Editorial

Finra right to watch indexed annuities

While there is no evidence yet that broker-dealers are taking advantage of investors with these products, there is potential for harm

May 11, 2014 @ 12:01 am

+ Zoom
(Roger Schillerstrom)

To its credit, the Financial Regulatory Authority Inc. is paying close attention to how and when investors are exchanging variable annuities for other products, such as indexed annuities.

While there is no evidence yet that broker-dealers as a whole are taking advantage of investors by persuading them to move out of variable annuities into equity indexed annuities, or from one indexed annuity to another, there is potential for harm to investors. Finra is right to keep an eye on these products and how they are being sold.

The indexed annuity business has been booming, with sales last year climbing to $38.6 billion, up 13.2% from 2012, according to Wink Inc. This growth alone warrants close attention from Finra.

As Bruce Kelly and Darla Mercado reported in last week's issue of InvestmentNews, during recent examinations at some firms, Finra scrutinized the policies and procedures related to exchanges into fixed annuities.

These are known as "1035 exchanges" because they fall under Section 1035 of the Internal Revenue Code. Broker-dealers are required to have procedures and controls in place to ensure that when such exchanges take place, they are in the best interests of clients, and that clients understand the advantages and disadvantages.

According to Susan Axelrod, executive vice president of regulatory operations at Finra, the regulator has seen some deficiencies in that area.

HOW THEY WORK

An indexed annuity is a hybrid investment vehicle falling between fixed annuities, which guarantee a fixed return and are virtually riskless, and a variable annuity, which guarantees a minimum return with additional return tied to the stock market.

Indexed annuities guarantee a minimum interest rate, often between 1% and 3% if held to maturity, but may provide a higher return tied to the market, though that return is capped.

Indexed annuities can be useful when investors want better returns than are currently available in bonds, CDs or savings accounts, but don't want to risk their capital by being fully in the stock market.

Indexed annuities might be appropriate for clients who have been in variable annuities, and who, having enjoyed nice gains, want more certainty of return, even if it's lower than a variable annuity might deliver. They could also be a fit for clients whose life circumstances have changed, and they have become more concerned with capital preservation than with growth.

Like all annuities, indexed annuities come with surrender charges for early withdrawal and the surrender periods range from three to more than 10 years.

CLIENTS MUST UNDERSTAND

Finra's concern is that surrender charges and other costs, as well as the pros and cons of switching from a variable or fixed annuity to an indexed annuity, are made clear to investors, and that investors understand and accept the tradeoffs.

No doubt the regulator is also concerned that some brokers may view switching clients from one annuity into another as a way to boost their own income and as a result encourage such moves — though transactions might cost the clients more than they could possibly gain.

It is altogether appropriate and commendable that Finra is being proactive about the indexed annuity business. Its attentiveness is likely to prevent a scandal involving the inappropriate sale of these products to unsophisticated or unwary investors, especially those who are retired or nearing retirement.

Indeed, it's better to head off a problem than try to repair any damage after it occurs.

0
Comments

What do you think?

View comments

Recommended for you

Latest news & opinion

New Jersey fines David Lerner Associates for nontraded REIT sales

Firm will pay $650,000 for suitability, compliance and books and records violations.

Report predicts $400 trillion retirement savings gap by 2050

Shortfall driven by longer life spans and disappointing investment returns.

Wells Fargo will ramp up spending to lure brokers

Wirehouse, after losing 400 brokers in first quarter, is bucking trend among rivals who have said they are going to cut back on spending big bucks recruiting veteran advisers

Trump is gutting rules that Corporate America hates

With executive orders, bureaucratic actions and unprecedented use of an obscure statute, the administration has killed or postponed dozens of regulations.

Wells Fargo Advisors restricting investments for retirement accounts

Mutual fund sales will be limited to T shares, while municipal bonds, preferred stock and international debt will be prohibited.

X

Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print