Earlier this month, MetLife Inc. (MET) broke a record, though not the type businesses hope for: The company settled allegations with the Financial Industry Regulatory Authority for $25 million, the second-largest penalty the regulatory body has levied in its history.
What sort of allegations could generate such a hefty price tag? In MetLife’s case, the core of the problem was the way the company handled variable annuities. According to FINRA, MetLife’s sales force allegedly provided customers with incomplete or misleading information when encouraging them to replace their variable annuities with newer products. The insurer neither admitted nor denied wrongdoing in the settlement.
Variable annuities are complicated products, often pitched as a key component of a retirement plan. Many of these products sold over the past decade included a guarantee of lifetime income, regardless of how the fund investments performed, making them especially attractive to investors – and especially expensive for insurance companies, which means they often come with high fees.
According to the allegations, between 2009 and 2014 certain broker-dealers at MetLife incorrectly told customers that new annuities were cheaper than the ones the brokers were encouraging them to replace. In some cases, MetLife also failed to explain that the new annuities would reduce or eliminate certain benefits. FINRA said that company representatives were not adequately trained on conducting a comparative analysis of products, suggesting this as a major reason for company-wide problems in these transactions. MetLife’s “annuity switching” generated at least $152 million in commissions for the period in question.
Such switches often hinge on a Section 1035 Exchange, so named for the relevant section of the tax code. As long as the transaction meets certain criteria, annuity holders can exchange their existing annuity for a new one without tax consequences. This provision creates an opportunity for brokers to offer a new annuity to a client without triggering tax liabilities. But that alone does not mean the new annuity is better for the client. This gap between the broker’s interests and the client’s is at the crux of FINRA’s allegations.
FINRA began to investigate MetLife’s annuity business after a 2014 complaint against two former MetLife brokers, who were accused of “[carrying] out a scheme” to submit falsified paperwork in order to collect extra commissions on annuity switches. After investigating, FINRA barred the two brokers – whom MetLife had already terminated – from the industry. But regulators also unearthed more widespread, systemic issues in the way MetLife handled annuity replacements, which led to the allegations against the insurer. Of the company’s settlement, $5 million will go to customers affected by the alleged misconduct.
It is little wonder that variable annuities tend to draw regulatory scrutiny. They are both complicated and expensive, giving brokers incentive to encourage clients to purchase them without a full understanding of how the product works or the total cost of buying and maintaining the investment. The new “fiduciary rule” from the Labor Department, which I discussed a few weeks ago, was in part designed to prevent these very tactics. Once it takes effect next year, it will no longer be enough for brokers to claim that the annuity is “suitable” for the customer’s needs by comparing the new annuity with the one the customer already holds. Instead, they will need to demonstrate that it is in the client’s best interest to change to the new product.
In the meantime, annuity holders should exercise a healthy skepticism when a broker recommends an annuity swap. Quite often, switching out of an existing annuity favors the insurance company and the broker, leaving the investor with a less favorable product and increased costs. Brokers typically earn a commission of as much as 6 or 7 percent when a consumer switches to a new annuity product (or buys one outright). Consumers who switch, on top of paying the commission, may forgo certain guaranteed benefits that were common several years ago but are rare today because of their cost to the insurer.
Additionally, though taxes may not be a concern because of the Section 1035 rules, some consumers may incur surrender charges for switching. Surrender charges typically start as high as 10 percent, and reduce gradually over the course of the surrender period, often seven or 10 years. FINRA, along with the Securities and Exchange Commission, has warned consumers about the dangers of variable annuity exchanges for years, largely because of the high fees involved.
This is not to say an exchange is never the right move, but investors have every reason to be wary of them. If a broker encourages a switch to a newer annuity, consumers should review the prospectus and compare it to their existing annuity contract. Key information to look for includes annual management and mortality fees, whether surrender charges will apply and whether the income and death benefit guarantees in the new contract are better or worse than those in the existing annuity.
Consumers should also ask their brokers how much of a sales commission they will earn. The commission amount may not be apparent because the fee is typically netted from the investment amount, but the consumer is paying a commission all the same. Incurring the sales charge means that less money will go into the investment. If a broker tries to tell you that he or she is not earning a commission, run.
Reading a prospectus can be slow going, and some investors may not feel comfortable conducting their own research. In that case, it is worth consulting with an independent party, such as a Certified Financial Planner™. An adviser whose compensation is not tied to a commission will be able to provide unbiased advice as to whether the switch is in the consumer’s favor.
Whether consumers do research themselves or hire professionals, the MetLife allegations illuminate the reasons not to simply rely on brokers’ recommendations. Insurance companies’ sales forces focus first and foremost on selling the companies’ products. Brokers thus have an inherent conflict of interest, at least until the Labor Department’s rules eventually force them to put consumers’ best interests first.