to discuss, immediate and deferred.

A deferred variable annuity has two phases:

  1. During the deferral phase, the deposited money may increase or decrease in value, depending on the performance of the underlying investments and the effect of various charges.  Similar to a traditional IRA, any gains accrue on a tax-deferred basis.
  2. The distribution or annuitization phase – At the end of the deferral period, the investor is allowed to withdraw the entire account value without a penalty, or they may annuitize it – meaning, convert it into an immediate annuity.

Often investors who are searching for additional tax-deferred savings after they have reached their limits with traditional IRAs or a 401(k) may look to annuities as another option.

Variable annuities have a life insurance component that varies with different products but typically guarantees against a loss of principal if the investor dies during the deferral period and the investments have lost value.

Unfortunately for investors, variable annuities are complex and have many risks that could outweigh the benefits.

Variable annuity distributions are taxed as ordinary income, and if they are sold to investors in an IRA account, there would not be a tax-deferral benefit anyway.

Another concern is the high commissions paid to the seller on variable annuities –up to 6% or more.  The commission may be paid by the insurance company, but the investor pays for it indirectly by either subjecting the invested amount to high operating expenses for 7 to 15 years or paying a surrender charge for withdrawals that exceed a nominal specified annual withdrawal benefit.

While the surrender charge typically declines each year, it may be as high as 10% in year one. In order to avoid the surrender charge, the invested amount will be illiquid for a long period of time.

As far as the life insurance benefit goes, the cost typically exceeds the benefit. In one example, a simple return-of-premium death benefit may only be worth between 0.01 percent to 0.1 percent, but the median charge for this benefit was 1.15 percent.

Further, the death benefit is rarely used.  The percentage of variable annuities surrendered as a result of death or disability is less than 0.5 percent and with only a small fraction allowing the death benefit.

Variable Annuity Switching

Financial advisors and brokers have a strong incentive to recommend variable annuity products because of the high commissions that come with these products, even though they are unsuitable for many investors.  Some brokers even resort to the fraudulent practice of variable annuity “switching” to generate new commissions.

Often an investor may be coerced to surrender the old variable annuity and buy a new “better” one if they are unhappy with the product.  The advisor may tell the investor that the surrender charge will be offset by an up-front bonus paid by the new annuity.  Unfortunately for investors, this bonus may be unavailable if the new variable annuity is annuitized and a new, even longer surrender period at an even higher rate begins.

There are newer features available on some products, such as guaranteed income riders, that may make them more appealing to investors.  The investors still must consider the added cost of such a rider to make sure it makes sense.

Immediate annuities are even more complex than deferred annuities.

Often brokers will recommend buying immediate annuities to reduce the risk of investors outliving their assets.  Aside from the risks mentioned above, variable immediate annuities also present interest rate risk.

The annuity payments may rise or fall to the extent the performance of investment sub-accounts exceeds or fall short of an “assumed interest rate.”

Further, the rating of the insurance company needs to be considered to make sure they will be able to pay.

FINRA Quantitative Suitability

The Financial Industry Regulatory Authority (FINRA) is the regulatory entity that governs the rules and guidelines brokers/advisors and brokerage firms follow.  Suitability obligations are critical to ensuring investor protection and promoting fair dealings with customers and ethical sales practices.  If the investment is not suitable, the broker failed in his or her duties, and the brokerage firm failed in its supervisory obligation.  FINRA Rule 2111 lists the three suitability obligations for firms and associated persons.

One of the three is quantitative suitability which states “a broker with actual or de facto (in fact) control over a customer’s account to have a reasonable basis for believing that a series of recommended transaction, even if suitable when viewed in isolation, is not excessive and unsuitable for the customer when taken together in light of the customer’s investment profile.”

This means your broker, who has control over the account, must be able to articulate and justify trading transactions to limit wrongdoings like annuity switching.  If a variable annuity is switched for the sole purpose of generating commissions and there is no legitimate investment reason for doing so, this likely violates FINRA’s quantitative suitability rule.

Potential Lawsuits to Recover Financial Losses

If you have investment losses or problems involving variable annuities and equity-indexed annuities, call the attorneys at  The White Law Group at (888)637-5510.  For more information, you can visit our website at

The White Law Group is a national securities arbitration, securities fraud, and investor protection law firm with offices in Chicago, Illinois.