Spotlight on Variable Annuity L Shares

Dionne C. Fajardo & Robert Jamieson

September 3, 2015

Variable Annuity Share Classes

B Shares:Longer surrender period, typically lowest M&E fees.

X Shares:“Bonus Shares” or “Premium Enhanced,” longer surrender period, moderate M&E fees, up-front bonus investment credit.

L Shares: Shorter surrender period, higher M&E fees.

C Shares:No surrender period, higher M&E fees.

A Shares:Up-front sales charge, typically no surrender period.

O Shares:No up-front sales charge, surrender period similar to B-Shares, progressively declining M&E fees.

Characteristics of L Shares

• No up-front sales charge.• Shorter surrender period (generally 3-4 years).• Relatively higher mortality & expense (M&E)

and administration fees.• Typically higher trail commissions.• May have higher surrender charges.• Underlying fund expenses typically similar to

other share classes.

Benefits of L Shares

• Shorter surrender charge period – earlier access to funds without penalty.

• Flexibility to reposition investments if needs or goals change, or in response to unexpected life events.

• Typically lower fees than C-Shares.• Implementing financial planning strategies, e.g.

laddering. • Possible that some “lower-cost” L Share variable

annuities may be available?

Concerns Regarding L Shares• Assessing and

documenting suitability.• Relatively higher M&E

fees (vs. B-Shares).• Impact of fees on overall

returns.• Benefits over other share

classes?• Commissions influencing

recommendations?

“FINRA will particularly focus on the sale and marketing of "L share" annuities as these shares typically have shorter surrender periods, but higher costs.”

- FINRA 2015 Regulatory and Examination Priorities Letter

Concerns Regarding L Shares

• L Share vs. Riders.• Incompatibility with “Premium Enhancement”

vesting.• Lack of L Share-specific guidance.• Marketing and disclosure issues.• Registered representative education and

training.• L Share variable annuities in IRAs.

Relevant Rules, Notices, and Laws

FINRA Rules• 2111 – Suitability• 2330 – Members’ Responsibilities Regarding Deferred Variable

Annuities (formerly NASD Rule 2821)

FINRA Regulatory Notices• 07-53 – Approval of NASD Rule 2821.• 09-32 – Amendments to NASD Rule 2821.• 10-05 – Responsibilities Under FINRA Rule 2330.• 11-02 – Approval of FINRA Rule 2111.• 11-25 – Additional guidance regarding FINRA Rule 2111.• 12-25 – Additional guidance regarding FINRA Rule 2111.• 13-31 – Examination approaches, common findings, and effective

practices for complying with the suitability rule.

Relevant Rules, Notices, and Laws

• State Specific Laws and Rules– Securities laws– Insurance laws, e.g. Fla. Stat. § 627.4554 • Fla. Admin. Code 69B-162-011 • Forms DFS-H1-1980 and DFS-H1-1981

Regulatory Activity

• Periodic guidance and customer “alerts” regarding variable annuities generally

• Specific statements from SEC in 2014 regarding growing prevalence of L Shares

• FINRA Examination Priorities Letter For 2015

Focus of Targeted Exams

• Investor Awareness • Appropriate Investment• Marketing • Conflicts of Interest

FINRA Guidance

• Monitoring– Investors with long-term time horizons– Representatives’ sales activities– Inclusion of riders

• Cost/Benefit Disclosure to Investors• Written Supervisory Procedures• Training

FINRA Examination Priorities Letter (2015)

• Sale and Marketing • Compensation • Suitability • Communications• Adequacy of disclosures• Training• Procedures

Targeted Exam Requests

• List of VA sales data– Client information– Investment amount– Selling representatives– Commissions

• Percentage of VA sales related to L Shares• Percentage of VA revenue derived from L Shares• IRA rollovers to L Share annuities• Interviews with Representatives

Recommendations to Investors

• Suitable for the investor’s situation• Educate investor regarding share class options• Assure investor awareness of fee differentials• Explain rationale for recommendation

FINRA Unsuitable Scenarios

• Riders Developed for Long-term Investment:– Income Benefit– Withdrawal Benefit– Death Benefit Step-Up– Spousal Continuation

• Premium Enhancements– May exceed surrender charge

period

• Surrender Charges

How to Address FINRA’s Concerns

• Point of Sale Disclosure– Conflict of interest– Comparison of fees– Rationale

• Consider Limiting Contract Riders

• Update Procedures

Procedures

• Specifically address L Shares• Due diligence • Address impact of riders• Principal review and approval• Monitoring• Training

Industry Activity

• Some firms no longer allow representatives to sell L Share if contract includes riders.

• Documenting Suitability • Range of Disclosures

– No discussion of L Shares versus other share classes.– “Each supplemental benefit is usually associated with a fee that will reduce the

total value of your account, it is important that you understand these charges before you invest.”

– “The share class selected will determine the fees and surrender charges associated with your variable annuity, you should familiarize yourself with all share class options before deciding to invest.”

– “The variable annuity is available in multiple share classes, which each have difference fees and charges described in the prospectus. The financial professionals’ commissions may also differ depending upon the share class selected.”

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Any Questions?

Dionne C. Fajardo

Email: dfajardo@wiandlaw.com

Robert Jamieson

Email: rjamieson@wiandlaw.com