Ending the Love-Hate
Relationship with Variable Annuities
by John Harline

Variable annuity sales have soared to new heights over the past few years. As with many thriving investment businesses and products, this growth has prompted some regulatory scrutiny, media attention, and broker interest and debate. In particular, the subject of client suitability has sparked debate among financial professionals who are offering this unique investment vehicle to clients.
    On closer examination, it’s clear that the suitability analysis for variable annuities and clients is very similar to the suitability analysis that’s done for other investments. The bottom line is that no investment or financial planning vehicle is a suitable match for every client or prospect. Until there is a one-size-fits-all retirement-planning solution, it’s up to financial professionals to understand the pros and cons of each investment option to determine which is suitable for each client.
    For the next several hundred words, let’s look at what’s meant by suitability and how to break through the perceived complexity. Taking a common sense look at client suitability can enable even the most wary financial professional to make more informed recommendations to clients.
    Let’s start with some basics. A variable annuity is just one savings investment vehicle that can help people accumulate assets or provide income for retirement. With an annuity, it’s possible to combine the protection of a death benefit with the growth potential of investing in the equity markets. A variable annuity can be an important part of a diversified portfolio, especially for payout options, which can provide income for life. But, just like any investment vehicle, it’s not for everyone.
    It seems simple enough. So, what is the concern about variable annuities and where did it come from? Unfortunately, much of the regulatory concern arose from inappropriate sales practices and weak supervision. During the two years before June 2004, there were more than 80 disciplinary actions related to variable annuity sales. Allegations of misconduct included excessive variable annuity switching, misleading marketing practices, failure to disclose facts, and unsuitable sales. In a joint effort, the NASD and SEC responded by issuing recommendations and guidelines for the suitable sale of variable annuities.
NASD released to the public its Notice to Members 99-35, titled “The NASD Reminds Members of Their Responsibilities Regarding the Sales of Variable Annuities.” In addition, the National Association for Variable Annuities published (NAVA) 12 best practices to help sales representatives and managers in “upholding the highest ethical standards in the sale of variable annuity products.” Both of these actions were newsworthy in the ultra-competitive retirement-planning marketplace.
    The perception is that variable annuities are bad. But, that wasn’t the NASD’s message. Although the NASD did raise concerns with certain product features, such as excessive surrender charges and overall costs, the major concern was with the sales practices that some variable annuity sellers have used to scare or confuse investors. In fact, the NASD asserts that “Variable annuities can be appropriate as an investment under the right circumstances.”
    Keeping this in mind, let’s examine common sense practices for the suitable sale of variable annuities. It is important to understand variable annuity features and benefits. The NASD says, “The myriad features and benefits of variable insurance products make the suitability analysis required under NASD rules particularly complex.” Admittedly, this complexity often results from the fusion of insurance features, guarantees, and investment options. Mix in ever-evolving choices with living benefits and death benefit options, and the level of detail incorporated into variable annuity product design becomes quite apparent.
People rely on their financial services professional for comprehensive information to help them make sound retirement planning decisions. Here are some practical tips to gain a better understanding of variable annuity features and benefits to determine whether they are suitable for a client:
    Seek ongoing training and support from your wholesaler. Sales representatives, sales associates, and registered principals need up-to-date information. Your partner firm should ensure that proper programs are available.
    Be prepared with easy-to-understand explanations of things, such as the features, benefits, restrictions, fees, taxation, investment risks, surrender charges, liquidity features, and penalties associated with a variable annuity.
Read the product prospectus and provide a copy to each client to whom you recommend a variable annuity.
    Learn about variable annuity pricing and fee arrangements and determine how to talk with clients about how fee arrangements can affect their overall return.
Understand variable annuity tax advantages and limitations. If needed, work with a tax attorney for support. Variable annuities do not provide additional tax-deferral on earnings outside of what qualified plans provide on their own. But, they may be included as part of qualified plans for other reasons. For example, for an additional fee, variable annuities may offer unique living and death benefit guarantees that could be appropriate for some clients’ qualified retirement plans.
    Determine who is most suited for a variable annuity by asking the right questions. According to NAVA, a typical variable annuity investor has long-term savings goals, has maxed out 401(k), IRA, or other qualified retirement accounts, and wants the following:
• Retirement income that cannot be outlived.
• Tax simplicity (no 1099s).
• Family protection in the form of guaranteed death benefits.
• Tax deferral until withdrawals begin.
• The ability to reallocate investment options on a tax-free basis.
    Even if a client seems suited for a variable annuity, it’s important to collect complete client information to determine the right match. At a minimum, you must get the following information from the client:
• Their age
• Annual income
• Financial situation
• Investment experience
• Investment objectives
• Liquidity needs
• Liquid net worth
• Marital status
• Number and age of dependents
• Occupation
• Risk tolerance
• Savings
• Tax status
• Any other information needed to make proper recommendations
    In addition to determining the suitability of the underlying variable annuity contract, financial services professionals must determine the suitability of living benefits and enhanced death benefits, which involve additional costs. Living benefits are suitable for different types of investors. For an additional cost, living benefits can be added to a variable annuity contract. With declining pension security and increasing news about Social Security instability, the guaranteed income generated by these benefits has spurred interest in variable annuity solutions. Mark Mackey, president and CEO of NAVA said, “Critics frequently question the value of putting an annuity, which offers tax-deferral benefits in another tax-deferred investment, such as a qualified plan or IRA. However, this argument fails to recognize the great value that annuity insurance guarantees can offer.”
Whether people want income now or in the future, it’s up to you to determine the suitability of living benefits, including income benefits, withdrawal benefits, or accumulation benefits.
    Income benefits are designed to provide a minimum income starting at a certain point in the future. The client must annuitize the contract to receive the benefit, which means the contract is turned into an income stream that can last for the rest of the contract owner’s life.
    Withdrawal benefits are designed to provide a minimum income starting immediately or in the near future. Withdrawal benefits may provide guaranteed lifetime income for the contract owner and generally do not require annuitization of the contract.
    Accumulation benefits provide a way to preserve capital while having the upside potential of the financial market. With this optional rider, the investor can capture market gains. However, the issuing company makes up the difference if the value of an investor’s annuity contract is below its initial premium after a specific holding period. The rider typically covers a one-time adjustment to the contract value.
    Death benefits protect an investor’s assets for beneficiaries. A basic death benefit, which is standard with most variable annuities, ensures that designated beneficiaries receive at least the amount of the premium paid in the event of the contract owner’s death. In recent years, enhanced death benefits have provided additional guarantees for an additional charge. Enhanced death benefits can be a good fit for clients who want to leave a legacy that they can’t find in most other investment vehicles.
    Asking your clients the right questions can be the answer to determining suitability for the underlying variable annuity contract and any enhanced living or death benefits, such as the following:
• Do you need to save for retirement, generate guaranteed retirement income, or both?
• When do you plan to use the funds you’re considering for an annuity investment?
• What percentage, or portion, of your assets may be appropriate for an annuity given your retirement objectives?
• What questions do you have about annuity guarantees?
• What questions do you have about variable annuity fees?
• What are your current and future income needs?
    While it’s sometimes tempting to do your own thing when it comes to marketing investment solutions, the best practice is to use only partner-approved materials to avoid the claim that you used scare tactics to make the sale. Let your partner do the work for you; their materials have been carefully developed and approved by industry professionals to accurately inform and protect consumers.
    It’s up to you now. Successful financial planning is not about loving or hating variable annuities, or any other investment vehicle, for that matter. It’s about being equipped to tackle all of our clients’ retirement-planning needs. We owe them exposure to a full range of options.
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John Harline of Orange County, Calif. is a senior vice president for ING and head of National Distribution/Financial Institutions. To reach the company, call 800-369-5303.