NASD renews alert on VA 1035 exchanges

Mar 13, 2006 @ 12:01 am

By Bruce Kelly

NEW YORK - NASD has renewed its alert to investors about potential confusion regarding the exchanging of variable annuities, leaving some industry attorneys wondering whether guidance to broker-dealers could follow.

"Investor alerts sometimes precede notices to members," said Lisa Roth, president of ComplianceMAX Financial Corp. in San Diego. In March 2004, she noted, NASD alerted investors to the risk of taking out a new mortgage or refinancing for the specific purpose of buying securities.

NASD of Washington followed up in December of that year, issuing a notice to members about its concerns over "liquefying home equity to purchase securities."

While some industry attorneys said they aren't aware of any NASD "sweep" or information gathering related to variable annuities, one broker-dealer executive, who asked not to be identified, said NASD had asked for information within the past two weeks from his firm on advisers' VA sales last year of more than $100,000.

NASD last issued a notice to members about variable annuities in 2000. It has a rule proposal pending with the Securities and Exchange Commission over VA point-of-sale disclosure and suitability.

Of course, the industry's self-regulator has kept a constant watch on variable annuities and variable insurance. Last year, in a first, NASD fined a broker-dealer for market timing in subaccounts of variable universal life insurance policies.

Also last year, it issued a notice to members on the sale of equity index annuities.

"NASD is issuing this alert because we have found investor confusion about variable annuity exchanges, and we have brought cases where investors were investing in variable annuities that were not suitable for them," NASD said in its March 2 alert, which was an update of a previous alert.

NASD noted that though tax laws make the exchange income tax free, and a new contract may sound like a better deal, investors may be losing rather than gaining in the exchange.

There are various reasons why a holder of a VA contract would want to exchange it, NASD said.

They include "premium" or "bonus" credits toward the value of the contract, usually a specified percentage between 1% and 5% for each payment the investor makes on the purchase.

Those may be deceiving, NASD said. Such "bonus" or "premium" payments given to the investor often are offset by the insurance company's adding other charges.

On the other hand, valid reasons exist for holders of a contract to consider an exchange, NASD said. Less expensive annuity contracts have been created, and the number of investment options has increased.

Some death and living benefits have been improved, and the stock markets' expansion in the 1990s led to many insurance contract holders' taking part in the market, NASD noted.

Some shortcomings

NASD, however, pointed to other shortcomings as reasons not to make the switch, officially known as a 1035 exchange because of its section in the Internal Revenue Code.

"Other contract provisions, like surrender charges, eventually expire with an existing contract," NASD said. "However, new charges may be imposed with a new contract, or [the contract] may increase the period of time for which the surrender charge applies."

Investors should watch out for jacked-up fees and charges, NASD said.

An investor also may have to pay higher charges, such as a

new annual fee, for the contract, NASD said, and buyers of the

contract may not need new, costly features.

Another risk for investors in an exchange of a VA contract is that registered representatives may earn a higher commission than they receive for the sale of a stock, bond or mutual fund, NASD said.

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