Finra report hints at trouble with L-share variable annuities

Regulators question why investors would pay more for additional liquidity on a long-term product

Dec 8, 2017 @ 1:18 pm

By Greg Iacurci

Variable annuities sold in an L share continue to turn up as products plaguing broker-dealers and their compliance departments.

Finra, in a recent report detailing its examination findings, called out "multi-share class and complex products" as a primary area of failure for brokerage firms, which struggle to ensure that products their representatives sell are suitable for investors.

The broker-dealer watchdog cited an example involving "short-term surrender variable annuity transactions." More than 50% of the customers involved in these transactions had a long-term investment horizon, despite the short-term nature of the annuities.

While Finra doesn't explicitly name L shares here, the description is an exact match. Investors pay more for the liquidity of L-share variable annuities, which often have three-to-four-year surrender periods. They carry fees roughly 0.35% to 0.50% higher than B shares, the most popular type of VA, which carry longer surrender periods, typically seven years.

However, regulators have questioned why investors would pay higher fees for an L-share annuity that carries a guaranteed-income feature, an inherently long-term rather than short-term play because it offers a lifelong income stream. In these cases, investors don't need more liquidity.


Finra has taken notice. Next Financial Group, for example, agreed this month to pay a $750,000 fine to Finra partly because of alleged supervisory failures related to L-share contracts. Similarly, another brokerage, Hornor, Townsend & Kent, agreed in November to pay a $275,000 fine due in part to its alleged L-share supervisory deficiencies. Ameritas Investment Corp. also agreed last month to pay a $180,000 fine in connection to these products.

Even so, in theory the shorter surrender period of L shares could benefit clients by allowing them to switch more quickly into a better product if one comes along. Some firms have adopted a new structure that can accomplish this goal in a more cost-effective way, by automatically lowering the contract cost if an investor doesn't exchange for a new annuity at the end of the surrender period.

Finra mentioned leveraged or inverse exchange-traded funds in its report as an example of another main problem area with respect to multi-share class and complex products.

"There's been a lot of openness by regulators about their concerns with L-share transactions," said Tamiko Toland, head of annuity research at CANNEX Financial Exchanges Limited.

Observers say distributors have largely heeded regulators' warnings. Some, such as Wells Fargo Advisors, Commonwealth Financial Network and Voya Financial Advisors, ditched the products entirely. As a result, many insurance companies no longer offer their products in an L share, Ms. Toland said.

The specter of the Department of Labor fiduciary rule, which ups investment-advice standards in retirement accounts, accelerated the trend.

"The expectation within the industry is that they're disappearing," Ms. Toland said.


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